The Big Picture on the Big Lie

by Dave Schuler on November 13, 2011

I don’t know about you but I find Barry Ritholtz’s explanation for the financial crisis as good as any. In his explication it was caused by a combination of interest rates held too low for too long, changes in regulation, a flight from regulation, Wall Street’s compensation scheme, and too much confidence in ratings agencies.

I think if you just say “excessive confidence” that pretty well sums it up. Confidence in the Fed, the Great Moderation, government regulations, the ratings agencies, and that housing prices will always rise, just to start the list.

{ 7 comments… read them below or add one }

Steve November 13, 2011 at 9:22 am

A fairly decent explanation noting that it took a lot of mistakes to make it happen. The one cause explanations leave too many needed parts to make it happen.

Steve

Ben Wolf November 13, 2011 at 1:24 pm

No, no and no. Ritholtz is pointing to a small crack at the bottom of the dam when there’s an asteroid-sized hole right over his head.

We have three sectors to our domestic economy: government, private and trade. For either the government or private sector to save money (surpluses) the other sectors must spend (deficits), and since our trade balance is permanently negative it’s no help to anybody. Look at the chart here:

http://pragcap.com/sectoral-balances-and-the-united-states

The federal government engineered budget surpluses in the late 1990′s. Our government sector begins to save and therefore draws money out of the private sector. With less currency comes fewer economic transactions and a slowdown, so the private sector did the next best thing and turned to credit.

By the time government returned to deficits and stopped starving the private sector the damage had been done. The credit industry, having received a massive boost by government incompetence, had become addicted to the massive short-term profit potential of liar loans and ficticious capital on the derivatives market. Basically the government drained the private sector of blood, put it on a heroin IV substitute, and then couldn’t understand why the patient wouldn’t quit, or why it took such enormous risks just to get another little taste.

steve November 13, 2011 at 8:25 pm

@Ben-Then we can never run budget surpluses?

Steve

Ben Wolf November 14, 2011 at 5:47 am

Steve,

The only time I can think it would be a good idea to do so is if monetary inflation becomes problematic. The government would then want to either cut spending or raise taxes to reduce demand. Other than that, running surpluses just reduces the private sector’s ability to save and create wealth.

Barry Ritholtz November 14, 2011 at 10:45 am

I tried to avoid 1) grossly over simplified explanations; 2) Irrelevant pet peeves & political boogie men; 3) irrelevant strawmen

I also steered away from the classic errors: randomness, statistical insignificance, non causative correlations, etc.

I tried to stay with proximate causes that were relevant, (near in time and space); that had data and/or dollars I could track; and a rational basis for causation.

Steve Verdon November 14, 2011 at 1:20 pm

I think the incentive problem should not be ignored. If there is a history of bailouts for big corporations who engage in overly risky behavior then that could lead to:

1. Firms wanting to get big to qualify for such bailouts.
2. First taking on excessive risk once they reach the necessary size in 1.

And unfortunately our history and political process pretty much assure us of this kind of a problem. The political pressure on a President and Congress when large companies are in danger of failing is enormous. And it is historical fact that firms/investors have been bailed out in the past.

Ben Wolf November 14, 2011 at 4:44 pm

“I think the incentive problem should not be ignored.”

Agreed. Perverse incentives are bound to play some role if the mindset you describe has or is becoming widespread. This is an area where I think Austrians have something: malinvestment triggered by wasteful government spending becoming a drag on economic performance.

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