Phillip Swagel, who served in the Treasury as Assistant Secretary for Economic Policy from December 2006 to the end of the Bush administration, has written a paper on his experiences in dealing with the financial crisis. This is a welcome insider description of the policy process in the Treasury. It looks like Summers and Geithner are continuing a number of the policy approaches of the Paulson Treasury, so it bears close reading. It also offers a test of my hypothesis that financial problems are non-partisan, meaning that once we identify the facts, reasonable people ought to be able to agree on the best solution.

Part of the paper describes the Treasury view of the housing market. Swagel tells us that the problem was becoming apparent in early 2007. Treasury and FDIC economists examined general data to estimate the foreclosure problem, and concluded that foreclosures would rise through 2007, and peak and then decline in 2008. He explains the error in this forecast:

What we missed was that the regressions did not use information on the quality of the underwriting of subprime mortgages in 2005, 2006, and 2007. This was something pointed out by staff from the Federal Deposit Insurance Corporation (FDIC), who had already (correctly) pointed out that the situation in housing was bad and getting worse and would have important implications for the banking system and the broader economy.

Then Swagel provides this chart:


Just think about what that chart says. In the period 2001-2004, at 48 months, total defaults in subprime mortgages were about 13%. For 2005, through 36 months, defaults were at 22%. For 2006, at 24 months, defaults were nearly 25%. Then look at 2007: in less than a year, defaults were about 17%. The loans were bad and getting worse. There is only one word to explain this: fraud. But that word doesn’t appear in Swagel’s paper. Treasury thought the problem was that “[t]oo many borrowers were in the wrong house, not the wrong mortgage.” Borrowers were reaching too far for their homes, and that was the problem.

Treasury’s view was that if homeowners couldn’t make the payments at the original teaser rate, they shouldn’t be helped. One of the assumptions for this view was that the loans were underwritten in a proper fashion. If the loans were properly underwritten, the borrowers should have been able to afford the homes. Of course, that is only theory, which never takes fraud into account.

The public discourse mirrored the idea that the problem was the bad borrowers. Congress didn’t want to vote directly to spend TARP money on foreclosure prevention:

… suggesting that members understood the poor optics of having the government write checks when some would find their way into the hands of “irresponsible homeowners.”

Treasury held two different pieces of information showing the guilty party was the industry, but no one in authority was pointing out the actual cause, the collapse of standards in the lending industry, and the separation of risk and reward that occurred in the securitization of the mortgages. It’s fair to characterize Treasury’s view as blaming the victim. They helped deflect attention from the real cause of the housing problem. If the public had been made fully aware of the real problem, fraud in mortgage origination, there might have been public support for a broader range of solutions.

One strike against my hypothesis. Can Geithner start telling the truth about the causes?



I read a lot of books.