Global financial crisis: one year later

[bascule]

http://www.nytimes.com/2009/09/15/business/15obama.html?bl&ex=1253160000&en=4a6d3f6f9f183e9c&ei=5087%0A

 

One year after Lehman Brothers collapsed under the weight of their toxic "financial instruments", Obama has renewed calls for financial reform and increased regulation, however it seems his calls are largely falling on deaf ears.

 

Considerable opposition to increased regulation is coming from Congress, although I'm still yet to see the specifics as to why. The only argument I've seen put forward is that further regulation of the financial sector would be detrimental to economic growth, which is sorely needed after the financial crisis. Yet I really have to wonder if these people think it wise to grow our economy on the back of collateralized debt obligations... they would have us repeat the same mistakes in the name of economic growth?

 

The key lesson of the financial crisis still rings true in the words of Alan Greenspan, who was able to say this in 20/20 hindsight following the financial crisis:

 

http://www.europeanaffairs.org/current_issue/2009_winter_spring/greenspan.php

 

I made a mistake in presuming that the self-interest of organizations' date=' specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms.

 

And it’s been my experience, having worked both as a regulator for 18 years and similar quantities in the private sector, especially 10 years at a major international bank, that the loan officers of those institutions knew far more about the risks involved in the people to whom they lent money, than I saw even our best regulators at the Fed capable of doing.

 

So the problem here is something which looked to be a very solid edifice, and, indeed a critical pillar to market competition and free markets, did break down. And I think that, as I said, shocked me. I still do not fully understand why it happened, and, obviously to the extent that I figure out where it happened and why, I will change my views. If the facts change, I will change.[/quote']

 

I believe in the minds of many free-market economists the collapse of Lehman Brothers simply shouldn't happen. A centuries old financial institution shouldn't simply vanish off the face of the earth, they should act at all times to preserve their institution and ensure the risks they take are balanced by their ability to absorb them. Surely they don't want to collapse! And yet they did. Their own self-interest was not sufficient to prevent them from taking too much risk, and in the battle between greed and fear, greed won, and now Lehman Brothers is no more, and threatened to bring the entire world financial system down with it.

 

Despite all of this, I still see many absurd ideas being bandied about: things like overregulation being the cause of the financial crisis, additional regulation not being able to solve the problem, and further deregulation being a solution to the problem. I am not sure through what distorted lens people who espouse these views see the world, but to me the financial sector was clearly underregulated and what Lehman Brothers was doing should be illegal. Lehman Brothers collapsed with a previously unheard of $613 billion debt.

 

Despite this, there seems very little interest in Congress at fixing the problem. Time had an interesting article on the lessons of the Lehman Brothers collapse:

 

http://www.time.com/time/business/article/0,8599,1923197,00.html?iid=tsmodule

 

Three main lessons present themselves. First, our complex financial system is awfully fragile. Second, government action is capable of keeping a financial panic from snowballing into a complete economic disaster along the lines of the Great Depression. Third, the government has — in large part because of its success in averting disaster — found it difficult to take any actions that would make the financial system less fragile in the future. That would, apparently, be too much government intervention.

 

Why anyone would support the bailout (i.e. TARP) but not support corrective measures to improve the stability of the financial system is beyond me. At least the views of those who didn't support a bailout and don't think we should further regulate the financial sector are consistent, albeit a little crazy. I really wonder if the "let it fail" people would be singing the same tune had we allowed the financial sector to collapse and plunged the country into a prolonged depression.

 

Yet, as it stands, the consensus among policymakers seems to be to maintain the status quo, ignoring the lessons of the financial crisis and just pretending the entire thing never happened. Obama seems like a lone voice pleading to try to fix the problems of the system which lead to the financial crisis in the first place, and it's rather depressing.

Edited September 15, 2009 by bascule

[CaptainPanic]

[...] The only argument I've seen put forward is that further regulation of the financial sector would be detrimental to economic growth [...]

 

That is the most worrying thing.

We aim for "economic growth", but the above statement shows that either that aim is wrong, or the definition of "economic growth" is wrong.

 

The majority of our world population don't want a very small group of people to become very rich while taking huge risks and thinking only about shares on the stockmarket and the next quarterly results.

 

The majority of the population see "economic growth" as a subjective measure of their fun and comfort in life, which is not easily quantified... and further regulation could very well cause an "economic growth" to most of us.

[bascule]

That is the most worrying thing.

We aim for "economic growth", but the above statement shows that either that aim is wrong, or the definition of "economic growth" is wrong.

 

I think it's extremely troublesome that people would continue to support the instruments that caused the financial crisis as viable means of economic growth, since obviously they lead to a sharp economic downturn before. It's like some crazed gambler who loses a lot of money, and decides the best way to get their money back is to continue gambling.

 

"The definition of insanity is doing the same thing over and over and expecting different results."

[abskebabs]

Bascule I think I agree with you that important lessons on what caused the crisis have not been learned, but entirely disagree with you on what those lessons were.

 

Do you only pay attention to people who get it wrong(with "free market" economists who have never predicted anything accurately like Ben Bernanke)? Have you not listened or learned from anything of the findings, predictions and conclusions about US financial and fiscal health by analysts like Peter Schiff and Marc Faber, or economists like Robert Murphy and Mark Thornton?

 

True, if you do regulate lending and other financial activities you will limit all kinds of investment, both good and bad; the Soviet Union never had to worry about business cycles. But you've entirely ignored the factor that caused the crisis; the credit expansion and low interest policies pursued by the Federal Reserve commbined with the moral hazard induced by Greenspan's put and Bernanke's Bailout policies.

 

The current regime does not look like it is remedying the Bush administration's policies; only exacerbating them.

[bascule]

Have you not listened or learned from anything of the findings, predictions and conclusions about US financial and fiscal health by analysts like Peter Schiff

 

I give Peter Schiff enormous credit for his foresight regarding the financial crisis, however I find his proposed solutions, which fall generally into the "let it collapse" school of thought, are a bit too preoccupied with economic theory and too little with the reality of the situation. I don't think letting the financial sector collapse and plunge the entire country/world into a second Great Depression is a particularly good solution to the problem.

 

I think free market economists like Peter Schiff are content in a fantasy land of pure economics where they can ignore the immense social consequences of an economic collapse.

 

I challenge anyone here to explain to me why the "let it collapse" school of thought is a good thing, and worth the profound systemic and social consequences of an economic collapse.

 

True, if you do regulate lending and other financial activities you will limit all kinds of investment, both good and bad; the Soviet Union never had to worry about business cycles. But you've entirely ignored the factor that caused the crisis; the credit expansion and low interest policies pursued by the Federal Reserve

 

Cheap credit was a cause, not the cause. A similarly huge factor in the financial crisis was financials creating complex financial products they couldn't understand, relying on computer models to try to understand them, and discovering that economics is no science as reality behaved substantially differently from their models. Lehman Brothers certainly got a megadose of reality.

 

commbined with the moral hazard induced by Greenspan's put and Bernanke's Bailout policies.

 

So I take it you're of the "let it collapse" school of thought? Do you think we'd be better off if the financial sector collapsed?

 

In 20/20 hindsight, letting Lehman Brothers collapse was a terrible idea, "moral hazards" aside. The systemic effect it had on the world financial system froze credit everywhere and instigated the financial crisis.

 

True, if you do regulate lending and other financial activities you will limit all kinds of investment, both good and bad

 

Okay, you're talking in generalities here. What if we were to more stringently regulate the types of financial instruments which lead to the crisis in the first place, such as collateralized debt obligations?

 

The current regime does not look like it is remedying the Bush administration's policies; only exacerbating them.

 

Which "regime" is that? The Obama Administration? Obama's calls for increased financial regulation are falling on deaf ears in Congress. What specifically is he doing that you think is exacerbating the problem?

 

Obama isn't proposing anything revolutionary. He wants a watchdog organization for consumers to protect them from bad or misleading loans. He wants to task the Federal Reserve with analyzing and resolving systemic risks. These reforms don't even go as far as what I'd like to see, and yet Obama is having trouble getting them passed.

Edited September 15, 2009 by bascule

[abskebabs]

Interesting, you agree with me that cheap credit was a problem that generated the crisis, but you also think that perhaps(golly gosh!) a halt in supply and correction in interest rates somehow generates the crisis itself.

 

I think a little eliucidation might be helpful here. The effect of distorting and lowering market interest rates by credit expansion as carried out by the Federal Reserve has a causal influence, in the sense it distorts economic calculation made by individuals as the price of credit enters into profit-loss calculations and produces mal-investment and expansion of the capital structure out of coordination with consumer demand.

 

In our current business cycle this produced a lot of investment demand and speculation in housing, and the prices of housing in this sector subsequently rose during the boom. But the mis-allocation of capital was made during the boom, the bust only reveals the mistakes and is the correction period.

 

The correction should be allowed to take place, and if undisturbed it can occur as quickly as possible. Ever heard of the "depression" of 1921? Indeed, the current regime is currently(even by it's own admission!), is looking to follow the policies of Roosevelt that turned the 1929 recession into a great depression(don't get me wrong, Hoover was almost as bad, indeed the Bush-Obama comparison is useful in this regard). Their policies have helped create a Great Depression, not prevented it!

 

Collateralised debt instruments and derivatives did play a role in this crisis, but this was only due to the initial impetus provided by central bank credit policy( especially, but not only in the US). Without the original distortions provided by this policy, these instruments do serve a useful purpose in the market, and do not require "consumer regulation."

 

Indeed, you clearly have not grasped what I meant by moral hazard. I think there is already deposit insurance afforded by the Federal government to all depositors, and given how high reserve ratios have been for the past year, even leading up to the crisis; I don't think the risks were high for consumers. Indeed, it is the "insurance" policies of the central bank and federal government that in part helped exacerbate the crisis as businesses made the decisions and took the risks they did knowing full well they'd be bailed out!(The Greenspan put) This is moral hazard at work!

 

As for the attempts to create new regulation in the financial sector, already one of the most over-regulated, it will at "best" raise entry barriers and reduce competition in this sector while not dealing with the root problems that caused the crisis, and are continuing to exacerbate it, like the "quantitative easing"(=inflation+even more credit expansion) being pursued by the Fed. I have blamed Obama partially for this, as I've never accepted the myth that somehow, the Federal Reserve is a miraculously politically independent entity. For more on this, check out the following article I wrote back in August.

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Merged post follows:

Consecutive posts merged

I think you might learn a lot from this:

[bascule]

abskebabs,

 

I think we're already talking past each other. I asked you a single question repeatedly which you ignored: do you think we'd be better off had we simply let the financial sector collapse?

 

Regarding "moral hazard": clearly this is a phrase that has been defined in a specific way by someone, however as a utilitarian student of moral philosophy in the school of Hume, I don't believe their usage of the word "moral" is particularly apt, and sounds of the same school of thought that Objectivists consider their philosophy a "moral" one. I'm not sure where this phrase comes from (the Austrian school?) but, frankly, I don't buy it. Perhaps you could give some examples of "moral hazards".

 

Perhaps you could spend some more time addressing the questions I asked in my previous post and less time being pedantic about your economic school du jour. Frankly, you are contradicting the entirety of analysis I am seeing out of anyone else, including the 20/20 hindsight of those who were directly involved and arguably instigated the crisis. These are the key people I pay attention to because they are recognizing and admitting their mistakes (particularly Greenspan).

[abskebabs]

abskebabs,

 

I think we're already talking past each other. I asked you a single question repeatedly which you ignored: do you think we'd be better off had we simply let the financial sector collapse?

 

Regarding "moral hazard": clearly this is a phrase that has been defined in a specific way by someone, however as a utilitarian student of moral philosophy in the school of Hume, I don't believe their usage of the word "moral" is particularly apt, and sounds of the same school of thought that Objectivists consider their philosophy a "moral" one. I'm not sure where this phrase comes from (the Austrian school?) but, frankly, I don't buy it. Perhaps you could give some examples of "moral hazards".

 

Perhaps you could spend some more time addressing the questions I asked in my previous post and less time being pedantic about your economic school du jour. Frankly, you are contradicting the entirety of analysis I am seeing out of anyone else, including the 20/20 hindsight of those who were directly involved and arguably instigated the crisis. These are the key people I pay attention to because they are recognizing and admitting their mistakes (particularly Greenspan).

 

I'm sorry, the short answer to your first question, which I thought you would have perceived from reading my reply is yes, let a few of the most incompetent companies fail, regardless of their size or abillity to lobby politically. It would not have entailed a collapse of the financial sector, smaller more efficient companies that anticipated events better would have been able to bid up the capital and labour previously being wasted and gaine market share. It wouldn't have quite been Schumpeterian "creative destruction" at work because of the fact the collapse was ultimately brought about by the bad consequences of inflationary and credit expanding monetary policy. But it definitely would have been better, and resolved much more quickly than piggybacking the losses onto the rest of the economy and the ordinary taxpayer. Indeed, I think the US is only surviving at the moment because it is able to consume capital which the Chinese are becoming less and less stupid about lending to them.

 

If you took the time to watch the short video I linked, you would not be confused about the meaning of moral hazard. It is the willingness of an actor to take excessive risk or make excessive use of resources because he believes the potential losses will be born by somebody else(e.g. the taxpayer, through taxes and inflation!). Despite it's name it does not have anything to do with a "moral philosophy." Neither is it a term exclusively used by the Austrians.

 

And yes, my analysis does contradict that of those who instigated the crisis, and I don't know why you place so much faith in those who believe problems created by credit expansion and debt are cured by further credit expansion and debt. Indeed, to be honest, I see the US getting close to hyperinflation or at least stagflation within a year, once the money pumped actually circulates; something I'm sure Greenspan and Bernanke will deny.

[bascule]

I'm sorry, the short answer to your first question, which I thought you would have perceived from reading my reply is yes, let a few of the most incompetent companies fail, regardless of their size or abillity to lobby politically. It would not have entailed a collapse of the financial sector

 

You seem to disagree with every single analyst on the matter that I've ever seen.

 

They did let one of the most incompetent companies fail, Lehman Brothers. That alone ignited the financial crisis. They went bankrupt with a debt greater than the GDP of most countries.

 

smaller more efficient companies that anticipated events better would have been able to bid up the capital and labour previously being wasted and gaine market share.

 

That's what Barclay's wanted to do with Lehman Brothers (and eventually did), however they were unable to swallow Lehman Brothers and all its toxic debt whole. Fortunately regulators didn't allow that. Barclay's did end up acquiring what was left of Lehman Brothers, after the bailout.

 

And yes, my analysis does contradict that of those who instigated the crisis, and I don't know why you place so much faith in those who believe problems created by credit expansion and debt are cured by further credit expansion and debt.

 

1) They were in the thick of it, and for that I find them some of the best candidates to deduce their own mistakes

2) The solutions they have put forward are more or less working

3) The solutions you put forward sound completely untenable

 

Indeed, to be honest, I see the US getting close to hyperinflation or at least stagflation within a year, once the money pumped actually circulates; something I'm sure Greenspan and Bernanke will deny.

 

We'll have to revisit this next year to check your prediction.

[abskebabs]

We'll have to revisit this next year to check your prediction.

 

Indeed, even your mate Greenspan's beginning to see the light of say on this.