Economists Do It With Models

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Think Of It As A Sunday Morning Cartoon…

March 8th, 2009 · 9 Comments

Something to go with your bloody mary (extra spicy, extra olives, preferably made with bacon vodka if you are like me)…it is a cute, somewhat simplistic (i.e. not necessarily groundbreaking for this audience, but tell your friends) video about how the credit crisis came about (since you Facebook people seem to really like talking about it!):

The Crisis of Credit Visualized from Jonathan Jarvis on Vimeo.

(You can watch the video on YouTube if you prefer, but it comes in two parts.) Credit to the wonderful folks at I will follow up in the next few days with some commentary on the subject, including an *ahem* interesting firsthand experience I had.

You should also check out the crisis of credit t-shirts – I just love how the “Sub-Prime” family includes a fat dude and a whole flock of screaming children…classy people, classy. 🙂

Tags: Markets

9 responses so far ↓

  • 1 Jenn // Mar 8, 2009 at 10:57 am

    Thanks for the video. Nice simplified explanation.

  • 2 econgirl // Mar 8, 2009 at 12:12 pm

    A quote from a friend of mine, taken from my Facebook page:

    That’s just too complex for us business school students. I think this explanation done entirely in stick figures does a better job explaining the crisis in terms even a Wharton MBA can understand.

    Oh, those Wharton MBAs…

  • 3 MEL // Mar 8, 2009 at 12:46 pm

    Nice video. Although it does leave out the role our federal government played in all of this: the Community Reinvestment Act, the Fed’s regulations on loosening credit standards, the creation of Fannie and Freddie, Freddie and Fannie playing a key role in bundling the assets into securities, etc.

  • 4 econgirl // Mar 8, 2009 at 3:58 pm

    Perhaps leaving out the government’s role is a metaphor for the fact it took a very hands off approach. 🙂

    On a random note, I am amused that I can see in the web site stats that a number of people are clicking on the bacon vodka link!

  • 5 The Wharton MBA // Mar 8, 2009 at 9:07 pm

    Hey Econgirl, thank’s for the reference.

    If everyone hasn’t seen it, read this article from Wired.

    It’s basically on the role statistical models invented by smart people with PhDs were misused by not-as-smart people with just MBAs. As a former “mathy” person who went soft (ie law school, then business school), I appreciated it a lot.

  • 6 MEL // Mar 9, 2009 at 12:38 pm

    The Community Reinvestment Act, the Fed’s forcing banks to loosen credit standards, Congress creating Fannie and Freddie, those two quasi-public entities bundling the assets into securities, etc…that is a hands-off approach?

    How much more hands-on can it get? We wouldn’t be in this mess without all that intervention.

    And yes, I checked out the bacon vodka link…I’m not sure I have the stomach for it!

  • 7 econgirl // Mar 9, 2009 at 2:48 pm

    Well, allowing Fannie Mae and Freddie Mac to operate pretty much on their own despite signs that that might not be such a hot idea (see the “scandals” section under Fannie’s Wikipedia page – – if you are curious) is pretty hands off. I am confused as to how the Fed “forced” banks to loosen credit standards, can you clarify? Since the Fed really only controls interest rates, discount window, etc., I am not sure I follow. Furthermore, Ben Bernanke was quoted at the beginning of his term that it is not the Fed’s job to regulate asset prices. (I wish I could find the quote itself, but I will have to settle for referencing some of his writing – “Should Central Banks Respond to Movements in Asset Prices?” by Ben S. Bernanke and Mark Gertler – can be found at – and their answer was no: “Changes in asset prices should affect monetary policy only to the extent that they affect the central bank’s forecast of inflation.” Only was even underlined in the original text.) I am guessing he has had to change his tune a little since then, but still…

    To be fair, there is not a clear link between the Community Reinvestment Act and the loans that “shouldn’t” have happened. (see for a discussion) To be fair in the other direction, however, not being able to prove that a link exists statistically doesn’t necessarily mean that a link isn’t there, since there could be many data issues that prevent the link from making itself known.

  • 8 The Wharton MBA // Mar 9, 2009 at 3:56 pm

    To be serious, I’ll throw in my own two cents. I have to agree with Econgirl that the relationship between the CRA and loosened bank lending standards is tenuous at best. Greed and stupidity are always much more likely causes of banking crises than bad government intervention.

    I think a much more likely answer is that the risk analysis frameworks applied to banks have changed significantly over the last couple decades and that regulators themselves have become much more reliant on banks own internal VaR models when measuring risk. Changes in the BASEL regulatory guidelines were supposed to reflect the new complexity of the system, but the reality was very different. The system got so complex no one really understood what the risks where and who actually held them.

    I’ll stop before I get too much off on a tangent (plus, this is more of a policy discussion on banking regulatory theory than an economics discussion). I would be interested to know though if any other readers out there have an interest in banking regulation.

  • 9 MEL // Mar 22, 2009 at 1:01 pm

    Hi again, Econgirl. I’m sorry for staying away for so long. I don’t get to my emails and favorite websites as often as I’d like. You’ll probably never read or respond to this now, but I’ll post my reply anyway. By the way, thanks for your links, etc. Fun reading.

    I’m not sure I agree with your minimalizing the effect of federal regulation on the banking industry. First of all, you say that Freddie and Fannie operate pretty much on their own. But these agencies were created by the government. Without government intervention these entities would not even exist, much less control the entire industry by virtue of its 50+% market share, which is (or was) worth multiple trillions of dollars. No private company could have accomplished that; there was simply too much competition out there.

    Secondly, there has been constant intervention into the way Freddie and Fannie are operated. For example, the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 required Fannie and Freddie, the two government sponsored enterprises that purchase and securitize mortgages, to devote a percentage of their lending to support affordable housing, i.e., to introduce more risky loans into their portfolios. The fact of the matter is that the calls for more regulation and more government oversight were to address the pending problems that were caused by regulation and government oversight in the first place.

    Freddie and Fannie would not have been created by the government if they did not think they could control it (even if that turned out not to be the case). Of course now, the Feds’ power is far more broad. Under 12 USCA 4611, signed by Bush in 2008, “the Director (of the Federal Housing Finance Agency) shall, by regulation, establish risk-based capital requirements for (Fannie, Freddie and the 12 Federal Home Loan Banks) to ensure that the enterprises operate in a safe and sound manner….” Is that enough government control for ya? But this was the response, not the cause, so I won’t get into that.

    Also, let’s not forget that the federal government always possessed warrants which, if exercised, allowed them to take a 79.9% ownership share in Fannie, Freddie, and the 12 Federal Home Loan Banks, including ownership of their bad debt ( Bankers and lenders have justifiably rationalized and interpreted these warrants as being a form of government security for these enterprises. And the bailouts are proving this to be the case.

    Now, as for your assertion that the Fed does not promulgate regulations, but only controls interest rates, etc., I would refer you to the CRA itself. It required each of the four supervisory agencies (including the Comptroller of the Currency, the FDIC, the Office of Thrift Supervision, AND the Federal Reserve System) to issue regulations to implement the CRA. So the CRA required the Fed to do more than just control interest rates, and the Fed complied.

    The Federal Code of Regulations, Title 12, Volume 3, Chapter 2, entitled “Community Reinvestment.” Section 228.11(a) is a part of the Fed’s regulations. It states that “the Board (of the Federal Reserve System) issues this part (i.e., these regulations) to implement the Community Reinvestment Act (12 U.S.C. 2901 et seq.) (CRA).” So the Federal Reserve did and does enforce lending standards under the CRA. This Chapter includes Fed-created lending standards, Fed-created investment standards, and Fed-created “community development” standards. It also discusses the effect of the Fed-created ratings on applications submitted by banks to the Fed. So the Fed has a hammer, and this section outlines how the Fed intends to use the hammer to enforce its standards under the CRA. That goes far beyond mere control of “interest rates, discount window, etc.”

    Here’s a link to just one of the Fed’s publications regarding how banks can show compliance with the CRA and their regulations: Its guidelines included doing away with the usual formula for the maximum ratio between the mortgage payment and the borrower’s income, because “many lower-income households are accustomed to allocating a large percentage of their income toward rent.” (Page 13) It also encouraged acceptance of smaller down payments and closing costs because “accumulating enough savings to cover the various costs associated with a mortgage loan is often a significant barrier to homeownership by lower-income applicants.” (Page 14) There’s more, but the bottom-line message to banks is that traditional methods of vetting should be tossed out the window, and the Fed regulators will help to ensure that they are. And the CRA requires annual review of a statement of compliance for each lending institution covered under its provisions.

    No question that the scandals could/should have been caught by regulators. But the fact remains that, without the federal government’s creation of Fannie and Freddie in the first place, and without the continued interference under the CRA and similar acts, we would not be here in the first place. There would have been no “scandal” to detect and no huge market share all affected in the same way were it not for the “hands-on” federal government.

    As for The Wharton MBA’s assertion that “greed and stupidity are always much more likely causes of banking crises than bad government intervention,” hasn’t there always been greed and stupidity throughout history? What, then, allowed such greed and stupidity to take the form of bad loans and the creation of bad securities (as facilitated by government sponsored enterprises) and the eventual collapse of the industry? This brings us back to my original point, which was not that we don’t need regulation, or that there was no private-sector stupidity contributing to the crisis, but only that the government’s role in this fiasco should not be ignored (as it was in the Cartoon). The government’s approach was not as “hands-off” as they would like us to believe.

    Thanks for reading!

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