Saturday, October 18, 2008

The Perfect Storm: Three Trends and a Train Wreck

The three fundamental factors behind the financial crisis have been 1) an enormous growth in wealth that needed to be moved into investments, 2) the greater willingness of both individuals and financial institutions to take on risk, and 3) weak governance and oversight, with a blindness to new forms of systematic risk. All three were needed to bring about the scope of the current mess — so that means we’ve had some very bad luck on top of everything else.

We've already been through a savings and loan crisis, a junk bond crisis and a dot-com bubble, but today’s crisis is by far the worst of the lot — and will probably prove to be more than just a bump in the road. We can do better the next time around, but we have to start by seeing that the current failure is far-reaching and that we can blame many different things and many different people.

The real problem is not some particular villain but rather the very fact that we cannot help but put the evaluation of risk into all-too-human hands.

~Tyler Cowen in today's NYTimes


At 10/18/2008 4:31 PM, Anonymous Anonymous said...

Schwartz, co-author with Friedman of A Monetary History of the United States, and a moneterist is sounding very Austrian here:

How did we get into this mess in the first place? As in the 1920s, the current "disturbance" started with a "mania." But manias always have a cause. "If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset.

"The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it's so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object. And then of course if monetary policy tightens, the boom collapses."

Sounds like she's quoting the Austrian Business Cycle Theory!

At 10/18/2008 5:35 PM, Anonymous Anonymous said...

Wall Street banks in $70 bn staff payout - Pay and bonus deals equivalent to 10% of US government bail-out package.

Financial workers at Wall Street's top banks are to receive pay deals worth more than $70bn (£40bn), a substantial proportion of which is expected to be paid in discretionary bonuses, for their work so far this year - despite plunging the global financial system into its worst crisis since the 1929 stock market crash, the Guardian has learned.

At 10/18/2008 5:56 PM, Anonymous Anonymous said...


You don't have to be a member of the Austrian school to think that interest rates held for an extended period at a 40 year low were part of the problem.

Many economists blame Greenspan for lax bank supervision and for keeping interest rates too low, too long from mid-2003 to mid-2004. That, the theory goes, fueled the housing bubble and spawned subprime and adjustable-rate mortgages for low-income people, vast numbers of whom can't make their payments now.

At 10/18/2008 6:06 PM, Blogger SBVOR said...

Dr. Perry,

Somewhere on the news yesterday, I heard a discussion about how we need more government regulation to prevent people from taking excessive risks.

I cringed!

What we need is for government to STOP preventing people from suffering the consequences of excessive risk taking!

We also need for government to STOP requiring people, by force of law, to take excessive risks!


If Obama is elected, we will be in for an even GREATER train wreck!

At 10/18/2008 9:59 PM, Anonymous Anonymous said...

I guess we have to recall all of the dumb things presidential candidates say to get elected ie. jobless recovery, thousand points of light, it's the economy, stupid,...

Obama can't actually believe in:
1. unilateral withdrawal from NAFTA (the trade relationship with Canada alone is the biggest bilateral trade relationship in the WORLD)
2. presidential meetings with leaders from despotic regimes without preconditions
3. that a refundable tax credit to 1/3 of the population that does not pay taxes is a tax cut (the word is welfare)
4. that capital cost allowance and foreign tax credits are tax loopholes rather than legitimate deductible expenses
5. that his election will mark the point at which the oceans started to go recede
6. that you can give everyone earning under $250,000 a year a tax cut...and balance the budget at the same time

Have to agree with the man when he says "You can't just make this stuff up".

On second thought, Sbvor, better start worrying.

At 10/19/2008 9:11 AM, Anonymous Anonymous said...

There's also Obama's plan for social security to consider.

Update 2: Andrew Biggs, an expert on this issue, emails me a more substantive problem:

There's a big mathematical hole in Sen. Obama's plans for Social Security. While Obama is vague about the exact tax rate he would apply to people earning over $250,000 and whether they would receive extra benefits in exchange for the new taxes, a best-case scenario is that Obama's plan would fix around 15% of the long-term deficit, adding 3-5 years to the life of the trust fund. He's ruled out cutting benefits or increasing the retirement age, which could otherwise fill the rest of the gap, so it's not clear where the other 85% of the fix comes from. Sen. Obama has put himself in a bit of a box, which is perhaps the best rationale for a post-election commission -- it lets both sides forget about their previous campaign promises.

At 10/19/2008 10:36 AM, Anonymous Anonymous said...

What we really need is four more years of our great Republican leader George W. Bush !!!

George W. Bush is of our greatest leaders I say let George W. Bush lead us through the next 8 years.

We don't need Obama making a mess of our economy and putting us in wars we can't win !!!!

At 10/19/2008 3:38 PM, Anonymous Anonymous said...

Sure it's a particular villain: The Federal Reserve, jerking around interest rates.

At 10/19/2008 8:34 PM, Anonymous Anonymous said...

The cause of the financial crisis is that the government got involved in the mortgage market. And the corrupt politicians who supported it....

At 10/19/2008 9:00 PM, Anonymous Anonymous said...

Few understand the U.S. economy in the 2000s was a Black Hole attracting imports and capital, from the world, and then attracting the foreigners themselves who own that capital. This was the result of American free market policies and government policies of export-led economies, which were inferior. There were "too many" assets, e.g. houses and autos, and "too many" goods, e.g. electronics and clothing. Low prices and low interest rates, because of abundant goods and capital, induced U.S. demand. This is viewed as a failure by many, because they ignore that the gains of U.S. consumption growth exceeded the losses of U.S. production growth. The net effect was a steeper rise in U.S. living standards. The U.S. maximized the quantity and quality of output (both domestic and foreign) for its masses, which also facilitated massive upward mobility or real household wealth.


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