Monday, January 07, 2008

Subprime meltdown and market's buying into discrimination drivel

The 'subprime meltdown' (or 'mortgage crisis') has brought mixed relief to me, at least on a personal level. The larger economy is not free from the rules that act on individuals within it. In trying to get my mind around the problem the US faced in rapidly rising home prices combined with a savings rate hovering around zero, I analogized it this way a couple of years ago:

I make $30,000 a year working. I spend $40,000 a year buying consumables (stuff that doesn't represent a future monetary benefit). I've been doing this for five years. Fortunately, I own a house that was worth $100,000 five years ago. Every year over the last five its value has been increasing by $11,000. To feed my consumption habits, I've been taking out a home equity loan for $11,000 on an annual basis. Thus, my net worth has been up $1,000 ($30,000income-$40,000spent+$11,000equity) for five years running. But what happens if the value of my house crashes? Or just stops appreciating? My standard of living will have to be adjusted downward drastically. If not, I'll fall into debt and the whole miasma will be compounded by high interest rates. This is not a happy situation. Eventually something's going to give.
That's hardly a unique 'insight'. People from across the economic and political spectrums had been arguing that the bubble couldn't keep on growing in perpetuity, that it was going to burst. But a couple of things that have been revealed following that inevitable bursting give reason to question confidence in the wider market as well.

Dennis Mangan has posted several items on the downturn. In one, he pulled together a couple of articles to determine that about 50% of subprime loans are held by blacks, 40% by Hispanics, and the remaining 10% by whites and Asians. In a separate post, he concludes, in citing economist Gary Becker, that many major financial institutions were caught off guard and didn't see the downturn coming:

Some of the most astute investment banks and investors didn't see this coming, and have lost billions as a result.
Which begs the questions: Are top business leaders buying into all the nonsense about how the market really has been irrationally discriminating against (non-Asian) minorities? Do many of them believe that the strategies their businesses have been using in dealing with their clients and consumers are riddled with 'institutional bias'? That by giving special preference to NAMs that they wouldn't otherwise have any economic justification to give, they will be able to reap greater rewards? Are they really taking their diversity training courses seriously, even though they don't work because they're based on lies?

That the downturn took so many major lenders and economists by surprise illustrates how ignoring group differences has serious negative consequences (and there are countless other examples, like the failure of pluralistic liberalism to take root in Iraq and the dumbening of the American Southwest in the face of massive immigration from Mexico) for the larger society as a whole.

It is not just lenders who are hurt by legislation that forces them to make loans they wouldn't otherwise make in NAM neighborhoods. Investors buy up mortgage-backed assets from these lenders, and that money is used by lending institutions to issue all kinds of other loans, which the public uses to start businesses, buy things, go to school, and the like. When the chickens come home to roost, the money flow dries up everywhere and the economy slows down.

The Big Lie keeps inflicting more and more damage.

9 comments:

John Savage said...

Glad to see someone else posting on this disaster. We are going to end up having a massive wealth transfer to immigrants, who should have known better but now are going to be coddled by our pro-Mexican Congress and President.

Are you going to tell us how to make money in the markets by using the truth on race, which most people are clueless about? I suppose one rule would be to avoid stocks of companies with a racial quota beneficiary as CEO, for example. We could have a "Race Realist Investment Club" or something, LOL.

Anonymous said...

Wait 'til Barry O gets the presidency ... or should I say wait until his crowd capture the executive branch of government. Then you will see some spoils being lavished about.

Audacious Epigone said...

John,

Without Duke v Griggs hanging over the heads of industry, it'd be an easier thing to do. I'd prefer, though, the more PC "Merit fund" or ETF moniker!

Steve Sailer said...

Did the finance industry expect that the taxpayers would have to bail out NAMs?

Audacious Epigone said...

Steve,

It raises so many questions. The answer is beyond me, although that would certainly be a textbook example of why socializing costs distorts the market and leads to inefficient allocation of resources.

Rob said...

ETF?

I saw a while back that companies with more diverse boards tended to outperform companies with whiter, maler boards. I don't know why. My guesses are a) No one is dumb enough to publish a study showing that having women on a board reduces performance. b) These companies have higher betas, and they looked at an up period. c) Growing companies feel more need to diversify than shrinking companies do, and growth is the actual underlying variable.

I think a good proxy for the "Merit Fund" would be how much the company spends on diversity training.

Audacious Epigone said...

Rob,

Exchange-traded funds are like mutual funds except that can be more easily traded and don't require loads or other fees.

You don't have a link to that study by chance, do you? I'd be more interested in chairmen and executive officers than the composition of the board in pursuit of a merit fund, anyway.

Rob said...

AP,

Here's an abstract:

http://www.blackwell-synergy.com/doi/abs/10.1111/1467-8683.00011

Thinking about diversity expense as a proxy, maybe not. Companies that had previously had profit-maximizing discrimination would have benefited from it, and then been forced to diversify (eg, Denny's)But it is a good first approximation.

Audacious Epigone said...

Rob,

I'm getting an error message with that URL. Is it correct?