GFC confusion, part 2: caused by ‘greed’
The first global financial crisis (GFC) fallacy is that the crisis was caused by the government not bailing out Lehman Brothers. Not true. The second GFC fallacy is that the crisis was caused by “greed”. This error, while popular, is very easy to debunk.
The assumption underlying the “greed did it” argument is that greed in an industry (eg US banking) leads to trouble in that industry (eg US banking). At first this looks appealing. There was greed in the US banking industry and also significant problems.
The problem with this thesis is that greed isn’t just limited to the US banking sector… it is everywhere. There is greed in the Australian banking sector, and it is doing fine. There is greed in hedge funds, and they did better than banks. There is greed in the fast food industry, shoe manufacturers, tour operators, software developers and every other business… but none of these industries imploded in crisis.
Basically, greed is a constant for all business (and indeed, all human behaviour) through all of time. The GFC & recession are temporary variables sparked in one country. You cannot explain a variable with a constant. To find the cause of the US banking troubles, you need to look for variables that are specific to the US banking sector over the past 10 years. And that isn’t greed.
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Of course greed is the problem!
Politicians are greedy for votes, and so distort the markets. Voters are greedy for goodies at other voters’ expense. The whole system is tainted with greed!
Are we agreed on that?
Being trained in economics is great. However, you still have to learn the local laws and regulation to get a hold of everything.
I think a good, well referenced, empirical case for the GFC can be summed up as:
1. Social policies with too great an economic risk [CRA, GSEs, FHA loans, no recourse mortgages, HUD social equity goals].
2. Uncompetitiveness of risk assessment [the effective SEC backed cartel of an oligopoly of risk assessors in what otherwise would be a very competitive market - the CDO and susbequent CDS risk ratings would not have been stuffed up if not for this].
3. Vulnerability of the economy open to macroeconomic shocks due to 1. and 2 [The far reaching costs of war such as increasing energy prices, years of falling labour productivity growth].
4. The enviroment of poor macroeconomic policy in the first instance [large Government debt and highly inflationary, speculation driving, investment misallocation and business cycle generating loose monetary policy].
When a short, sharp recessionary shock (technically not a recession, but a sharp drop off in GDP or production) occured in March 2007, this sparked off a wave of defaults which in turn morphed into the credit crisis, GFC and general low growth we have seen for the past year.
However, let’s go back to 1. The role of the CRA and GSEs has been discussed. FHA loans have not. These are critical in understanding how the whole stinking thing worked.
Essentially, loans that would not be granted by private industry would be available under US Federal FHA loan insurance. Ginnie Mae, for example was chartered to offer loans of these kind.
Essentially, besides some of the bad ideas above (like GSEs being able to draw down a 2 trillion USD line of credit from the sovereign US Treasury), the US Federal Government was udnerwriting unsustainable and ultimately non-performing loans.
The underwriting of these loans was essentially as irresponsible as GSEs originating, underwriting (or buying off loans banks were coerced to make under the CRA*) 70% of the US mortgage market, without pricing for loan risk but borrowing at the sovereign rate.
More about the FHA loans and FHA loan insurance here:
http://en.wikipedia.org/wiki/FHA_loan
“FHA loan is a federal assistance mortgage loan in the United States insured by the Federal Housing Administration. The loan may be issued by federally qualified lenders.
FHA loans have historically allowed lower income Americans to borrow money for the purchase of a home that they would not otherwise be able to afford. The program originated during the Great Depression of the 1930s, when the rates of foreclosures and defaults rose sharply, and the program was intended to provide lenders with sufficient insurance. Some FHA programs were subsidized by the government, but the goal was to make it self-supporting, based on insurance premiums paid by borrowers.
Over time, private mortgage insurance (PMI) companies came into play, and now FHA primarily serves people who cannot afford a conventional down payment or otherwise do not qualify for PMI.”
The poor Americans are still paying for bad ideas like this and no-recourse mortgages which were well intentioned but poorly thought out policies of the Great Depression.
Yep it was greed…. To believe that you would have to believe that if a customer walked into a bank, presented with acceptable credit credentials and the bank had room to make a loan, the bank should refuse to make a loan in case left wing drop kicks (that have never worked a day in the private sector) thought making a loan was greedy.
Where’s the bucket.
Furthermore recessions etc. occur on average about once every 7 odd years, so will these people carefully explain when recessions became a thing of the past?
It seems that this recession might be a thing of the past sooner than many expected.
Blaming the GFC on greed seems to me to be akin to blaming the devil. Evil in our midst brought pestilence and famine. Better light a bonfire.
Terje, based on what?
Media reports such as the following:-
http://www.theaustralian.news.com.au/story/0,25197,25430957-12377,00.html
Upbeat profit forcasts from the likes of Westpac and News Limited.
A surprise drop in Australias unemployment figures.
http://online.wsj.com/article/SB124166607101794945.html
And a quick walk down main street.
We obviously need a greed index to target greed at approx 2-3% per anum because cpi targeting obviously works like a charm. It’s those damn crazy animal spirits that keep screwing everything up.
We’re hearing a lot from KRudd about ending “unfettered” markets (as if we ever had them), but has he actually proposed any substantial new regulation?
Are we going to have Lindsay Tanner (who I quite respect, despite his shortcomings), the Minister for “De”regulation announcing massive new red tape for our businesses?
I’m hoping it’s just the usual Labor spin.
You may see a lot more regulation simply creeping it’s way in like it has in the UK.
I don’t think it’s Labor spin at all. I think they will really try to make changes in the vision they hold. How about the ETS? That has to be one of the biggest regulatory boondoggles in ages.
The ETS is obviously stupid, but its purpose isn’t exactly financial oversight of the kind I meant.
And the Liberals support the ETS too.
Yes John, it’s not called the stupid party for nothing. The idiots.
The joke is that I bet there aren’t any fewer sceptics in the ALP either but seem forced to go with the flow.
The ETS is obviously stupid, but its purpose isn’t exactly financial oversight of the kind I meant.
The oversight will come through various international agencies such as the BIS etc. as the system for oversight is going to become far more global and even more uniform.
If you’re going to run a socialist banking system some of the things I’ve read don’t sound bad at all though.
Supervisory bodies used to only check on banks periodically like weekly or monthly. The system currently being touted is to have a real time capital adequacy system where banks positions etc can actually be checked real time or almost when transactions occur.
So what are they going to call it: CapitalWatch?
The stupid thing about mandating bank reserves is that when there is a run on the banks you actually want them to deplete their reserves to ensure customers feel confident not hold onto them and shatter confidence.
The GFC was caused by developed economies relying too much on debt to keep the party going.
The solution, if our Dear Leaders are to be believed, is more booze and drugs – at least until election night.
[...] articles in this series are about Lehmann collapse, greed & the savings [...]
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