Questions from a Young Friend

Photo Credit: Penn State || Being at Penn State is better than being at State Pen.

Recently at my congregation, a bright young lady showed up who received an internship at a DC think tank. We’ve had a number of good conversations since that led her to ask me questions about mortality tables, and the causes of the Great FInancial Crisis.

On the Great Financial Crisis, I pointed her to this article that I wrote: Who Dares Oppose a Boom? This piece won third prize in a contest held by the Society of Actuaries. That said, I ended up giving a series of talks off of the article, about six in all. If there is demand for it, I will update my presentations page with all the slide decks from the talks I have given over the last ten years, and you can see that one as well.

Here are her questions for me:

What is regulatory capture? How does it contribute to/impact debt? 

When an industry has more sway over its regulators than the Executive Branch of the government does, the industry has captured its regulator and made the regulator to be its ally, rather than its adversary.

This happens more frequently than you might expect. Many high-ranking people working for the regulators know that there is a high-paying job waiting for them if they go easy on the firms that they regulate. After all, firms reward their friends. The government doesn’t, at least not to the same degree.

Most of the time, regulatory capture does not affect debt much, unless that capture is of the banking system. If banking regulators compromise on capital levels and allow banks to lend too much versus their capital, it will compromise the solvency of the banking system, as they did in 2004-2008.

I worked for a hedge fund at that time that was devoted to financials, mostly banks. The banking regulators were captured in two ways: first, banks could choose their regulator, which led many banks to choose to choose the weakest regulator, and the rest of the regulators, fearing a loss of relevance, began weakening their standards in order to retain banks to regulate. Second, legislators brought pressure on the regulators when banks complained to their legislators that persistent regulators were “business killers.”

As such, lending quality suffered. There is a saying in banking that there are three factors: quantity, quality and price. In a good environment, you can get two of them. In a bad environment, you can get one of them. And in 2004-2008, you could only get one of them if you wanted to grow, and that was quantity. Price and quality were out the window.

Do attempts to magnify “booms” accelerate their end?

Initially, no; they delay the bust. Bt eventually, yes, the bust comes with greater vengeance. As Warren Buffett once allegedly said, “What the wise do in the beginning, fools do in the end.” Most booms start with a good idea. In the great financial crisis, tha idea was “Let’s make it affordable for people to buy homes.” As people and firms pursue that idea, the initial ideas are typically useful. But as time goes along efforts to expand either increase debt, or compromise underwriting.

In the process housing prices were pushed up until the only way that marginal people could afford a house was through a loan that passed risks to the borrower — loans that offered a low interest rate for a few years, but at the end would reprice higher, making payments more than double. Borrowers were told, “Don’t worry, you can refinance into a new low rate loan.” By the time that most hit the refinance date, housing prices were falling, and no one would refinance them. This led to a lot of defaults, and falling housing prices generally.

The loose monetary policy of the Fed helped coax this along, but once the bubble bursts, the Fed is impotent. In general, all loosening of lending standards prolong the boom, but they make the bust more ugly when it comes. Time is delayed, but severity is increased.

Can mortality/should mortality tables be used as an indicator of economic health and prosperity?

Yes. Mortality tables can be used as an indicator of economic health and prosperity. That said, they don’t measure everything related to prosperity. The US is the great example in this. Because much of the US is given to hedonism, many people pursue pleasure without regard to how long they will live. What is prosperity, anyway? To Christians, it is living to serve God without any undue constraint from outside forces. To others it is pursuing whatever they please. For Christians, long life is a blessing from God. For others, long life is a burden. I personally expect suicides to increase among the elderly in the US over the next ten years.

As The Who sang, “I hope I die before I get old (talkin’ ’bout my generation)”

Reviewing the presentation, something that I was also thinking about was how mortality rates in the U.S. compare to other countries, and if those comparisons impact risk evaluation?

The US compares badly to most of the developed world on death rates, and longevity has actually been shortening in the US, while lengthening in most of the rest of the world.

The American experiment is interesting, but is a failure in many ways. SIgnificant freedom is offered to all, but many abuse it to their harm. Christianity, broadly understood, once dominated the culture of the US, but it never dominated its politics. It will take a Reformation to change things here, and a Reformation that cares more for the state of the souls of persons more than their economic well-being. The churches need to change first. Then maybe we can change the culture, and ultimately politics. Maybe my grandchildren will see it.

Going back, mortality rates are an indicator, not the indicator. In a good society, no one wants to die, and all fight death, aside from martyrs.

Thanks for your questions. May the Lord bless your efforts at college.

David