I wonder if the following sentence from Paul Krugman’s blog fills you with as much dread as it does me:
Health reform, for all the complexities of its details, was a pretty clear issue; there was almost a theorem-theorem-lemma feel to figuring out what had to be done, leading you to something like the actual reform we got. Yes, there should have been a public option. But the basic structure of the issue was clear.
That’s an unforeseen secondary effect waiting to happen.
In the body of the post Dr. Krugman lists six theories (which he refers to as doctrines, something that also fills me with dread) for explaining the financial crisis:
– Size: Our largest financial institutions have just gotten too big
– Shadows: The rise of shadow banking, institutions that fulfill banking functions but evade the regulatory regime, has undermined stability
– Opacity: We’ve come to rely on complex financial instruments that neither regulators nor the private sector
– Predation: Financial firms deliberately misled consumers and investors
– Government intervention: Public policy pushed lenders into making bad loans, especially to the poor
– Monetary mismanagement: The Fed did it by keeping interest rates too low for too long, and/or policymakers panicked in 2008 and spooked the markets
and goes on to analyze each at greater length. I note that regulatory capture does not even make a guest appearance.
How’s this for an explanation that doesn’t fit into Dr. Krugman’s doctrines? A lot of traders were doing exactly what you’d expect them to do which is pursuing the incentives they had and there was nobody at any level to stop them because everybody, e.g. managers, customers, rating agencies, and regulators, were also pursuing the incentives they had. If they won, they’d make billions. If they lost, somebody else would be left holding the bag.
How does pending legislation address that?
It doesn’t. As I’ve noted limited purpose banking would go a long ways to addressing many of the issues, but we’ll never get it as you’ve noted.
I read Krugman’s list and thought, “Not bad.” I bet we’d part ways when it came down to partisan politics. I see both sides as being responsible. As you’ve noted Robert Rubin is the Forrest Gump of this crisis. He can be placed at just about every critical juncture. Who was his boss? Was that person a Democrat or Republican? Republicans also have plenty of dirt on thier hands for this crisis too.
You are right that Krugman misses the public choice/regulatory capture aspect of the problem. I’d say all of the items on his list are ultimately due to that explanation. Wall Street can get rich with policy X if it wins and if not the tax payers are left holding the bag….politicians will get lots of money, high level bureaucrats can take cushy jobs on Wall Street (Larry Summers), so vote for policy X. Considering that these things can take years before the problems develop chances are you’ll be out of office by the time things go pear shaped.
Steve Verdon, if you are like me and suprised that Krugman included government invention on his list, you may want to read the link. He thinks this theory is silly, but includes it because he is not a partisan pundit.
I would broaden the theory to say that home ownership has been treated as an unvarnished good by both sides of the aisle, which has created fiscal and monetary policies that made the bubble worse.
No disagreement here.
If you want to include regulatory capture, and I would, you need to find some way to explain why the regulators of the 2000s were different from those of the 1990s. If you broaden it out, regulators performed well at least until the 80s, after the Great Depression. I keep meaning to research this, but get distracted. Why didn’t they get captured before? Bankers have always made a lot of money.
Pending legislation, last time I looked, was going to put derivatives into an open market, reducing opacity. Closing down proprietary trading should reduce predation one hopes.
Providing the FDIC the means to resolve the bigger banks should help to reduce the moral hazard issue. Even if you thought BoA was heading towards insolvency, what could you do about it?
That’s easy. The financial sector was much larger in the 2000s than it was in the 1990s which means that the incentives were much greater to regulate with a light hand were much higher, too.
So it was the high pay of the traders and the executives which the regulators could hope to achieve when they went through the revolving door? Nah, the right has long maintained that you need to pay these guys bazillions or they won’t work. More seriously, I have thought of that, but that incentive has always been there, it was just more prevalent. Bonuses may have been $10 million in 2005, but they were $4 million in 1995. They were still doing the revolving door thing in the 90s, the 80s, the 70s and so on.
I think that there was also a cultural change of some sort. I think that they all believed that markets did better left to their own devices. Also, IIRC, individual states tried to intervene in the subprime markets, but were stopped by judicial decisions. Perhaps the judiciary is a factor also.
Hahahahaha…steve, steve, steve….really get cracking on that research. Really I’ve mentioned Long Term Capital Management, did you forget about that? The swap market started in the 1980s and grew rapidly. They were outside the regulatory regime (the Commodity Trading Futures Trading Commission, CTFC) since the law creating that entity did not cover “forward delivery” contracts, but only “future delivery contracts”.
There was pressure to regulate them under the CTFC, but we can find the Forrest Gump of the financial crisis, Robert Rubin, again arguing against this. Rubin along with Greenspan and Arthur Levitt argued against moving OTC derivatives into a regulated exchange. Their fear is that this would call into question billions of dollars worth of existing swaps and could lead to serious problems. Of course, by not doing it it let a serious problem fester until it burst like a boil spewing puss everywhere and plunging the economy into one of the worst recessions in the modern era.
So…you were saying what about regulators in the 1990s?
Rubin also just got done saying, “Whoops, my bad,” to Congress regarding Citigroup by the way. Rubin is indeed the Forrest Gump of this crisis. Every time you follow something back to its roots there he is.
But lets just blame Bush, its so much easier and makes the liberal progressives feel warm and fuzzy inside.
Another who argued forecfully that OTC derivatives did not create “concentration of financial risk” unlike exchange traded derivatives was Brooksley Born, Clinton’s appointee to the CFTC. Her tesitmony can be found here. Here is the graph where the above quote comes from,
What she is saying in the italicized portion of the testimony is that those engaged in trading OTC derivatives are sophisticated–i.e. know what they are doing–and as such there is less risk there. Thus, that market does not need to be regulated.
That testimony was delivered on April 15, 1997.
TL;DR–the regulators were captured in the 1990s. Shouldn’t be a surprise the top guy at Treasurey was Robert Rubin a Goldman Sachs alum.
Now pardon me while I fall down laughing.
Oh and for good measure:
Bushitler is evil.
There I hope the liberals reading this feel better now.
I think that’s included in the first of the six, “Size”, to some degree – some of the banks are so massive that they know they are “too big to fail”, and can thus pass some of the risk on to taxpayers.
For what? It’s not exactly news that the Clintonites were in bed with the financial sector guys – that practically an unofficial part of being a “New Democrat”.
But that was the counter claim, that the regulators in the 1990s were different, but when we start digging we find out, nope, they were enablers too. What makes it possible even worse is that after LTCM those same regulators had a chance to stop this before it got so out of hand.