Any explanation that ignores the central role that Fannie Mae and Freddie Mac played in the crisis leaves a lot to be desired - and can hardly be considered a "good summary" of the financial collapse essentially since they were taken over quite early on in the crisis.
Can we also blame traders and financiers for mispricing risk? Definitely - but let's also be clear that government influence through GSE's like Fannie Mae and Freddie Mac, and poor government regulation played a central role in this. Further, as for leverage, high corporate taxes give companies large incentives to borrow to fund growth. What about the role the Fed played in keeping interest rates low and the credit bubble going? Sorry, I really can't see how this summary can be considered even remotely "good".
The leverage is a magnitude or two greater than possible defaults covered by Fannie and Freddie. At least when you talk about home mortgages, you still have a tangible asset behind it. The many layer of leverage on top of this provided phantom value and is where most of the horror is in the big numbers.
I read it and wondered why stupidity vs. greed were presented as exclusive alternatives. They could both be true -- there was a lot of clubby legislation to benefit the financial community, and the models were wrong.
I read the article and wondered that exact thing the whole time, but this type of rhetoric is quite typical of David Brooks. He tends to paint things in a way where such that in the end he can point to the article as a conservative pundit and say "conservatism is the way". He is kind of a wanker in that regard.
I have studied markets empirically for a long time. They fascinate me. But ultimately they're very simple. Markets are just games with certain rules. It's human nature to exploit knowledge for gain. And we're very good at it, which is why you see home sapiens running things and not dogs or chimps. The emergent properties of nearly all markets are pretty obvious from the outset if you know the rules and just extrapolate.
Brooks is analyzing psychological motives, but he half misses the point (for the above reason; he wanted to come to a conclusion that supported a "conservative" viewpoint). I get really annoyed when people make the argument "but if only people hadn't mis-behaved we wouldn't be in this mess." Umm, any exploitable situation will be exploited by someone. Quit expecting morality to protect humanity. Don't you grok the Tragedy of the Commons?
In the case of the financial crisis the market failure was one of externalities. If you look at the value chain of how loans were originated, sold, and re-sold, the current crisis was inevitable. It's always been obvious that several of the layers of the industry simply had no risk, because intermediaries were able to make profit regardless of risk and the risk was concentrated in an external entity. This is my favorite (and funny!) explanation of the situation:
So ultimately stupidity vs greed is a red herring. In reality, a few evil geniuses knew that they could make a ton of money with no risk, and they unleashed their massive resources to turn this money train into a years-long profit engine. The people that caused this have already punched out for more money than they could ever imagine.
IMHO the real solution here is:
1) prosecute thousands of people for fraud.
2) Let the current banks rot with the pile of assets they've amassed. 3) capitalize new banks to re-start the credit markets.
3) Vastly increase regulation.
It is not in the taxpayers' interest to have a system in which a misbehaving company can destabilize the economy.
Arbitrage is not evil - ie making money without risk. The problem is not behaviour - particularly since it is regulation that warped incentives. Everywhere you look is regulation - regulation encouraged home buying over rentals, taxes encouraged borrowing over equity, government sponsored enterprises underpriced/didnt evaluate risk, regulation increases the time it takes to fund and create new banks, and I've yet to see a convincing explanation of how the repeal of Glass-Steagall caused this mess in the first place. I also don't get why government doesn't allow for some form of rapid bankruptcy to restructure balance sheets and wipe out shareholders and to some degree, bondholders. I'm not sure why taxpayers and "good" innovative industries should be subsidizing bond holders and shareholders of businesses that didn't adequately plan for risk. If they're worried about runs on banks, the bulk of the capital in these firms are not depositors.
The irony is that we're looking to regulation to solve this crisis? This while we're looking to bail out dying industries?
You say a lot of things... let me take them a few at a time:
On arbitrage - I don't consider this financial crisis to have much to do with arbitrage. I am not sure you understand what arbitrage is; it isn't ANY money-making activity. It's when a middleman exploits transient differences in prices in markets. In any case, I never said arbitrage was evil. However, if the arbiter makes his money by exploiting an externality, then someone is losing. This is simply a notable side-effect.
On incentives - I don't buy the line that regulation caused that many warped incentives. Maybe some, but not all. And this would have happened WITHOUT the regs that might have caused some of the incentive anyway. None of the tax policies shifted behavior that significantly. Being able to deduct mortgage interest does differentially favor homeowners, but it doesn't affect the risks involved in becoming a homeowner. At worst it artificially inflates home prices.
On Glass-Steagall - I don't know it well, but one very useful effect of it was to compartmentalize risk. As anyone on HN should know; isolating risks in independent buckets drastically reduces the chance of major bad things happening. It's the sheer scale of the crisis that makes it bad; most of this stuff was ultimately pushed by a small handful of banks at the top. It also separated different types of investing which prevented oligopoly situations and group-think from having as big of an effect on the market. It put different companies on opposites sides of investments rather than the same side and probably had the effect of improving real-world due diligence. But I am just WAG'ing here on this one.
On bailout - I don't think taxpayers should be subsidizing bond or equity holders in any of these financial companies. Not sure where you got that idea, not from me.
On regulation - it's not ironic at all. You are presenting logical fallacy. Just because reg A is stupid doesn't mean regs B-Z are. They are unrelated. I am all for regs that help prevent massive market failures or allow massive externalities to persist over time. In the end, the citizens pay for it in taxes and instability. It is true that more regs would probably dampen some of the GDP upside, but IMHO that's a fine tradeoff compared to the economic havoc of massive recessions.
Markets are just games with certain rules. It's human nature to exploit knowledge for gain. And we're very good at it, which is why you see home sapiens running things and not dogs or chimps. The emergent properties of nearly all markets are pretty obvious from the outset if you know the rules and just extrapolate.
Markets adapt to the ways people exploit the rules. For example, for a long time the rule was that houses made great collateral, because mortgages were government-subsidized and housing prices never dropped year over year. That was completely true until it was totally false.
Brooks is analyzing psychological motives, but he half misses the point (for the above reason; he wanted to come to a conclusion that supported a "conservative" viewpoint). I get really annoyed when people make the argument "but if only people hadn't mis-behaved we wouldn't be in this mess." Umm, any exploitable situation will be exploited by someone. Quit expecting morality to protect humanity. Don't you grok the Tragedy of the Commons?
It may be 'no true Scotsman', but I always thought the basic difference between right and left was that the right embraced exactly the view you have, e.g. "Don't rehabilitate prisoners; hang them," or "Don't give people a handout when they lose their jobs; you'll just subsidize laziness."
It is odd to me that so many people are looking for some kind of abnormality which "caused" the crisis. Capitalism has had cyclical crises since its inception 300 years ago, so I would say that the crisis was not "caused" by either greed or stupidity, but is a naturally emergent behavior of the capitalist system.
Actually it is even more general than that. The pattern of exponential growth followed by die-off is common throughout nature - algal blooms, for example.
It seems that the whole discussion over the financial crisis has been warped and twisted by this absurd belief, in the face of all evidence, that the economy is in some sense "rational," that it has some kind of steady-state equilibrium, and that its problems are therefore caused by too little or too much regulation, too little or too much greed, etc.
I don't think the terminology is very much standardized. Our system is not "pure" capitalism, and perhaps it would be better to call it a mixed economy. By using the word capitalism, I mainly meant to contrast it with radically different systems, such as feudalism and central planning (I'm not aware of whether these systems also encountered boom/bust cycles.)
> so I would say that the crisis was not "caused" by either greed or stupidity, but is a naturally emergent behavior of the capitalist system.
But greed and stupidity are "natural" forces at work within the capitalist system. Asserting that crises are cyclical and "naturally emergent" doesn't rule out greed and stupidity as causes. It actually doesn't say anything about causes at all.
I'd also be wary of concluding that because certain phenomena appear to be cyclical, any similar phenomena must necessarily be an expression of that cycle.
Yeah, I don't think it's exactly wrong to say that greed and stupidity caused the crisis, but it seems like a category error. If a farmer kept planting crops in September, and they died during the winter, and he said that they died because it got cold, then he'd be perfectly correct. But that way of phrasing it almost suggests that he expects it not to get cold again next year.
I think it's very hard for people to see bubbles as forces of nature, because in retrospect you can always see how dumb they were. So it always seems as though, if we just rationalize the system a bit, then we'll no longer have bubbles. However, no system has yet been invented which is capable of preserving rationality within a modern economic system. Hundreds of years of evidence suggest that whatever reforms are attempted as a result of this crisis will eventually run into the same mishaps and errors as ever before, unless someone comes up with a truly systematic account of bubbles.
You're right that I shouldn't assume that this crisis is an expression of cyclical booms and busts. I'm very puzzled by this crisis, and the information that's available is maddeningly vague and handwaving.
17 comments
[ 228 ms ] story [ 832 ms ] threadCan we also blame traders and financiers for mispricing risk? Definitely - but let's also be clear that government influence through GSE's like Fannie Mae and Freddie Mac, and poor government regulation played a central role in this. Further, as for leverage, high corporate taxes give companies large incentives to borrow to fund growth. What about the role the Fed played in keeping interest rates low and the credit bubble going? Sorry, I really can't see how this summary can be considered even remotely "good".
I have studied markets empirically for a long time. They fascinate me. But ultimately they're very simple. Markets are just games with certain rules. It's human nature to exploit knowledge for gain. And we're very good at it, which is why you see home sapiens running things and not dogs or chimps. The emergent properties of nearly all markets are pretty obvious from the outset if you know the rules and just extrapolate.
Brooks is analyzing psychological motives, but he half misses the point (for the above reason; he wanted to come to a conclusion that supported a "conservative" viewpoint). I get really annoyed when people make the argument "but if only people hadn't mis-behaved we wouldn't be in this mess." Umm, any exploitable situation will be exploited by someone. Quit expecting morality to protect humanity. Don't you grok the Tragedy of the Commons?
In the case of the financial crisis the market failure was one of externalities. If you look at the value chain of how loans were originated, sold, and re-sold, the current crisis was inevitable. It's always been obvious that several of the layers of the industry simply had no risk, because intermediaries were able to make profit regardless of risk and the risk was concentrated in an external entity. This is my favorite (and funny!) explanation of the situation:
http://docs.google.com/TeamPresent?docid=ddp4zq7n_0cdjsr4fn&...
So ultimately stupidity vs greed is a red herring. In reality, a few evil geniuses knew that they could make a ton of money with no risk, and they unleashed their massive resources to turn this money train into a years-long profit engine. The people that caused this have already punched out for more money than they could ever imagine.
IMHO the real solution here is:
1) prosecute thousands of people for fraud.
2) Let the current banks rot with the pile of assets they've amassed. 3) capitalize new banks to re-start the credit markets.
3) Vastly increase regulation.
It is not in the taxpayers' interest to have a system in which a misbehaving company can destabilize the economy.
The irony is that we're looking to regulation to solve this crisis? This while we're looking to bail out dying industries?
On arbitrage - I don't consider this financial crisis to have much to do with arbitrage. I am not sure you understand what arbitrage is; it isn't ANY money-making activity. It's when a middleman exploits transient differences in prices in markets. In any case, I never said arbitrage was evil. However, if the arbiter makes his money by exploiting an externality, then someone is losing. This is simply a notable side-effect.
On incentives - I don't buy the line that regulation caused that many warped incentives. Maybe some, but not all. And this would have happened WITHOUT the regs that might have caused some of the incentive anyway. None of the tax policies shifted behavior that significantly. Being able to deduct mortgage interest does differentially favor homeowners, but it doesn't affect the risks involved in becoming a homeowner. At worst it artificially inflates home prices.
On Glass-Steagall - I don't know it well, but one very useful effect of it was to compartmentalize risk. As anyone on HN should know; isolating risks in independent buckets drastically reduces the chance of major bad things happening. It's the sheer scale of the crisis that makes it bad; most of this stuff was ultimately pushed by a small handful of banks at the top. It also separated different types of investing which prevented oligopoly situations and group-think from having as big of an effect on the market. It put different companies on opposites sides of investments rather than the same side and probably had the effect of improving real-world due diligence. But I am just WAG'ing here on this one.
On bailout - I don't think taxpayers should be subsidizing bond or equity holders in any of these financial companies. Not sure where you got that idea, not from me.
On regulation - it's not ironic at all. You are presenting logical fallacy. Just because reg A is stupid doesn't mean regs B-Z are. They are unrelated. I am all for regs that help prevent massive market failures or allow massive externalities to persist over time. In the end, the citizens pay for it in taxes and instability. It is true that more regs would probably dampen some of the GDP upside, but IMHO that's a fine tradeoff compared to the economic havoc of massive recessions.
Markets adapt to the ways people exploit the rules. For example, for a long time the rule was that houses made great collateral, because mortgages were government-subsidized and housing prices never dropped year over year. That was completely true until it was totally false.
Brooks is analyzing psychological motives, but he half misses the point (for the above reason; he wanted to come to a conclusion that supported a "conservative" viewpoint). I get really annoyed when people make the argument "but if only people hadn't mis-behaved we wouldn't be in this mess." Umm, any exploitable situation will be exploited by someone. Quit expecting morality to protect humanity. Don't you grok the Tragedy of the Commons?
It may be 'no true Scotsman', but I always thought the basic difference between right and left was that the right embraced exactly the view you have, e.g. "Don't rehabilitate prisoners; hang them," or "Don't give people a handout when they lose their jobs; you'll just subsidize laziness."
Actually it is even more general than that. The pattern of exponential growth followed by die-off is common throughout nature - algal blooms, for example.
It seems that the whole discussion over the financial crisis has been warped and twisted by this absurd belief, in the face of all evidence, that the economy is in some sense "rational," that it has some kind of steady-state equilibrium, and that its problems are therefore caused by too little or too much regulation, too little or too much greed, etc.
But greed and stupidity are "natural" forces at work within the capitalist system. Asserting that crises are cyclical and "naturally emergent" doesn't rule out greed and stupidity as causes. It actually doesn't say anything about causes at all.
I'd also be wary of concluding that because certain phenomena appear to be cyclical, any similar phenomena must necessarily be an expression of that cycle.
I think it's very hard for people to see bubbles as forces of nature, because in retrospect you can always see how dumb they were. So it always seems as though, if we just rationalize the system a bit, then we'll no longer have bubbles. However, no system has yet been invented which is capable of preserving rationality within a modern economic system. Hundreds of years of evidence suggest that whatever reforms are attempted as a result of this crisis will eventually run into the same mishaps and errors as ever before, unless someone comes up with a truly systematic account of bubbles.
You're right that I shouldn't assume that this crisis is an expression of cyclical booms and busts. I'm very puzzled by this crisis, and the information that's available is maddeningly vague and handwaving.