Both right wing Austrians and many liberals have a common theory of how all this happened: Alan Greenspan dunnit. The mechanisms by which he accomplished his foul task are different in the two cases, of course. Austrians, and many other free-market types, believe that by lowering short-term interest rates after 9/11, Alan Greenspan made the housing bubble, and its eventual bust, inevitable. The liberals think that by failing to regulate . . . er, something (usually either mortgage originations or CDS's) more closely, he made the crisis inevitable. In the latter case, sometimes Phil Gramm, with an assist from Conservative Ideology, fills in the role of convenient demon.
Here's the problem: if markets are so great, how come the entire system can be brought low by a smallish injection of short-term capital? The alternative question for the liberals: if regulation is so great, how come one guy, or one fairly minor bill, can apparently single-handedly destroy the most heavily regulated industry in America that doesn't actively involve radioactive material? If your preferred system is really that fragile, then maybe we should be looking into alternatives.
Update: Let me expand a little.
Austrians: If the market does not price the injection of short term capital into its actions, why would we trust it to price anything else correctly? If the markets treat short-term capital as substantially equivalent to long-term capital, we have much bigger problems than Alan Greenspan.
Gramm/Greenspan haters from the left: If regulation is so impotent that a single rule change, or even two, can leave the system vulnerable to this kind of collapse--indeed, make it worse with other rules that are still there--then why the hell do we bother regulating? If your regulators need to get it right 100% of the time, we might as well pack it in now, because there is no system on earth that can guarantee no one will ever be wrong. If one guy can leave us in a position where the regulatory system makes things worse rather than better, we may well be better off without the regulatory regime.
Copyright © 2010 by The Atlantic Monthly Group. All rights reserved.
I understand that this is a very, very hard day for you and your fellow libertarians. Buck up. Think of it this way, at least you're not one of the people who lost your home or your job or your retirement savings because Greenspan and an entire generation of biz school grads believed the crackpot theories of a handful of laughingstock economic theorists and dimwit politicians.
A further question in my mind would be: why are the European banks in so much trouble? They don't borrow at the Fed funds rate. Indeed the ECB has kept interest rates much higher in the past few years than has the Fed. And, while derivatives are lightly regulated in Europe, it isn't due to Phil Gramm.
I think this part of the global problem probably has to be blamed George Bush. I know that, in NYC, Bush has been criticized for years for letting the dollar get so cheap (it makes travel in Europe very expensive) and is not criticized for letting the dollar get so expensive (it reduces foreign demand for our apartments and brownstones).
Whoops, make that "Bush is NOW criticized for letting the dollar get so expensive."
Good question, Megan_McArdle, and I've argued the point in other contexts against libertarian arguments that suppose implausible mechanisms.
But here, it has a good answer: who is doing the smallish injections (hey -- great command of English there, btw) of short-term loans? And who is implicitly promising a bunch of vague guarantees of various business model's profitability?
One person. By whim.
There's nothing contradictory, or even uneasy about saying that markets can handle "[small] injections of short-term capital" in the abstract, while holding that subjecting them to the power of one person to make significant changes such as that, can destabilize them.
Remember, the whole point of libertarianism is to make sure that you don't concentrate such huge, arbitrary authority in any one person. So why should libertarians have to explain why such a system should work?
As a matter of fact, I as a libertarian, absolutely do expect markets to be robust against "[small] injections of short-term capital", and if they weren't, that would be strong counterevidence. But there's a catch -- those injections have to originate in real saving by a corresponding party. If the savings for those loans had originated that way, there wouldn't have been a crisis.
You trivialization of the Fed's actions as "[small] injections of short-term capital" is unacceptable. Contrary to what your buddies tell you the Fed does not adhere to the requisites of the Real Bills Doctrine. When it prints money, the Fed does NOT increase its assets by a corresponding amount; some of it is handed over the the federal government. This is what people mean by "paying bills with the printing press". Once this significantly ramps up -- and it will -- whatever confidence previously grounded the dollar will go as well.
@y81: Europe's central banks do the same thing -- fund loans without real savings and keep some of the monopoly profits for themselves. The fact that they have slightly different rates is irrelevant.
.....destroy the most heavily regulated industry in America.....
Wasn't it the lightly or unregulated bits that fell apart first cascading into the more heavily regulated parts?
LOL Megan:
If one thing *has* become clear, it's that our financial system *is* that fragile, and we should *definitely* be thinking about something different.
Liberals have one vision for what that alternative might look like, and you can read all about it in the NYTimes.
Austrians also have a vision, but you need to go to some pretty obscure blogs to find that.
Finally, it is inaccurate to characterize Greenspan lowering rates to 1-2% for as long as he did as a small injection of capital. It was a massive injection. A Fed with so little control over (or awareness of) money supply is an unambiguous ep1c fail
-winterspeak
I've heard plenty of liberals who blame Greenspan and his deregulation, but I've never met a libertarian who totally blamed Greenspan's inflationism. (The Mises Institute would be the usual suspect, but they have a much more nuanced approach this time around.) Libertarians usually couple that criticism with criticism of FM&FM/HUD/FHA/CRA, and the more subtle ones also recognize the influence of differential tax policy. Call it the holy trifecta. But I just feel like sometimes, in your effort to take the middle-ground, you short change some of the libertarians' ideas about this current crisis, which is a shame. There is a truth about this crisis – don't be so timid in seeking it out.
The alternative question for the liberals: if regulation is so great, how come one guy, or one fairly minor bill, can apparently single-handedly destroy the most heavily regulated industry in America that doesn't actively involve radioactive material?
Assuming you're talking about Phil Gramm, it seems like he provided the dynamite but the industry in question actually placed and set off the charges.
Here's what I want to know: why did the financial smart guys use the one area in which they weren't regulated to blow up their own system? If they're capable of doing that, then it's hard to believe that LESS regulation would lead to better results.
Um, Megan...
Pretty much the entire set of freedoms we all in enjoy in the United States rests upon a frail reed called the Bill of Rights. If we were to abolish them, bad things would happen. Some say this has already been happening even with the Bill of Rights (Gitmo).
So, sometimes, important things are protected by one piece of legislation. It happens. This is why we liberals get upset when these pieces of legislation get undermined or revoked.
Why do I feel like I'm explaining things to a 12-year-old?
Here's what I want to know: why did the financial smart guys use the one area in which they weren't regulated to blow up their own system?
Each one was busy setting up the charges for profit under bridges he didn't expect to be crossing. Then somebody got around to pushing the plunger and voila...
Uh, markets "brought down"??? Last I checked the mushroom cloud over NYC did not exist. A recent FED report that said credit flows aren't as bad as all that, and the Lehman CDS's settled out without causing the ripple effect.
The idea that one itsy bitsy teeny little guy could manipulate markets makes for a nice elbows akimbo sort of incredulity, but it doesn't ring true. The FED controls a more powerful economic lever than probably most of he CEO's of Wall St. combined.
But let's talk in principle rather than this empiricism you're so fond of. Market's work because they are a set of intricately laced up biofeedback systems. In that fashion individual agents acting on the basis of their own success or failure (even if with less than perfect information) serve to make a whole system which to the extent that ANYONE can predict adapt to information. The final arbiter is reality, success or failure. Bad decisions are punished in the long run, and good decisions are rewarded. The FED operates under no such feedback mechanism, and as such, given the power it wields can distort the functioning of all the other little feedback loops.
That's principle. Anyone given arbitrary power, and no check by the ultimate arbiter of reality can "bring down" the system, if that's what you want to call it.
Megan touched on this in an earlier post, but it bears repeating: regulation is fantastic as a tool to prevent individual institutions from corrupting the financial system through trickery and malpractice. But regulation ISN'T good at preventing meltdowns that are caused by a systemic problem like inflated housing prices. Why? Because systemic biases affect regulators as much as they do traders; it's not as if the traders were trying to drive their companies into the ground while the brave-but-savvy regulators numbered too few to fight back. Both traders and regulators assumed, wrongly, that house prices would continue to climb.
As for the question of blaming monetary policy, why would the Fed's interest moves make a bubble inevitable only in housing? Shouldn't we be seeing bubbles every credit-based industry? But that's obviously not what happened.
Oregon Guy wrote: So, sometimes, important things are protected by one piece of legislation. It happens. This is why we liberals get upset when these pieces of legislation get undermined or revoked.
Why do I feel like I'm explaining things to a 12-year-old?
Your mom.
And more seriously, in this case, important things were NOT protected by "one piece of legislation". And certainly not by anything so plain and foundational as the Bill of Rights. Which, come to think of it, might be why some of the rest of us are perrennially frustrated by the tendency of some liberals to conflate "things I think I like" with "things that are essential and have unimpeachable explanatory power."
The upshot is, you guys have some really good coffee up there.
I believe that regulation should be minimal, and work. As Greenspan said:
"It is important to remember, however, that whatever regulatory changes are made, they will pale in comparison to the change already evident in today’s markets. Those markets for an indefinite future will be far more restrained than would any currently contemplated new regulatory regime."
That's what I've always believed. If you allow a crisis, it's much worse than minimal regulation.
By minimal, to the extent that I understand them, I would include CDO's and CDS's. Anything meant to shift risk, in other words, needs to be looked at. I'm not saying always regulated, but looked at to make sure the system is transparent and collateralized.
As to the Fed, I think that Greenspan willfully ignored problems, but I'm not a fan of the spigot theory, which says that if interest rates are too low or there's too much capital around, you'll end up with a bubble. After all, even if people have to invest, there's no imperative to do it unwisely. Politically, if people are making money and feeling secure, however foolish they are in feeling that way, raising interest rates to spoil the party on a theory will be hard.
The sad thing is that, I know I could be wrong, the things that we needed to do, like a clearinghouse for swaps and Greenspan slowing the economy a bit to get us to check the engine, would not have been that hard or onerous to the market.
...how come one guy, or one fairly minor bill, can apparently single-handedly destroy...[yada, yada]
Because Megan's practiced eye can tell that this is a 2 to 3 guy, and 2 minor bills job, minimum. Maybe more.
Needless to say, this makes no sense.
What about the whole glut of savings flowing in from China? Wouldn't that have distorted things here no matter what Greenspan did?
Oh, Megan, don't you get it?
You voted for GWB, and that has tainted all decisions (with which I do not agree with you) you have made since.
You thought the war was good, and that has biased all opinions (with which I do not agree with you) on all topics you have had since.
Some of the things you have written about The One have not been 110% positive, and that has revealed your secret support of The Evil Right.
Wow, I feel like I'm part of something now!
And also: systemic risk. Small perturbations can have large consequences in scenarios of systemic risk. House of cards and all that.
But hey, liberals are dumb, so whatevs...
As the theory goes, a low Fed funds rate made Treasury bonds less attractive for the large capital pools, many of them based in Europe and developing regions, that began to appear in the late 90's. The more attractive option was the CDO's, which looked pretty safe for the 10-15 years preceeding this event.
This is another version of the spigot theory but its compelling.
There are three types of people involved here:
1) The left who see the crisis as supporting evidence for their ideology
2) The right who see the crisis as supporting evidence for their ideology
3) Tiresome hacks who piously scold the left and the right for being too dogmatic
I prefer the first two types.
I wonder why there wasn't a recession in the late 80's or 90's or around 2000. Could it be that the Fed successfully headed them off, by pumping more debt into the system? (the infamous Plunge Protection Team!)
I also wonder whether if we'd had a normal recession in the last 25 years, we'd be in this mess now. It seems like a recession would have cleaned out a lot of the really speculative stuff that grew into trillion dollar bubbles instead.
I think of it like forest fires. If you put them all out, you build up fuel and guarantee a bigger fire later.
The Greenspan story starts two weeks after taking the Chair. Black Monday Oct. 87. Interest rates were rising and the dollar was falling. M3 was rising and M3 was the stat of the decade as Friedman's monetarism held sway in the popular conception of monetary policy.
The market cratered as the newly birthed era of high tech driven leveraged speculation fell apart in moments as the ill conceived idea of 'portfolio insurance' sent the newly minted stock index futures markets into a plunge. The markets saw God.
Then they saw the devil. Not enough liquidity. At mid morning Greenspan promised unlimited open market ops to support the markets. On Friday and for years before any hint of lose monetary policy sent bonds into the tank. On that Monday bonds soared. 30 year T Bonds have never risen above the rate of that morning. The bond vigilaties quit the field of battle.
The credit bubble was born.
"Smallish"? The Fed has been running the money pumps nearly wide-open for 7 years. Yes the market is great but if you drop hundreds of billions of dollars from helicopters, bad stuff happens.
We have just now worked off all the post 9/11 excesses. The question is if we start to work off the excesses from around 1982.
Greenspan was the right man to nurture the bubbles. Fulfilling the necessary historic role of new era demigod. If he hadn't existed surely another would have taken the role. History called out for a fool and he just happened to be the right man at the right time.
In all honesty, and in all sobriety: Megan is on the verge of an intellectual and conceptual breakthrough that may move her out of her disciplinary straight-jacket and into something interesting, especially if she gets past her self-protective shell of a culture of expertise The result will put her out of orthodoxy and probably alienate most everyone here, left, right, or otherwise. But it would be cool.
Megan, go to graduate school. You need a stronger foundation in more substantial thought in spheres outside of economics. Then, you will soar.
Oh, dear -- where to even begin?
1) "Here's the problem: if markets are so great, how come the entire system can be brought low by a smallish injection of short-term capital?" -- McArdle.
Please define "smallish."
Was it really "smallish"?
2) "The alternative question for the liberals: if regulation is so great, how come one guy, or one fairly minor bill, can apparently single-handedly destroy the most heavily regulated industry in America that doesn't actively involve radioactive material?"
Is "heavily" synonymous with "competently"?
How do you determine it's the most regulated? Amount of regulations? Regulatory agencies? Strength or breadth of regulations?
Are regulations of anything inherently comparable -- outright measurable?
Or is it just that dumbass libertarians demonize regulations to the extent that they seem all the same to them?
Take your time, honey. I know it's not easy, what with your whole worldview gone up in smoke and all.
Later, if you're feeling a bit better, we can get into the concept of moral equivalence and your ludicrous efforts to equate some strawman "liberal" who may have said (or posted) something dumb about this crisis with the foolish ideologues like yourself who have been so brutally refuted by recent events.
We'll promise to be kind, Megan. Though, Lord knows, history won't be.
This is pretty scary. But at least that man injecting smallish bits of short-term capital isn't also in charge of regulat...oh. oops.
Something to consider: the recession that followed the dot-com bubble of the 1990s was ridiculously mild by historic standards (thanks to loose monetary policy); it didn't clear out all the excesses in the system. We went from one bubble to another with hardly a break, and now the coming recession will probably be twice as bad because of that.
If one fails to see the writing on the wall, who is to blame?
Mr. Greenspan, still marching around under the banner of the moron Ayn Rand, refuses to take any blame for the mess he almost singlehandedly created. The mortgage crisis is the tip of the iceberg (5 trillion dollars in bad debt). When the 55 trillion dollars in bad debt in the derivatives market is finally revealed the world capital markets will collapse like a house of cards. Thank you very much, libertarians.
The alternative question for the liberals: if regulation is so great, how come one guy, or one fairly minor bill, can apparently single-handedly destroy the most heavily regulated industry in America that doesn't actively involve radioactive material?
Well, I don't count myself as an economic liberal, but the obvious response is that the parts of the system which most contributed to the failure were not heavily regulated. In fact, they were in some cases effectively not regulated at all. If you don't believe me, just listen to Alan Greenspan circa Oct. 23, 2008.
Look, partly this is a question of being blindsided by systemic effects which nobody currently understands (and if you believe Taleb/Mandelbrot, are essentially not understandable). But things like sensible loan origination and transparent exchanges for financial instruments are not especially difficult to understand. Greenspan chose, for reasons ultimately knowable only to him, to believe that it was preferable to allow the financial institutions themselves to police risk. He did so despite the obvious distortions that competitive pressures and asymmetrical compensation schemes could cause in private risk assessment. He did so despite a growing base of empirical data that suggested historically anomalous levels of risk in loan origination.
I truly do not give a damn about philosophical underpinnings, the isms, the ideologies, behind Greenspan's reasoning. I only care that it was incorrect, and we have to clearly understand what was incorrect about it if we're to have effective economic policy moving forward. And to that end, Megan's continual refusal to acknowledge that there is any way to foresee a crisis arising from fairly simple origins is distinctly counterproductive.
At this point, I much prefer the commentary of people like Barry Ritholz and Calculated Risk, who understand finance from both a practical and theoretical level, and whose opinions affected customers, employees, and themselves. In other words, they've had to be responsible for the consequences of their opinions.
Of the two strawmen you present, I think the liberal one is a little more fake, but also less strong.
The 1% rate was a perhaps critical error, but it was pretty much one decision. Deregulation was an entire political movement in the late 90's and early 00's, not at all Greenspan's baby by immaculate conception.
Well, it took a whole 7 minutes / 4 comments for you to be made to look like a fool this time.
Remind me why The Atlantic pays you again, please?
If your preferred system is really that fragile, then maybe we should be looking into alternatives.
It really is, & indeed we should - but a large number of rich & powerful folks are standing in our way. Seems they're not fond of losing the keys to a perfectly good scam, & have no reluctance to do ANYTHING to maintain it.
Write about THAT sometime, like an adult, & you might become interesting. As this proves, you can & have done worse.
What a responsible central banker sounds like.
http://www.bloomberg.com/avp/avp.htm?clipSRC=mms://media2.bloomberg.com/cache/vl8TvJRLodUg.asf
Spring 08
Perhaps your question is answered by Greenspan's
Mea Culpa to Congress: His ideology was in error,
but because it worked well for 40 years, he came
to believe it was correct; An _emotional_ error.
Mac Reynold's caustic cautionary comment applies:
"Tomorrow might be Different": A Meritocracy.
So does Heinlein's "Future History" of the US,
hopefully not including the Last President.
For a helpful change of perspective, browse
jerrypournelle.com for views on economics,
politics, psychology, technology, and the 2nd
scariest book I have ever read: Ortega's
"Revolt of the Masses".
No.1 is Stephen Wolfram's "A New Kind of Science".
jim wrote:
Were I a less kind person, I might suggest that someone who believes that the Fed should adhere to the Real Bills Doctrine and exploits a comment on such to yet again impugn a stranger's character and call for the rescission of her livelihood is the biggest fool of them all.
The real problem is that the US conservatives have confined morality to issues like abortion, gay rights and such, totally ignoring such critical things as 1)ethics in business or the need to enforce it; 2) ethics in public life (Bush's first election which was a fraud) and rewarding financial frauds AND not prosecuting the criminals and 3)invading other countries based on lies and killing foreigners just because you can get away with it. Why get into party or ideology when clear wrong doing can be identified and punished, even now? As a somewhat conservative foreigner one sees that the US conservative have strange values or morality. And no respect for truth, ethics, fairness,equity and such things!
Odd that the biggest 'deregulation' red flag lefties can find was signed into law by Bill Clinton. Bush, on the other hand, signed into law the most onerous financial regulation in decades (Sarbanes-Oxley).
A smallish injection of short-term capital?
When Greenspan took over as Fed chairman in August 1987 M2 money supply stood at 2792.2 billion, when he left t was at 6743 billion. THE TOTAL MONEY IN THE ECONOMY UNDER GREENSPAN MORE THAN DOUBLED.
Please understand Ms Megan_McArdle, Upto a point positive economics is fine, but ultimately one has to be normative. Economics is certainly not a natural science and without an ethical underpinning it will not be respected; nor does it deserve to be.
Megan, go to graduate school. You need a stronger foundation in more substantial thought in spheres outside of economics. Then, you will soar.
Surely you are joking. The woman cannot think straight and thus spends half of her blog threads painfully retracting some earlier idiocy.
Typical McArdle crash and burn thread sequence:
1. Why should I pay for medical insurance for fat and irresponsible poor people?
2. I didn't mean to call them irresponsible. Maybe they were just born fat.
3. Maybe fat people should be insured, but I don't have to like it.
4. I'm for sensible social policies, but why do poor people make me so uncomfortable?
5. I don't know what the fuss is about. I didn't say anything controversial.
She should go back to high school and take English composition again.
Who says it was brought low? You go to work at a job you chose for an employer who chose you. You get a paycheck that may not be everything you want, but you certainly find acceptable. You take that paycheck, and probably plenty of credit when needed, to the store and buy from a vast assortment of things. All pretty much the same as you did last week and last year. The main thing gumming up the works at all seems to be that everyone is girding themselves for an impending major change in the system forced by government and that, the force of government, is the only thing that can bring it low.
Oregon Guy wrote, "This is why we liberals get upset when these pieces of legislation get undermined or revoked. "
....then why do you like the concept of the Fairness Doctrine.....?
I'm not for a command economy of any kind. But I do believe that Government should put country first and business second. That means business will have to lose now and then. One shouldn't have any illusions about this, things will go back to business as usual. We will see foolish credit moves again.
As someone who actually used to regulate and industry that involve radioactive material, I can tell you that it is not easy to figure out all of the creative ways that regulatees develop to get around the regulations. The regulators do not have access to all of the information that the industry has, they have a fraction of the staff resources available, and they cannot see inside the minds of the regulatees to understand what they really mean when they say something. It is a constant game of question and answer, with lots of "stakeholders" on the sidelines, jeering away at the participants.
In any regulated industry situation, the regulators need to have confidence that the regulatees are not crazy or stupid, and that the system they are working in is "robust", i.e., not susceptible to systemic failures from simple single causes. THis, unfortunately, is exactly what happened in the financial collapse, because the system of interlocking credits/insurance could not take any major "hits" without triggering a chain reaction failure.
In the nuclear industry, chain reaction accidents are considered VERY SERIOUS, and LOTS of work is done to try to identify their possible initiators and eliminate them. However, it is never possible to completely eliminate all possibilities. Regulators need to be given enough leeway to understand what regulatees are doing, and they need both the support and oversight of a management (and Congress) that understands and appreciates the systems they are dealing with. When you get political intervention without careful consideration of the consequences, you get results such as this financial meltdown.
Re: I wonder why there wasn't a recession in the late 80's or 90's or around 2000.
There were recessions in 1990-91 and in 2001-02. The point can be made that they were fairly shallow recessions, but they were also rather prolonged, in that the economy and sepcially the job market remained stagnant for a very long time after the period of negative growth ended.
For the Austrians, let me put it another way: if the market is so irrational that it fails to price a widely announced injection of short term capital into its future expectations, why should we expect it to be rational in any other context? If the market treats short term capital as substantially equivalent to long-term capital, we have much bigger problems than the Fed.
Megan_McArdle: If that were all the Fed-related stuff the market had to price in, you would be right. However, it also has to price in what the *future* announcements will be. Plus, even if people know the boom is fake, the short-term credit can prop up anyone not realizing its fake, long enough to take their cut.
The argument that "well regulation hasn't worked before, so why not strip out all regulation?" is ridiculous.
Regulation is like security: you're only as secure as your weakest link. If CDSes were the easiest way to go short on an entity's credit, what do you expect? People are going to take that easy route. CDSes aren't the root cause of the current crisis, but there's no denying that the estimated 55 trillion worth of them have magnified it to the potential depression-level disaster that we see today.
As I'm sure has been pointed out multiple times already, regulatory environments fall into two modes: roughly, the prescriptive, and the descriptive. The first emphasizes goals and intents, the second detail. Traditionally - at least in the U.S. - the latter is the usual model. The justification being that, supposedly, regulations that are left open to the officials to interpret will be a 'trap' for the unwary entrepreneur. Uh-huh. Prescriptive regulation fails though precisely because what is not covered in detail is usually assumed by fiat to be allowed. So it is comparatively easy to game the system with enough money and enough inside help.
Which is exactly what has happened. So we need to go back to the prescriptive interpretive model, hire able and dedicated civil servants to enforce the law . . . and enforce draconian penalties for so-called 'white-collar' crime. I'm thinking that if someone like Mozillo is proven to have committed fraud, given the amount we're talking about, he should face life in prison without parole, and he should be stripped of all of his estate. Everything.
That's the other side of the regulation phenomenon, enforcement. This sort of crime isn't penalized nearly hard enough, or frequently enough. Companies and people shouldn't get fines; they should get broken up or do hard time in jail. Employees who lose their jobs should be able to sue, and sue handsomely for losses.
If the market does not price the injection of short term capital into its actions, why would we trust it to price anything else correctly?
If you think that prices convey information, then this shouldn't be too hard to understand.
SoV, that was a common theory until Britain started going belly up too. I don't mean to sound snotty--I too think principles-based accounting would be an improvement, though I'm told it would be hard to implement in our liability environment. But it won't get us nearly as far as I, for one, thought it might six months ago.
Um, Megan? Don't you owe me an admission of error?
I read an article last month that described how 60% of American corporations paid no taxes due to loopholes and offshore tax havens. I don't know if it's accurate, but it's certainly suggestive.
The answer is that it's a combination of deregulation and a deliberate failure to enforce the remaining regulations that caused the crisis.
Enforcement is the answer.
When you have good rules that nobody follows, sh!t happens.
@Megan
"For the Austrians, let me put it another way: if the market is so irrational that it fails to price a widely announced injection of short term capital into its future expectations, why should we expect it to be rational in any other context?"
It seems as if you're asking the Austrians to justify their system based on the reaction of a non-Austrian system to something that the Austrian system would never allow - Namely a "central bank" capable of "injecting capital".
Fred:
Was/Is Sarbanes-Oxley that onerous? Bush had to sign it after the Enron meltdown. He had no choice considering he was good friends with Ken Lay.Companies still don't have enough transparency. Look at GE. They just came out earlier today and said they are tapping one of the Fed's short term lending facilities. Why? I know why. Do you?
Um, Megan? Don't you owe me an admission of error?
You're on the wrong side of waaaayyy too many bookies to be playing that game, buddy.
" Employees who lose their jobs should be able to sue, and sue handsomely for losses."
-Sue who? - You already broke up the company and put the executives in jail - are they going to pay in cigs or "shower privelages"?
- Investment and business will always have some risk. That's not to say there shouldn't be regulations and strong enforcement - there should, but you can only reduce or manage the risk, you can't eliminate it. Without risk, there is very little room for profit.
"as/Is Sarbanes-Oxley that onerous? Bush had to sign it after the Enron meltdown."
-Well, a lot of foreign companies that now avoid issuing stocks on the NYSE and instead choose London or elsewhere seem to think it is. I think some of it was very necessary, but some excessive - a perhaps natural overeaction. Even Chuck Schumer reaized this a while ago and proposed that some parts of SarbOx be re-examined, though I don't think we are presently in the correct political climate to do it. I don't know the answer, bu maybe top execs would be willing to trade some of their compensation for reduced personal liability?
It's been awhile, but I don't know that Austrians think that markets price anything "correctly". They think that markets price things better than anything else does, or, if you want to be a stickler, they think that markets are the only thing that attaches something properly called a price to anything.
I'm guessing that that an 'Austrian' view would be: the present crisis could only happen if people who are lending money have their incentives systematically detached from the likelihood that their borrowers will pay them back. Since markets don't do anything systematically, look for how the government did the detaching.
"The alternative question for the liberals: if regulation is so great, how come one guy, or one fairly minor bill, can apparently single-handedly destroy the most heavily regulated industry in America that doesn't actively involve radioactive material?"
Who the hell destroyed the pharmaceutical industry? When did this happen?
Seriously, calling the financial sector the most heavily regulated industry in America apart from the nuclear industry is the sort of comment that ought to disqualify a pundit from ever being published in any medium other than fliers stuck on light posts.
I mean, you can laugh and sneer all you want at the mounting evidence about the role self-regulated credit markets in allowing the crisis to metastasize beyond the mortgage refinancing sector, but there's a serious lack of awareness on your part. In practical terms, we had two parallel financial systems. One was heavily regulated, and the other was almost completely unregulated.
The regulated sector ran into serious problems due to a bubble, a cyclical downturn, poor individual decision-making, the relaxation of limits on leverage, questionable lending practices, and a thousand other factors that indict both political parties and several different philosophies.
But the unregulated sector -- the credit swaps and derivatives -- failed catastrophically due to massive systemic flaws in the way risk was distributed... flaws that could have been resolved by sensible regulations. THAT is the issue that you seem unwilling to address.
Companies and people shouldn't get fines; they should get broken up or do hard time in jail. Employees who lose their jobs should be able to sue, and sue handsomely for losses.
A few points: 1) These two goals are at odds. Companies are typically worth far more than their assets; break them up, and that's not true anymore. 2) Litigation is rarely the best way to solve problems, and I say that as a litigator myself. It enriches lawyers more than anyone. 3) There is a sometimes-fine line between bad management and fraud. While it would be very nice to prevent bad managers from getting golden parachutes, it's far from clear that criminalizing incompetence and hubris is going to solve anything.
Megan,
I'm not an Austrian economist, nor an Austrian advocate (in fact I often find Austrians to be irritating) but they got this one right. However, it is not just the Greenspan Put that was the problem, that is just one part, and I don't know of a single Austrian who says that this was the single source of our problems.
Now as far as the market not taking into account the increased credit, all you have to realize is that the market is people. Millions of people responding to the information that is present at the time.
Add one part low interest rates and increased credit
Add one part CRA forcing high risk mortgages.
Throw in the response of creative securities.
Watch price rise.
Watch home buyers respond when price gets too high.
Watch it all collapse.
People responded to the incentives just as Austrians and any free market advocate would predict.
Free markets are great, but they are only as good as the information within. When government distorts that information it behaves less than ideal.
My problem with Greenspan is that his Put did create the basis of our current crisis. In 2001-2003 his actions shifted the economic crisis by helping to move capital away from the tech bubble which popped. That capital found its way to home prices which kick started the housing bubble.
Again, that is one part.
But Greenspan mentions nothing about the problem with Fed rate cuts and increased credit, or problems with fractional reserve banking. He just comes out and says, “Oh, sorry, we could have regulated better.” He doesn’t address the core issue and he shifts the blame elsewhere.
George Bush and Alan Greenspan have been the two most disastrous things that could happen to the concept of Free Market Capitalism that I have seen or read about.
@Radish
The Austrian view would be that buyers and sellers both attach a value to something. When those values meet, a transaction takes place.
A seller with too high of a price will reduce their price until a buyer is found unless they value whatever they want to sell more than the buyer. In other words, prices are determined by the buyer and the seller *together*. And at that moment in time, the price is "correct" for both.
Hey, that's called a market, right? In fact, I think it's called a "free market".
The Austrian view is that the current crisis could not happen without:
1) A central bank inflating the supply of money/credit
2) Government coercion of banks to extend that supply of credit to those who didn't previously qualify
These two things more than any others are directly responsible for this crisis. Without them there would have been no real-estate bubble.
The rest of the national and international regulatory structure merely made sure that everything was so inexorably intertwined that the bubble crash spread throughout not only US markets, but the world at large.
The problem with the world financial systems and markets is not under or over regulation or any such nonsense. The issue is that there is no underlying fundamental price for anything. There is not a price list written in stone by "God" that says this is the bottom line on what a thing is worth. At any instant in time it is only worth what someone is willing to pay. Oil a few months back was going for $140 a barrel and now it is around half of that at $70 a barrel. Housing prices in some areas of California have dropped by half, yet they have not been damaged by an earthquake, or a slide down the hill in a mudslide, which would change their fundamental usefulness as shelter. A fancy Lexus sitting in the drive of the upscale new house emotionally validated the success of its owner to his friends and neighbors, only to later come crashing down. It is all just real time emotional value assessment, whether it is real property, or a credit default swap on a pool of sub-prime mortgages that no one can any longer value.
When the herd is anxious to get on the gravy train of ever increasing home prices nothing interferes with the emotion of evaluating that current price as correct and rational. When the herd suddenly evaluates everything as fundamentally flawed in value nothing can set the floor of what it is now worth. Only when everyone is not acting in emotional unison will stability and rationality return.
Megan,
I think you over-simplify the Austrian view a bit.
First of all, I wouldn't call Greenspan "evil"...and I don't think many other libertarians do either. I simply think he is victim of his own limitations and perhaps a bit of arrogance...meaning that he is human and incapable of accurately pricing interest rates the way prices self-adjust for all other things we take for granted. Besides, Greenspan's error is simply one way in which ABCT manifests itself.
For the Austrians, let me put it another way: if the market is so irrational that it fails to price a widely announced injection of short term capital into its future expectations, why should we expect it to be rational in any other context? If the market treats short term capital as substantially equivalent to long-term capital, we have much bigger problems than the Fed.
Well, Megan, I'm no economist and I'm one to sirt here and defend the ABCT in detail. BUT, having read about it from people who actually understand it, I can easily say that you don't know what you're talking about.
One would think you should understand something in strongest and unskewed form before judging it.
Why not discuss this matter with Austrians (Horwitz, Boettke, Robert Murphy, D. Henderson, Rizzo etc. etc etc.....you KNOW who they are!) who know what they are talking about and give an informed rebuttal?
I would think you actually WANT to know and not just criticize a shadowy reduction of the theory.
CORRECTION:
I'm NOT one to sit here and defend the ABCT in detail.
In regards to Megan's second point, I offer an observation from Michael Lewis's Liar's Poker.
Lewis points out that one reason why bond traders like himself loved to create exotic trading vehicles (outside of the adrenaline) was to get outside defined regulatory categories.
For all of the retrospective pro-regulatory responses to the current crisis -- including Greenspan's -- I keep asking the same question:
Without knowing what you know NOW, how would you have known THEN what to regulate?
Rothbard on Greenspan's ascendancy to Fed Chairman, August 1987.
Say what you will about the crazy ol' anarcho-capitalist and all his radical views. Yes, some of his views are pretty out there (whether some, many or any of them are false, flawed or crazy is another matter) but that is totally and 100% beside the point.
If we treat the thrust of the message in his critique of Greenspan before he even did a thing as Fed chairman and not cop out by dwelling on the messenger in general, he hits the nail squarely on the head in this linked article.
snips:
what the firm (Townsend-Greenspan) really sells is not its econometric forecasting models, or its famous numbers, but Greenspan himself, and his gift for saying absolutely nothing at great length and in rococo syntax with no clearcut position of any kind.....He has long positioned himself in the very middle of the economic spectrum. He is, like most other long-time Republican economists, a conservative Keynesian, ...Which means that he wants moderate deficits and tax increases, and will loudly worry about inflation as he pours on increases in the money supply.
...As an alleged "laissez-faire pragmatist," at no time in his prominent twenty-year career in politics has he ever advocated anything that even remotely smacks of laissez-faire....
...
Yes, the Establishment has good reason to sleep soundly with Greenspan at our monetary helm. And as icing on the cake, they know that Greenspan's "philosophical" Randianism will undoubtedly fool many free market advocates into thinking that a champion of their cause now perches high in the seats of power.
Rothbard can, at times, be like that crazy ol' uncle you keep in the back so your guests don't meet him. He may shock people with some pretty crude (however true or false) stuff but can often times really cut to the chase with the blunt truth and just tell it like it is.
And on Greenspan, he had read like 1 page book from the very beginning.
And again, I don't think Rothbard would call him "evil"...just misguided.
HTML Goof:
Rothbard's quote ends at "...the seats of power.".
I would think you actually WANT to know and not just criticize a shadowy reduction of the theory.
Actually her question is perfectly pertinent, but it isn't unique to Austrians. Lots of theories in mainstream economics, as well as Austrian school economics, assume rational economic actors and a relatively free flow of information. If the free market produces a situation where irrational economic activity can make a big profit (bigger than rational activity) in the short and medium term, and information gets bottled up, you've knocked two very important assumptions out from under lots of economic theories (not just the Austrians, but including them).
Megan,
By analogy, let's say you have a thousand acres of prime farmland. Yields are incredible.
Then you spray massive amounts of fertilizer all over the fields. Yields increase, right? And you keep doing this year after year. More and more fertilizer.
What happens eventually? You need more and more fertilizer just to keep yields the same. Because you've depleted the soil. At some point the soil is just too depleted and you can't grow anything anymore. Your prime farmland has turned into a wasteland that will take decades or centuries to return to a semblance of productivity.
Why does this happen? Because the land is an enormously complex, self-regulating system. The nutrients in the soil provide food for microbes that create more nutrients and these all fuel the growth of plants that harness energy from the sun and reproduce and grow and make more plants, and the plants are eaten by insects the insects reproduce and eventually every plant or insect dies and decomposes and adds its nutrients back to the soil which becomes richer and richer leading to ever more growth and lush, green expansion.
But when you indiscriminately spray fertilizer all over the field, it disrupts this balance and eventually destroys the system. Does this mean that the system was bad? No! It means you shouldn't piss fertilizer indiscriminately all over the place!
Now, I'm not saying that using fertilizer is always bad. Farmland is not the economy. However, you can easily see from this analogy that blaming the system for a problem THE FED CREATED is stupid. We have not seen "a smallish injection of short term capital", we have seen a massive increase in the money supply. Our economic soil is now depleted and it will take time to rebuild.
That said, Megan, while I increasingly disagree with your conclusions (you started getting nuts about the time you began working for the Atlantic) I always find your writing and your thought-process intelligent and rewarding. I notice that you have some commenters who say that you are stupid, or insult you, or that your writing is worthless. Since these people, by their own words, can't possibly be on here for any reason other than that they find reading your work and then insulting you to be rewarding and entertaining to themselves, I strongly suggest that you charge them a fee for providing them this opportunity. If they can't contribute any meaningful discussion, the least they can do is pay you something for the entertainment value they seem to derive from insulting you.
P.S. - It's getting cold. You should do your next bloggingheadsTV appearance someplace warm. Consider a wardrobe change as well - e.g., a bikini.
Hi Megan:
I am not an Austrian, but I think I have the Austrian's answer to your question: "if the market is so irrational that it fails to price a widely announced injection of short term capital into its future expectations, why should we expect it to be rational in any other context?" You actually answered it in your next point: "If the market treats short term capital as substantially equivalent to long-term capital, we have much bigger problems than the Fed."
Austrians think that maturity transformation is a disaster waiting to happen. MT enables the market to treat "short term capital as substantially equivalent to long-term capital" and as we have seen, without a lender of last resort, in an MT world this is a total disaster.
When this disaster will happen cannot be predicted. It is a random switch in the Nash Equilibrium (Diamond-Dybvig model) and could be caused by sunspots, butterfly wings, etc. We're in Taleb's fourth quadrant here and it is simply outside the realm of any model, rational or not. There is also considerable uncertainty over the terms the Treasury's money is going to come with and what the Treasury is going to do in the future.
For example: will the Treasury start to shut down weak banks and only support strong banks -- like many are recommending -- so as to avoid the "zombie bank" situation in Japan? If so, do reserves and balance sheets matter? Will hoarding cash now help make the Treasury think you are not a zombie, and so not shoot you twice in the head?
Austrians might also say that the announced injection of short term capital is much too small, and is swamped by the decrease in money supply as the economy takes it's very long journey back to the sustainable consumption/investment frontier. Certainly the Government thinks its past capital injections are too small, as it keeps announcing new ones.
Let me know if you want to talk about the Austrian view further (not that I am an Austrian)
-winterspeak
Megan: Just saw your update.
Are you sure you're talking about Austrian economists, or neo-classical Chicago school economists? You say Austrian, but efficient markets is more central to Chicago school economics.
Are you really asking about Austrian Business Cycle Theory, or the EMH/forward looking rational utility maximizer model? They aren't the same.
I always thought Megan was Chicago School, but I'm an ignorant layman.
Regulations are only as impotent as the regulators enforcing them. For the past 30-odd years there has been an increasing emphasis on NOT regulating and disempowering and neutering regulators. Additionally, through a series of poorly (or cannily) thought out legislative and business practice decisions this "shadow banking system" was allowed to spring up that was subject to practically no regulation of any kind. It wasn't a matter of if it would collapse but of when.
I loved Greenspan's "mea culpa," which apparently basically boiled down to "I never expected the financial wizards to be greedy rapacious b-st-rds only out to make money for themselves." Who'da thunk?
If your system relies on "ethical behavior" from its participants, once you expose that system to the real world it is doomed.
I'm with winterspeak. I believe Megan is mistaking the neo-classical/rational expectations model with the Austrian model. In the Austrian model monetary distortions are central to the bussines cycle, wich includes a process of assest overpricing. That's why Mises defended the gold standard his entire life. And so do his followers.
To put it another way, Mises believed (unlike Lucas) that market participants are indeed fooled by monetary malpractice.
On another note, I'm writing from Spain. Our regulatory framework, and even our financial structure, are very, very different to those in the States, and still we pretty much have the same problems (gigantic real estate bubble financed through foreign debt). Massive monetary expansion (How can Megan talk about a "smallish injection of short-term capital"?!?) is the common link (Spain had joined the Euro and was "enjoying" German interest rates).
Yet another element in common is the fact that the bubbles were allowed to form withouth substantial downward currency pressure. In Spain's case because it had adopted the Euro and in the American case because of the effort on the part of East Asian countries and petrostates to mantain the dollar block.
On yet another note, Greenspan is, indeed, a disgrace. He mantained rates low because it was politically expedient and justified himself by arguing that asset prices have nothing to do with inflation. When catastrophe inevitably ensued he argued that asset prices were inmune to monetary mesures so, what could've he done?. Now he's talking about the morality of bankers and whatnot. What a dishonest scoundrel.
I actually think that Megan is wrong on both counts here.
To defend the Austrians, who I am not in the habit of defending, the market issue was largely a failure of pricing, brought about partly by A.G.'s actions and inactions (and those of a suite of other actors, including ratings agencies).
To defend the neo-Keynesians (to put all of the critics into an ideological bucket), calling the S-O repeal "minor" is simply incorrect, since it transformed the nature of financial regulation, especially with regard to accounting rules. Regardless, Megan's argument here is largely along the lines of "if we repeal good laws or introduce bad laws, and disaster results, doesn't that mean that the legal system is ineffective?"
I'm not an economist (much less an Austrian one), nor did I stay at a Holiday Inn Express last night. Nevertheless, I think I can provide something worthwhile to the conversation.
At the most basic level (in my understanding) the Austrian school believes that information is widely-dispersed, ever-changing, and passed along indirectly in the form of price.
They're on pretty solid ground here.
I don't believe that they've ever posited that a government, central bank, or some weird combination of the two is unable to distort price (and thus, the information indirectly conveyed).
Let's take a step back, and juxtapose this with Smith's observation about business concerns being hostile to competition.
Adding to the money supply in the manner the Fed did, enabled a great degree of consolidation in the financial industry. (Which is conveniantly verifiable.) With this consolidation necessarily came a great degree of centralization.
From the Austrian perspective, as I understand it, this means that the financial concerns necessarily were seperated from direct knowledge by their centralized structure, and became more dependant upon the indirect information conveyed by price. Which the government, Fed (and yes, public sentiment) were actively distorting.
There's anecdotal evidence supporting this. The community banks were subjected to the same pressures, but did not make the same choices. Had there not been a bailout, I speculate that these localized concerns would now be buying up and decentralizing the financial concerns that crashed. To my mind, this would have been a good thing for future financial stability.
I don't believe the Austrian school posits that man is a rational actor. (If so, it would be demonstratably wrong.) I believe it merely claims that those in the position to make the most-informed choices, and pass along this information indirectly in the form of prices are inherently decentralized. And that it's much more effecient to have countless people making relatively-informed choices (perfect knowledge being impossible) and passing along the results in the form of price, than to have a few individuals with only partial and dated information attempting to make sweeping choices for the society. (There are also some philisophiocal arguments about voluntary choices being morally superiour to the coerced action. It looks like a few of your readers would be well-served to familiarize themselves with these.)
Nor am I aware of any critique of Greenspan as evil.
I'm sure good intentions were informing his hubris, just as much as in the cases of the politicians and financial gurus who were also driving this trainwreck. This is, I'm afraid, hurting us in the current debate. A rousing cry of "Snowball did it" inflames the passions, and our reason is generally a slave to our passions. Arguing that it was a confluence of several factors, nearly all advanced with the best of intentions, unfortunately, doesn't carry the same weight.
Austrian economist Bob Murphy has responded to Ms. McArdle's post @ http://consultingbyrpm.com/blog. Although he has a tone of irreverence he does produce a fairly straight forward relationship between the real fed funds rate and the boom in housing. I do hope Ms. McArdle will respond and not use his unfortunate tone to excuse not responding to his (dare I say for an Austrian) empirical argument.
SOV - "Employees who lose their jobs should be able to sue, and sue handsomely for losses."
Rob Lyman nicely covered the fact that extra litigation would eat up huge amounts of cash while likely solving few problems.
But if companies can be punished for layoffs, they're going to be far more conservative about taking anyone new on. Employment will be lower. And injured companies will frequently wind up in death spirals which ensures that everyone in the company winds up on the street. Increased employee litigation isn't going to be better for employees overall and in the long run.
Also, I don't think this solution properly addresses the parties injured by corporate fraud. I can't sue the grocery store if they don't provide me some food that I've come to rely on. But I can if they falsely misrepresent their products.
Or to put it another way:
I'm all for punishing CEOs for committing fraud. But the repeated political attempts to punish corporations via the state for who they hire or fire seem unhelpful in the bigger picture. The legally injured parties should be confined to those investing in the corporation or those defrauded by it.
Also, turnabout is fair play. If we're going to make it possible to sue people for layoffs, then corporations should be able to sue their employees too, either for incompetence or for simply leaving the company if they were needed. I certainly don't want that. I'd rather just have people freely associate so long as they don't defraud one another.