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An excellent piece in macrobusiness (see here) deconstructs theory and common understanding about our current financial mess. Here is part of the piece:
[Money] is rules. Rules about value and obligation. Those rules are usually based on legally enforced structures, although that need not be the case. In the case of cross border capital markets, the enforcement is informal because there is no supranational government to impose penalties. Disputes are resolved by a handful of law firms, the main penalty is to be prevented from participating for a period. Now if money is rules, then what does it mean to “de-regulate financial markets” as was claimed in the 1990s? Can you de-regulate rules? Obviously not. So what happened? The place where rules were set shifted. Instead of government for the most part making the rules, the traders started making the rules. The logic was, as Alan Greenspan argued, that because everyone was acting in their self interest then nothing could possibly go wrong. Pricing would be accurate, the less formal self organisation of the market would be superior to the formal oversight of governments (what would governments, which are always bad, know?) and everyone would win. Free lunches as far as the eye can see.
We live in transition period where new rules need to be carved out.
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Greenspan knows how to argue and his points certainly seemed logical, but I think there is a growing consensus that he was a horrible Chairman, and rightfully so he overlooked strong empirical evidence that was staring him in the face for years. (Time magazine named him number 3 on the top 25 people to blame for the crisis)
ReplyDeletehttp://www.time.com/time/specials/packages/article/0,28804,1877351_1877350_1877339,00.html
I don't think there is anyone arguing that the low interest rate policy of Greenspan didn't have some negative consequences.
ReplyDeleteThe global pool of money increased from $36 trillion in 2000, to $70 trillion in 2006! A big reason for this incredible amount of growth was emerging economies (india, china, brazil..).
They wanted to invest in money making, low risk investments. But, because Greenspan kept interest rates so low that these new investors were deterred from investing in the usual product: US treasury bonds.
So they turned to the real estate market through the structured products we've been talking about. This worked so well that the increased to the point where the banks started lending to subprime borrowers (think Seth Rogan in "Knocked Up").
Why is this Greenspan's fault? He has his theory about letting bubbles grow and then using interest rates to keep the economy from taking too large of a hit. I don't think many people knew just how big and unstable the housing bubble was. The problem was the subprime lending standards, and the fed chairman doesn't regulate that (at least I don't think he does?)
Take these away, and I think Greenspan's policy is a wise one.
I also think that he is the only person who had an effective, immediate solution for to the crisis once it started to unfold: "the government needs to buy up all the foreclosed houses, and burn them". He's a supply and demand guy, a man after my own heart. And, I think that would have been better all the way around.
Burning the houses is better all the way around? Think of all the carbon emissions! I think Greenspan had a big influence on what happened but I also think you cannot pin it on one man alone. I think that he did help out a lot by being not doing things when he had the opportunity but I also think that the financial crisis was a result of the zeitgeist of the times.
ReplyDeleteI really liked this post because it tackled how sometimes economic theory doesn't dictate the speculative economy. I feel like the government made the problems worse by allowing this “too big to fail” notion. This notion created a moral hazard similar to what happened during the Asian Financial Crisis of the 90′s. The framework had a serious flaw and that allowed traders to do run amok and pretty much control the market. The issue is that the government allowed banks to operate all kinds of businesses with basically free money and preferential treatment. It is not surprising that we didn't have a choice but to bail them out.
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