Earlier quoted context omitted.
You're assuming that "credit-worthiness" == "financial responsibility", but they're not the same thing, because "credit" as it's used in our current economy is not the same as "credit" as you would think of it just using ordinary common sense. When you get a loan for a car or a house or pretty much anything else, the bank is lending you money it doesn't actually have. (This is called "fractional-reserve banking" in o…
> You're assuming that "credit-worthiness" == "financial responsibility" No. I am saying that it doesn't, but should to a larger degree. > This is called "fractional-reserve banking" Yeah, I'm pretty well familiar with our banking system. No need for the Dr. Evil-style "laser" air quotes. It's not germane to this discussion in any event, as defaulted loans aren't good for the bank. > So the bank doesn't really care w…
Ok, fair enough. I agree that it should; but then again I don't think fractional reserve banking is as good an idea as most economists appear to think it is.
It's not germane to this discussion in any event
I think it is, because the fact that making loans causes money to be created on the spot means that loans are cheaper (in some cases, much cheaper) than they would otherwise be. That greatly reduces the incentive to increase one's financial responsibility. Also see below.
defaulted loans aren't good for the bank
They aren't if the bank still owns them and if the bank was booking them at an inflated value, yes.
Many banks/lenders actually service most of their non-real estate loans vs. selling them.
Yes, I should have drawn a distinction between real estate loans and other loans.
to the extent that they do sell loans, they care about credit-worthiness because higher quality loans fetch a higher price.
They care about creditworthiness in the sense of ratings, yes; but I thought we agreed that that's not the same as actual financial responsibility, i.e., as whether the borrower can actually pay back the loan. See below.
In some ways, the problem was that they "spread the risk" too much.
They thought they were spreading the risk by re-packaging loans in all these creative ways, when they actually weren't. (This may be what you were referring to by putting "spread the risk" in scare-quotes. Note that I did not do that in my previous post.) Spreading risk means the risk of any one loan defaulting is independent of the risk of other loans defaulting. That turned out not to be true, because real estate was in a bubble, created by low interest rates and consequent cheap mortgages (and the fact that the money for the loans was being created out of thin air), and when the bubble popped, lots of loan defaults happened that were correlated, not independent.
Had we simply seen a series of defaults, the systemic threat would have been greatly reduced. It was the leverage that created the real crisis.
I agree that leverage greatly exacerbated the problem; but note that the leverage doesn't just come from the derivatives. It comes from fractional-reserve banking in general, i.e., from giving out more loans (up to 10 times as many with the current reserve requirement of 10%) than the actual supply of real savings justifies. That's going to create a bubble in whatever the loan vehicle du jour is, even if no other leveraging is present.