Six Ideological Errors That Led to Financial Crisis
Princeton professor Alan Blinder identifies the 6 key policy errors that were the key elements in the financial crisis.
He especially notes that this was not a neccessary outcome of capitalism, but rather, was the result of six avoidable errors. And while the professor calls them “human errors” he himself errs — these were not merely cases of poor judgment, but rather, they were ideological errors.
As I noted in Bailout Nation, these decisions were driven not by pragmatic realism, not bad attempts at problem solving, but rather, due to an intellectual free market jihad. They were caused by a radical deregulatory zeal that could only be affected by “religious” ideologues:
WILD DERIVATIVES In 1998, Brooksley E. Born, chairwoman of the Commodity Futures Trading Commission, tried to reign in derivatives. She was shouted down by Robert Rubin, Alan Greenspan, and Larry Summers.
SKY-HIGH LEVERAGE In 2004, the S.E.C. let securities firms raise their leverage from 12 to 1 to 33 to 1 and greater.
SUBPRIME SURGE From 2003 to 2007, subprime lending grew unsupervised by the Fed into a large, dangerous credit facility. Lending standards fell disgracefully, as dubious transactions became common.
FIDDLING ON FORECLOSURES This is one where I mostly disagree with professor Blinder’s conclusions. Home prices remian dangerously elevated; Foreclosures are driving prices back to a more normalized range. Until prives revert to historical metrics, real estate will stay weak, and the economy soft.
LETTING LEHMAN GO Its not that letting Lehman Brothers fail was such a terrible decision — it was that there was no undferstandable difference between LEH and Bear Stearns. The inconsistency was part of the problem. Add to it, the idiotic managment of LEH, who should have asked for an orderly dissolution assistance from the Fed.
TARP’S DETOUR The Troubled Asset Relief Program was an on-the-fly, no strategic planning, seat of the pants, inconsistent mess.
Purchase bad assets? Recapitalize banks? Rescue homeowners? Jumpstart the economy? Just WTF was the point of TARP? Its morphed so many times no one has a clue . . .
Professor Blinder notes these were a series of largely avoidable errors — but he does not explain what types of errors they were. They were not due to greed, or miscalculation or even systemic regulatory problems. They were inavoidable errors caused by a faulty belief system.
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Source:
Six Errors on the Path to the Financial Crisis
ALAN S. BLINDER
NYT, January 24, 2009
http://www.nytimes.com/2009/01/25/business/economy/25view.html
January 25th, 2009 at 8:05 am
“faulty belief system”. So financial markets and economics are faith-based systems. That’s really sad.
On the other hand, the thought lifts a veil of confusion I’ve had for years– why are economists so dumb as to, for example, not realize that 20%/year house price increases aren’t sustainable. I’ve been trying to understand Soros’ Reflexivity– what’s the big deal to say people follow illogical trends causing unstable behavioral systems? I guess the big deal is that it’s not just a new prophet, it’s altogether heresy. View the last 20 years with religious psychology and behaviors in mind, and things make a lot more sense.
January 25th, 2009 at 8:10 am
Well, as I see (just a dumb old middle-class software engineer), the heart of the problem that was not addressed was the regulators not holding big companies accountable (e.g. naked shorting). This is a systemic problem for USA politics and I don’t know of any work-around.
Going further, clearly allowing financial institutions (which for centuries have been going bust) get too big to fail was a key problem. This is just another manifestation of my first point.
Finally, it appears to me that the whole fractional reserve banking system is inherently unstable and corrupt (allowing big bankers to unfairly profit by creating money from thin air) and should be eliminated. I believe the late Murray Rothbard had an alternative banking system.
Of course, what are the chances of any actual fixes of this fundamental a nature actually happening. I don’t spend much time thinking about it. I spend most of my time just trying to defend myself from the unfair actions of a system that has become rotten to the core.
MontyHigh
January 25th, 2009 at 8:20 am
From the credit crisis and economic collapse, to our health care policy, to the Katrina response, to the Iraq adventure, and on and on and on, you can count on our ideological blind to lead our ideological blind. Not only can you count on it, you can take it to the bank and short this pig all the way down to SPX 150.
January 25th, 2009 at 8:26 am
Change “WILD DERIVATIVES” to ALL derivatives, and the other five items disappear.
Getting rid of all that systemic risk with the elimination of one financial ‘inovation’ is worth missing whatever good they’ve done. Getting rid of derivatives at this time would cause major systemic problems, but guess what, that’s what they’re causing anyway!
January 25th, 2009 at 8:30 am
SKY-HIGH LEVERAGE In 2004, the S.E.C. let securities firms raise their leverage from 12 to 1 to 33 to 1 and greater
——————-
I’m sorry but these numbers are so incredibly exorbitant, and the naysayers were so incredibly crushed that these were not mistakes anymore. They are, pure and simple, the sign of a system that had run amok.
The problem is so complex that it is impossible to find a solution. We will try everything because that’s what human being do.
January 25th, 2009 at 8:31 am
Makes sense — ideological pitfalls are the most difficult to avoid, as we resist all efforts to recognize or avoid them.
“Faced with the choice between changing one’s mind and proving there is no need to do so, almost everyone gets busy on the proof.”
~ John Kenneth Galbraith
Sadly, I cannot imagine a system run by human beings that is capable of avoiding ideological pitfalls. It takes extreme pain to impose learning on the masses, and that learning lasts only so long as the people who have experienced it do — witness the deconstruction of most of the barriers erected following the Great Depression (Glass-Steagall, debt avoidance, etc) as the majority of those who were around in those times pass on into history. We will doubtless see regimes repeat the Nazi experience in decades to come, and there lies ahead of us a long, long series of massive frauds and real estate calamities.
Perhaps humanity will eventually evolve from almost-sentience into true thoughtful contemplative beings, capable of constructing social systems capable of inculcating long-term learning. But I am certain it will not be for many tens of thousands of years, assuming people have survived overpopulation, global warming, and widespread access to nuclear weapons (and worse) in the interim.
January 25th, 2009 at 8:40 am
Have you ever played Snakes and Ladders with a child?
The last time I played this game with my 7-year old, I had quite the revelation. She kept on losing and with every loss, her anger would grow. I was amazed at her reaction because this is a game of luck. In no way does it reflect a lack of skill. I remembered losing to my dad when I was around her age and reacting the same way.
There and then, I came to the realization that above feeling competent, human beings want to be lucky. We WANT to believe that there is a free lunch just for us.
January 25th, 2009 at 9:02 am
Ok…now I’m really aggravated. This whole article, and Barry’s critique of it, totally whiffs. Nobody wants to admit the ugly truth…over the last 30 years Americans have been conditioned to take pleasure now and worry about the bills later…and they finally came due. To blame derivatives from 1998 on, leverage since 2004, sub-prime, Lehman, TARP is to blame the catalysts for finally ending the madness, not the root cause. It is like losing the Superbowl 42-0 and blaming the loss on your fumble that caused the last touchdown from you opponent.
The irony is that Blinder almost put his finger on it in his first paragraph when he asked “Didn’t we learn how to avoid such catastrophes decades ago? ” Well it was the very moves to avoid or lessen any and all recession since the early 1980’s that got us into this mess…tinkering with the free market. Few can see it for what is is now, because they are still drinking the kool-aid…still brainwashed that the last 30 years was anything but a credit bubble…so large that it’s mere slowing down has caused so many problems. Total credit has not even deflated an iota as yet…still 359% of GDP.
The “crisis” wasn’t caused by “free market jihad”…quite the opposite…this was caused by 30 years of messing with the true meaning of free market. Getting back to sanity will be unbelievably hard and painful…think quitting heroin cold turkey.
January 25th, 2009 at 9:14 am
danm and Steve Barry hit the nail on the head:
I would articulate the ruling ideology as the following: “Everyone else has an ensconced Aristocracy, why can’t we”?
Because this is America! (or, at least used to be…)
January 25th, 2009 at 9:18 am
Oh! I think I see a trend here …
“5 Financial Crises”
“6 Ideological Errors”
…
Will the next be “7 Deadly Sins” ?
January 25th, 2009 at 9:30 am
Steve Barry is right. I’m just as annoyed as he is about the whole avoidance/denial of our national addiction. I’ve been watching the disease progress for years, knowing that it was going to consume its host in the end. Now the disease is beginning it’s final stage of destruction, and we are still in denial about the basic illness.
January 25th, 2009 at 10:08 am
I can’t disagree that a lot of people are hurting. Some even had nothing to do with any part of the excessiveness. People on the fringes of high times are now in the middle of dark days.
Then there are the ones who bailed in time, more or less. The ones who didn’t participate in the excesses. The ones who sold their homes at inflated prices and didn’t replace their home with a McMansion. The ones who lived modestly and have a pile of savings to show for it.
I bailed at the peak in late 2007. Got back in when I thought things had bottomed in 2008. I ended up losing most of my 2007 profits before bailing completely. (If Cramer hadn’t said ’sell everything’ I would probably have held on for a few more days and lost a lot lot more.) Now I’m back in a little and suspect this is pretty much a bottom.
Over the past decade, I’m up a lot. I suspect a lot of others are, too.
The point I’m trying to make is the market is a zero sum game. For every dollar lost, someone else won it. The losers are the whiners. A lot of the losers really believed that magic skills existed that permit gifted souls to always win in the markets. Technical Analysis helps keep this stupid idea alive by making guesswork look mathy, thus precise.
Anyone who gave their hard earned money to these fluffsters probably lost a lot of it. The fluffsters only real skill was/is the ability to hype themselves and probably believe the fluff they used to rangle in the rubes. The fluffsters still run the house, only the game has changed to take money from Uncle Stupid and whine about the unfairness of it all.
Some of us are only inconvenienced and impatient for some normality to return. Unfortunately, this will not happen until eithe the US Govt has gone broke subsidizing the fluffsters OR a new bunch of real managers enters the picture, ruthlessly dealing with the crooks and incompetents still running banks and Investment houses. A complacent press and public and Congress is tacitly supporting the fluffsters because most still have their jobs and none are yet in jail.
Stupidity shouldn’t be rewarded. Unfortunately, if the penalty doesn’t hit a personal pocketbook, the instigators just continue to get away with it and mock the rest of us.
January 25th, 2009 at 10:15 am
OK, we have ideological errors.
But isn’t there something structurally wrong when those ideological errors can threaten other more fundamental parts of the financial system? After all, 5 of those 6 errors are the playthings of a small elite of people who have managed to move themselves into positions to profit handsomely from the reckless manipulation of other people’s money – and those other people have no knowledge, control and, ultimately, recourse.
Let’s start with an obvious structural problem: there ought to be no connection between banks that perform the useful basic banking functions and those that are engaged in running leveraged investment programs. Yes, I know we nominally have a degree of differentiation today, but it ought to be absolute. Could we have a number of regional or national banks that were legally non-profits? Closely regulated, earnings untaxed, fully government guaranteed, no limit. And other companies (let’s not call them banks, either) that were able to do leveraged investing, are absolutely not guaranteed actually or implicitly and are heavily taxed.
It bothers me that so much of what comes out of the mouths of economists and government oficials to date about this whole problem has simply been short-term noise. We have to save-save-save-save these critical institutions. This is simply BS. We have to destroy some and change the rest or we will not have fixed any problems. So – which ones and why and how? We have, at best, a rudimentary understanding of the Great Depression. Now we have a chance to live through a second example, live and in person, with supposedly a better understanding of the fundamentals of economics. We should be learning and making suggestions of fundamental change but are instead arguing points of yesterday’s ideologies as though they are religions.
January 25th, 2009 at 10:15 am
This idea that you can separate the political system from the economic system is what needs to get wrung out of people’s “beliefs.”
The only place you’ll have a perfectly free market is in a political system that is perfectly unfree, the middle of a jungle, or in the speech of some GOP candidate. Groups have different needs. Laws and rules are there to restrict someone’s behavior …always. Get off the free market ideology and get into the real world.
Ironically, while politicians complain that banker’s pay needs to move from short-term to long-term incentives, our political system also is full of short-term incentives. We are in a long experiment on getting the political system running resource distribution just right. Blinder’s points, BR’s points and the multi-year credit bubble are all part of the institutional, system-wide learning process.
January 25th, 2009 at 10:21 am
Thanks SB.
On bubbles, The Atlantic had a neat little article on university bubble research last month, written by Virginia Postrel(formerly of Reason magazine). I love The Atlantic, some great thought provoking stuff..
http://www.theatlantic.com/doc/200812/financial-bubbles
It was really enlightening, a quote: “Besides, Noussair emphasizes, “you don’t just get random noise. You get bubbles and crashes.” Ninety percent of the time.”
Get yours now, hope for the greater fool, inevitable crash cycle, repeat. Matches up to my layman’s understanding of E-wave.
January 25th, 2009 at 10:24 am
I do not understand the fixation on stopping foreclosures. I understand that lowering the number of foreclosures is a good thing, but until the layoffs stop, you are pissing into a hurricane force wind. Any monies allocated to stop foreclosures will be a total waste. Better to utilize those dollars to increase commerce and save jobs; or keep increasing unemployment assistance. Until job growth appears, the homes are going to go under the auctioneer’s gavel.
January 25th, 2009 at 10:26 am
@Steve Barry
I agree with everything you say except your time frame. I think it goes back at least forty years and possibly longer.
January 25th, 2009 at 10:44 am
Why post those 6 and leave out the most important three?
1. Believing that the Federal Reserve can stimulate the economy short term w/o doing damage in the long term. Easy money 20’s and Easy money 01-04 both lead to the successive Great Depressions, I & (soon to be) II.
2. Believing that rating agencies that get their money from the sellers of products they regulate, will regulate judiciously. “It could be structured by cows and we would rate it.”
3. Believing that GSE have helped the housing market rather than hurt it. GSE’s that allow people to buy homes who otherwise can’t buy homes are as bad as government bailouts that keep zombie banks (and I use that term loosely) alive when they should be put down.
Just as the monetarists on the right are wrong, so too are the keynesians on the left. Both do the same amount of damage; they just use different weapons.
January 25th, 2009 at 10:45 am
@Andrew:
Thanks…great piece. It does seem that human nature never changes. Every 70 years or so, like clockwork, there is a bubble of some kind. It takes that whole generation to die out to fool the next generation…railroads in 1850…radios in 1920s…Internet in 1990’s. In 2070, there will be something else, maybe teleportation.
The ancients knew about this…they took steps to prevent bubbles:
“In biblical times, the Israelites were forbidden from planting or harvesting every seventh year in order to allow the land to replenish itself. For the people living on the land, it was also a time of replenishment: every seventh year debts were cancelled. ”
http://www.ajws.org/who_we_are/news/archives/viewpoints/a_call_for_a_sabbath_year_to.html
January 25th, 2009 at 10:49 am
@whos on first:
You could have a point about the bubble being even longer. I have the cart back to the 1920s…Credit has been rising virtually non-stop since 1953, when The Diner’s Club issued the first general purpose credit card…I just think from 1980 on is when it really started becoming a problem.
January 25th, 2009 at 10:54 am
gak Said:
January 25th, 2009 at 10:44 am
1. Believing that the Federal Reserve can stimulate the economy short term w/o doing damage in the long term. Easy money 20’s and Easy money 01-04 both lead to the successive Great Depressions, I & (soon to be) II.
reply:
Most people have it wrong, even the textbooks. The money supply doesn’t mean squat.
The availability of credit is the power behind growth and bubbles. Cash could fall from the sky and that would do little to stimulate the economy, although it would probably do a lot more than giving cash to banks. Lower interest rates help make credit affordable, but a lack of credit is what keep the economy down. Low rates by themselves won’t hurt a fly, let alone crash an economy. Japan provides evidence of this.
Congress needs to make credit available to people, not just give cash to banks. Then the economy will right itself.
Then, if the banking industry returns to normal and credit becomes as free as Herpes, we might see another boom/ bust cycle. Nothing being done now is inflationary in the slightest. All Congress is doing now is subsidizing fluffsters.
January 25th, 2009 at 11:29 am
Barry, it would seem to me that the flaw in Professor Blinders point, especially the first three, is that because these things were available, they had to be utilized. It is constantly argued that the excessive CEO pay packages are required to get the ” best of the best” candidates for the position. And what did we get for believing this? We got Jimmy Cayne, Stan O’Neal, Dick Fuld, John Thain, Ken Lay, Bernie Ebbers,Dennis Kowsloski,Angelo Mozilo and so on and so on. Not a single one of “the best of the best” had the vision to see that these things were not the sound choice to make? For the hundreds of millions of dollars we were paying them, you would think one of them would have had the brains to steer there company on a different course.
If I may draw an analogy to Apple Inc..A large portion of the public and pundits are currently arguing that Steve Jobs and Apple need to enter the sub $1000 desktop computer business and build one for $500-$600 in order to compete with the other manufacturers. Now I think there is no doubt that Steve Jobs knows he could build this machine, slap an Apple logo on it, and instantly increase their market share, but as he has so aptly put it, that never has been nor will it ever be Apples vision. This is what a real CEO is supposed to do. He is supposed to have a sound vision and plan for his company, and then he is to execute that plan and vision better than any one else in the industry. That is what you pay large compensation for, not for a CEO who merely does whatever anyone else is doing.
Until we accept the fact that the majority of CEO’s are in fact not much smarter than the average politician, and that we should be looking elsewhere for talent, we will continue to have guys like Ken Lewis running our companies, and guys like him on the Board of Directors Compensation Committees.
The very fact that all these men have testified to Congress, that no one saw this coming, is all you really need as proof. They just aren’t very bright! Betcha they thought the ipod wouldn’t sell, nobody would pay for music, and why would Apple even think of entering the cell phone market?
January 25th, 2009 at 11:36 am
How are these “ideological” mistakes? There is no coherent ideology animating any of them, except perhaps, an ideology that believes pain is best when delayed the longest, which of course, SB more or less observed above, seems to be the relevant ideology for most of America the last forty years.
Here’s my “ideological” mistakes:
1) Allowing markets to work until they don’t. Something tremendously bad happened in 1998, but it wasn’t the failure to regulate derivatives. It was the fed’s forcing of the rescue of LTCM. You can’t believe in markets on the upside only to completely abandon them on the threat of failure, systemic or otherwise. LTCM’s rescue was the “mustard seed” of moral hazard that grew into a giant tree by 2007.
2) Mismanagement of the money/credit supply, beginning in roughly 2001, and steamrolling all the way through 2007, particularly getting out of hand in the last four years of the era. Money is just a medium of exchange, store of value, and method of measurement. The ideological idea that it can be adroitly managed to create real wealth is just fallacy. All it can be managed to do is create real illusions, that ultimately then destroy real wealth.
3) Not allowing Bear, AIG, Citi, Bank of America, Goldman, et al., to fail. Just like all the other Steinerists, Blinder blunders when he claims allowing Lehman to fail was a mistake. It was the only sane thing that happened in 2008. Had we let all the rest fail, had we believed that markets give us good price signals on the way down as well as up, we would be much closer to having this excess-money/credit-induced madness behind us. Now we just have a bunch of zombie banks that will be dead in every aspect except their continued consumption of our precious resources.
The thing that gets me in all this is that nobody seemed concerned at abnormal-sized gains on the way up, in housing and otherwise–there was no need for government intervention then to deflate the bubble–even though, the government’s expansionary monetary policies caused them in the first place.
But now, once it all lies shattered on the floor, we must rescue all these institutions so that we can get things back to “normal”. Does “normal” mean overpriced, ie., inflation-induced price illusions, for assets? ‘Cause that’s the only way things can get back to “normal” with the existing system.
I think we’d be better served to try and move past the past, let what will fail, fail, and gain the sobering realization going forward that assets don’t go up 20% per year outside of some serious government tinkering with the method by which their prices are calculated, so let’s not tinker going forward
January 25th, 2009 at 12:19 pm
Oh god, the jihad continues.
January 25th, 2009 at 1:13 pm
I think that letting Lehman fail was the best decision that Paulson made during the course of 2008. Would it have been nice if he had come up with a consistent, all-encompassing policy for dealing with failed financial firms? Of course. But at the time, it probably not so easy to predict the exact course of events that would occur between March of 2008 and January 20th of 2009. (Who in the Bush administration is going to care what happens after 1/20/09…?). Furthermore, as I understand it, the amount of taxpayer money put at risk would have had to be far greater in the case of Lehman.
In any case, had the Treasury adopted a consistent policy regarding Lehman and Bear
(i.e., bail out both or neither),I really doubt that the current state of the economy would be any different than it is now. I see this as a rather petty issue in the grand scheme of things.
January 25th, 2009 at 1:56 pm
OFHEO had a staff of 200 people. They had the authority and responsibility to supervise a grand total of two organizations, Fannie and Freddie. What a spendid job those regulators did, huh? Both organizations have been complete basket cases for almost a decade.
The rest of the financial services industry is among the most regulated of all industries. Off the top of my head, I can think of several regualtory bodies who have responsibilty to regulate the financial services industry. The Federal Reserve, The Office of Thrift Supervision, The FDIC, The CFTC, Comptroller of the Currency, The SEC, state insurance regulatory bodies, and probably several minor regulatory agencies that escape me at the moment. And on top of all that, we have Congressional oversight committees charged with looking over the industry. All those regulators and overseers failed to prevent the current mess, but more regulation is the answer?
Take Madoff as an example. One man, Markopoulos, gave The SEC the Madoff fraud on a silver platter years ago and the regulators ignored it. But the SEC wants to give priority to going after one of the nation’s top entrepreneurs and visionaries, Steve Jobs, for possibly not fully disclosing his health issues. More regulation is coming, that much is for sure.
God help us all.
As I’ve said repeatedly, the failures occurred in the board rooms and executive suites. It was a systemic failure of corporate governance that’s the primary cause. Boards breeched their fiduciary duties to shareholders to hold management accountable. Boards allowed perverse incentive systems at sharholder expense. Boards allowed management to rely on retarded risk management systems (value at risk) to take on greater and greater risk.
The outrage is that boards allowed all this to occur. Why do we have such weak boards? I think in part it can be traced to the fact that the vast majority of common stock in this country is held by institutional investors like pension funds, mutual funds and hedge funds who would rather sell the stock when they don’t like the direction a company is going rather than roll up their sleaves, take a board position and make strategic changes. And D&O insurance insulate boards from liability for bad decisions making.
We need to reform corporate governance, not piss all over free markets and cry for more regulation.
January 25th, 2009 at 3:24 pm
dead hobo said:
“Most people have it wrong, even the textbooks. The money supply doesn’t mean squat.
The availability of credit is the power behind growth and bubbles. Cash could fall from the sky and that would do little to stimulate the economy, although it would probably do a lot more than giving cash to banks. Lower interest rates help make credit affordable, but a lack of credit is what keep the economy down. Low rates by themselves won’t hurt a fly, let alone crash an economy. Japan provides evidence of this.
Congress needs to make credit available to people, not just give cash to banks. Then the economy will right itself.”
1. Easy Money doesn’t just necessarily mean increasing the money supply. Easy Money can mean (and usually does mean) an increase in credit that is not backed by savings or a sound money standard.
2. Malinvestment is directly proportional to an increase in using Other People’s Money (see Thain, John, 30 to 1 leverage, S&L criss, 1920’s margin accounts in the stock market, etc)
3.The availability of savings is the engine of sustainable growth. Credit that is backed by fractional lending is a fraud that always collapses on itself. The size of the credit extended determines the length of time of the bubble.
4.Congress doesn’t make credit available to people. On the surface it may appear that they do, but you have to look past the surface. Congress and/or the Fed (depends on the situation) confiscates savings from people and then tries (poorly) to central plan its use. (See Roosevelt Gold Confiscation, purchasing power of the dollar 1913 to present, etc). That is not making credit. That is forced redistribution of assets. When looked at generationally, our $11 Trillion debt (but is really $55-$60 Trillion) is the prime example of that. Future generations will pay dearly for Congress “making credit available to people”
It is disheartening that so many think that Congress actually has that power of making credit. Savings and a sound currency make *sustainable* credit available to people. The sooner we relearn that, the better of we will be.
Gak
January 25th, 2009 at 3:26 pm
“…these decisions were driven not by pragmatic realism, not bad attempts at problem solving, but rather, due to an intellectual free market jihad. They were caused by a radical deregulatory zeal that could only be affected by “religious” ideologues.”
You are 100% correct. It comes down to people in power who took Ayn Rand’s horrible piece of fiction and held it up as their economic bible. Remarkably similar to how that other talentless writer L. Ron Hubbard created a religion.
You would think that after this disaster they would recognize the failure of their ideology, but not so. Though, at least Allen Greenspan have expressed regret.
January 25th, 2009 at 4:44 pm
This argument against “ideology” is a total nonsense. The alternative to this so-called free-wheeling capitalism is…. no ideology at all? No principles? So when something happens, you take somewhat random actions with no reference to the “big picture”? Something like… I don’t know… maybe TARP?
In fact, it’s a disagreement between ideologies, and that’s a much better way to frame it than to simply dismiss anyone who claims to have a principle you disagree with as a religious zealot.
I actually agree with most of Barry’s conclusions… just not the idea that this is only or even mainly caused by the free-market. It’s caused by the unholy union of the free-market and rampant interventionism. I would be very hard for something of this scale to happen without government control of the money supply, interest rates, and GSEs.
And the lesson I see is, if you’re going to have the government meddling, you damn well better regulate it heavily. I’d, of course, prefer to get rid of the meddling, rather than removing the capitalism. Sorry I’m such a “zealot.”
January 25th, 2009 at 5:31 pm
ToadB Says:
January 25th, 2009 at 3:26 pm
” It comes down to people in power who took Ayn Rand’s horrible piece of fiction and held it up as their economic bible. Remarkably similar to how that other talentless writer L. Ron Hubbard created a religion.”
Wrong. Allen Greenspan who wrote about gold and a sound currency in the 60’s is not the same Allen Greenspan who became a statist as a Central Banker in the 80,90, 00’s. Think Darth Vader/Annakin Skywalker and you get the right idea.
Gak
January 25th, 2009 at 5:37 pm
How is that 33-1 leverage calculated? They weren’t borrowing all that money were they? Is it driven up by the nominal value of the swaps and derivatives they sold?
January 25th, 2009 at 6:07 pm
The alternative to this ideology is pragmatism. Just the necessary level of regulation, doing what works and not what your ideology demands you to do.
Gak, I think you might have Greenspan backwards.
NYT had a piece titled “Greenspan Shrugged’; When Greed Was a Virtue And Regulation the Enemy.”
“Mr. Greenspan’s embrace of greater regulation is a remarkable turnaround for an economist who for many years was a close friend and colleague of Ayn Rand, the high priestess of unfettered capitalism, who fulminated against the ideas Mr. Greenspan now espouses.”
January 25th, 2009 at 6:32 pm
Sorry to sound like a sycophant Barry but I agree with you in every respect. Alan is right except with respect to price controls. We need to let housing fall to its normal level which in my judgement would end up being 30% below its current price level. Evidently, brilliant minds think alike.
January 25th, 2009 at 7:42 pm
since the main problem was a policy of credit that was too easy, too long from the central bank, why is the free market subject to so much blame? what free market has ever created such an institution?
January 25th, 2009 at 10:08 pm
Good list. I think the Bush administration ran the ball over the goal line (or maybe got the safety!) by not doing the basics: enforcing the law and being real conservatives. For example, why fiddle with the short uptick rule- fixing something not broken because it’s not enforced?
Also, the ultimate free market ideology leads to laziness in the regulators, doesn’t it? They don’t have to do anything.
I actually think the military issues have been handled not too badly, but the political economy is a disaster. The other thing that’s so ridiculous is that it’s an “administration”/group of people. Bush wasn’t the only guy in the room… much like Hoover. He was the most respected business/economic mind of the time, and now he is derided. The free marketers (like me) should take a hard look at that.
I voted for Bush both times, and still think his opponents would have been worse. That’s all that matters in the voting booth in real time…..20/20 hindsight- well, who knows….
January 26th, 2009 at 3:12 am
Ritholtz’s posts are becoming a broken record (”Free market ideology is the root of all evil”), but I’m enjoying more and more reading the comments section, where this simplistic read of current events is regularly dismantled by his more thoughtful readers. Here’s my take on six real ideological errors at work here:
1. The belief that ending the Fed is “tilting at windmills,” a hopeless pursuit at best, and so therefore, we should simply learn to live with this elephant in the room by taming it as best we can with a slapdash (pardon, “pragmatic”) set of regulations and regulatory agencies to try and whack the various credit moles that will continually pop up when you have a central bank continually goosing the system with credit.
In reality, there’s absolutely nothing in history to suggest that the Fed or fiat money are permanent fixtures in the American economic landscape. Quite the opposite, in fact. The Fed’s 95-year history is an absolute catastrophe, with the Dow average measured in terms of ounces of gold having gone almost nowhere in that period (in contrast with the nineteenth century, a period of largely free, wild, laissez-faire [horrors!], wildcat banking, in which both real economic growth and the rise in stocks were more sustained and robust)
Surely, though, the Fed is the fault of free market ideology taken to excess!
2. Saving Bear Stearns, or, more generally, privatizing profits when the market heads up, and socializing losses and providing bailouts when it goes down. This idea has reigned ascendant since 1987 at least. It was the prime culprit in convincing market participants to ignore risk, because almost no large player ever failed from having taken on too much risk.
I’m not sure what this has to do with free market ideology, but maybe Barry explains it in his new book “Bailout Nation.”
3. The belief that centralized regulatory bodies will remain immune to bullish, pro-speculative forces dominating the rest of society.
Essentially, to believe that government regulatory bodies instituted in the aftermath of spectacular market crashes like 1929 and 2008 will work, you have to believe that they will retain a cautious, wary mindset even as the broader atmosphere eventually becomes one of incautious risk-taking, as the old post-crash hangover finally disappears completely. In other words, you have to believe regulators will (1) successfully stand apart from the permabull mood sweeping the rest of society (2) accurately perceive that such a dangerous mood has developed, and (3) most incredibly, will succeed in breaking the developing speculative fervor.
There’s no reason to believe regulators are capable of achieving any of these three things. Furthermore, if they *try* to achieve them, they’ll lose their jobs. Imagine if, in 2001, the head of OFHEO had demanded that Fannie & Freddie delever their balance sheets and rein in mortgage lending. He would have been shitcanned in a heartbeat. In a democracy, people will vote in whatever policies they desire. If they want to break down regulatory obstacles to levering up the balance sheet, they’ll do it. The only ways to stop it from happening are to write banking regulations into the Constitution (and hope the Supreme Court bothers to actually uphold these Amendments), or to ban expressions of anti-regulatory sentiment completely.
4. Crass pragmatism and anti-ideological fervor, as expressed in the “do something!” panicked mentality that produced the TARP, and Bush’s shocking honest statement that he had “abandoned free market principles to save the free market.” The idea that one can just try something and see if it works, with a hugely complex system like the modern economy, is preposterous. It’s why you need a consistent appeal to principles, such as, “freely-operating economies tend to self-organize better than those overseen by supposedly powerful directors,” to understand what the impact of various policy decisions will be.
5. Believing that regulators have the investing public’s best interests at heart and will faithfully protect those interests. This was apparently *never* the case under either Democratic and Republican administrations. Most of the “re-regulate now!” crowd has not proposed any solutions at all to the problems of “cognitive regulatory capture.”
6. Belief in “something for nothing.” In a way, this is the philosophical conceit that spawned all the mistakes mentioned above. It’s what makes people think you can have money without stored value like gold, that you can have financial markets without occasional panics and crashes to weed out the weakest players, that you can have a banking system where a regulator (FDIC) supposedly makes sure that your bank is safe for you, and you have no chance of losing your deposit, and on and on and on.
January 26th, 2009 at 9:41 am
Yes, ideology had a major impact here – in great part because it served certain groups’ and individuals’ interests, whether business or political. Rubin v. reigning in derivatives: ’nuff said.
Yet the Bush Administration was perfectly happy to abandon its alleged free market “principles” and slap tariffs on foreign steel (back in 2003 or something), with the 2004 election and key swing states in mind.
That said, I don’t disagree that they and many others in the financial world, politics, etc., are/were blinded by their ideology.
January 26th, 2009 at 12:10 pm
Graphite Says:
January 26th, 2009 at 3:12 am
Ritholtz’s posts are becoming a broken record (”Free market ideology is the root of all evil”), but I’m enjoying more and more reading the comments section, where this simplistic read of current events is regularly dismantled by his more thoughtful readers.
Couldn’t agree more with that.
There never was a free market in the first place. And the only ideology that was practised was to be downright greedy, borrow, make money, change the rules midway through and well, pass on all the risks to someone else and do the best to delay the inevitable. Well, guess what, the inevitable is here.
The comments are just so good.
About letting Lehman fail being the only right thing that Paulson did. Just too good. Keep it coming guys, sheer education.
BR, you sure don’t wanna tweak your book a little?