The Return of Depression Economics and the Crisis of 2008
Author
Paul Krugman
Paul Krugman
Date of Publication
2009
Reason for reading
The author is a recent nobel laureate in economics, and the book is an update of an earlier version from ~1998, so I felt it was a good book to read on the topic of the recent financial events in which the author had written on the topic previously, rather than some other books where I get the impression the authors had no foresight of the coming problems, yet somehow feel compelled to write an explanation of what happened within a couple months of it happening.Synopsis
The book doesn't necessarily attempt to explain the current situation, though offers a lot of insight into some of the factors that contributed. Rather, the author starts by saying that many people thought fundamental problems that lead to depressions had been eliminated, and that people/governments had essentially learned their lesson. However, in the 1980's and 1990's, a lot of the significant factors (or symptoms) of depressions had started showing up in other economies (Argentina, Mexico, Japan, Thailand/Asia, etc.). He discusses each country's economic situation individually, as well as the responses made by the respective government. Additionally, he ties these things into the current global crisis.
The book doesn't necessarily attempt to explain the current situation, though offers a lot of insight into some of the factors that contributed. Rather, the author starts by saying that many people thought fundamental problems that lead to depressions had been eliminated, and that people/governments had essentially learned their lesson. However, in the 1980's and 1990's, a lot of the significant factors (or symptoms) of depressions had started showing up in other economies (Argentina, Mexico, Japan, Thailand/Asia, etc.). He discusses each country's economic situation individually, as well as the responses made by the respective government. Additionally, he ties these things into the current global crisis.
Review
I have a tough time reviewing things on a 4 or 5 point scale. I require a 10 point scale. I would give it 7 out of 10. I'm not sure if this should be referred to as points, stars, or anything else (blogos?). I thought it was good background information that didn't try to put the financial crisis into a cookie cutter situation and say it was easily explainable.
Quotes (italics are mine)
"The standard response to a recession is to cut interest rates. . . Japan was slow to cut interest rates after the bubble burst, but it eventually cut them all the way to zero, and it still wasn't enough. Now what?
The classic answer, the one that has been associated with the name of John Maynard Keynes, is that if the private sector won't spend enough to maintain full employment, the public sector must take up the slack. Let the government borrow money and use the funds to finance public investment projects-if possible to good purpose, but that is a secondary consideration-and thereby provide jobs, which will generate still more jobs, and so on. The Great Depression in the United States was brought to an end by a massive deficit-financed public works program, known as World War II. Why not try to jump-start Japanese growth with a more pacific version of the same?"
page 71
"If government spending is one standard response to a stalled economy, pumping up the banks is another. One widely held view about the Great Depression is that it persisted so long because the banking crises of 1930-31 inflicted long term damage to credit markets. According to this view, there were businessmen who would have been willing to spend more if they could have gotten access to credit, and who would in fact have been qualified borrowers. But the bankers who could have made those loans were themselves either out of business or unable to raise funds because the public's confidence in banks had been so shaken."
page 72
This is more of an excerpt than a quote:
"The financial crisis has, inevitably led to a hunt for villians.
Some of the accusations are entirely spurious, like the claim, popular on the right, that all our problems were caused by the Community Reinvestment Act, which supposedly forced banks to lend to minority home buyers who then defaulted on their mortgages; in fact, the act was passed in 1977, which makes it hard to see how it can be blamed for a crisis that didn't happen until three decades later. Anyway, the act applied only to depository banks, which accounted for a small fraction of the bad loans during the housing bubble.
Other accusations have a grain of truth, but are more wrong than right. Conservatives like to blame Fannie Mae and Freddie Mac, the government-sponsored lenders that pioneered securitization, for the housing bubble and the fragility of the financial system. The grain of truth here is that Fannie and Freddie, which had grown enormously between 1990 and 2003-largely because they were filling the hole left by the collapse of many savings and loans-did make some imprudent loans, and suffered from accounting scandals besides. But the very scrutiny Fannie and Freddie attracted as a result of those scandals kept them mainly out of the picture during the housing bubble's most feverish period, from 2004 to 2006. As a result, the agencies played only a minor role in the epidemic of bad lending.
On the left, it's popular to blame deregulation for the crisis-specifically, the 1999 repeal of the Glass-Steagall Act, which allowed commercial banks to get into the investment banking business and thereby take on more risks. In retrospect, this was surely a move in the wrong direction, and it may have contributed in subtle ways to the crisis-for example, some of the risky financial structures created during the boom years were the "off balance sheet" operations of commercial banks. Yet the crisis, for the most part, hasn't involved problems with deregulated institutions that took new risks. Instead, it has involved risks taken by institutions that were never regulated in the first place.
After that, I'd argue, is the core of what happened. As the shadow banking system expanded to rival or even surpass conventional banking in importance, politicians and government officials should have realized that we were re-creating the kind of financial vulnerability that made the Great Depression possible-and they should have responded by extending regulation and the financial safety net to cover these institutions. Influential figures should have proclaimed a simple rule: anything that does what a bank does, anything that has to be rescued in crises the way banks are, should be regulated like a bank.
In fact, the Long Term Capital Management crisis, described in Chapter 6, should have served as an object lesson of the dangers posed by the shadow banking siystem. Certainly many people were aware of just how close the system had come to collapse.
But this warning was ignored, and there was no move to extend regulation. On the contrary, the spirit of the times-and the ideology of the George W. Bush administration-was deeply antiregulation. This attitude was symbolized by a photo-op held in 2003, in which representatives of the various agencies that play roles in bank oversight used pruning shears and a chainsaw to cut up stacks of regulations. More concretely, the Bush administration used federal power, including obscure powers of the Office of the Comptroller of the Currency, to block state-level efforts to impose some oversight on subprime lending.
Meanwhile, the people who should have been worrying about the fragility of the system were, instead, singing the praises of 'financial innovation.' 'Not only have individual financial institutionsbecome less vulnerable to shocks from underlying risk factors,' declared Alan Greenspan in 2004, ' but also the financial system as a whole has become more resilient.'
So the growing risks of a crisis for the financial system and the economy as a whole were ignored or dismissed. And the crisis came."
Pages 163-4
I have a tough time reviewing things on a 4 or 5 point scale. I require a 10 point scale. I would give it 7 out of 10. I'm not sure if this should be referred to as points, stars, or anything else (blogos?). I thought it was good background information that didn't try to put the financial crisis into a cookie cutter situation and say it was easily explainable.
Quotes (italics are mine)
"The standard response to a recession is to cut interest rates. . . Japan was slow to cut interest rates after the bubble burst, but it eventually cut them all the way to zero, and it still wasn't enough. Now what?
The classic answer, the one that has been associated with the name of John Maynard Keynes, is that if the private sector won't spend enough to maintain full employment, the public sector must take up the slack. Let the government borrow money and use the funds to finance public investment projects-if possible to good purpose, but that is a secondary consideration-and thereby provide jobs, which will generate still more jobs, and so on. The Great Depression in the United States was brought to an end by a massive deficit-financed public works program, known as World War II. Why not try to jump-start Japanese growth with a more pacific version of the same?"
page 71
"If government spending is one standard response to a stalled economy, pumping up the banks is another. One widely held view about the Great Depression is that it persisted so long because the banking crises of 1930-31 inflicted long term damage to credit markets. According to this view, there were businessmen who would have been willing to spend more if they could have gotten access to credit, and who would in fact have been qualified borrowers. But the bankers who could have made those loans were themselves either out of business or unable to raise funds because the public's confidence in banks had been so shaken."
page 72
This is more of an excerpt than a quote:
"The financial crisis has, inevitably led to a hunt for villians.
Some of the accusations are entirely spurious, like the claim, popular on the right, that all our problems were caused by the Community Reinvestment Act, which supposedly forced banks to lend to minority home buyers who then defaulted on their mortgages; in fact, the act was passed in 1977, which makes it hard to see how it can be blamed for a crisis that didn't happen until three decades later. Anyway, the act applied only to depository banks, which accounted for a small fraction of the bad loans during the housing bubble.
Other accusations have a grain of truth, but are more wrong than right. Conservatives like to blame Fannie Mae and Freddie Mac, the government-sponsored lenders that pioneered securitization, for the housing bubble and the fragility of the financial system. The grain of truth here is that Fannie and Freddie, which had grown enormously between 1990 and 2003-largely because they were filling the hole left by the collapse of many savings and loans-did make some imprudent loans, and suffered from accounting scandals besides. But the very scrutiny Fannie and Freddie attracted as a result of those scandals kept them mainly out of the picture during the housing bubble's most feverish period, from 2004 to 2006. As a result, the agencies played only a minor role in the epidemic of bad lending.
On the left, it's popular to blame deregulation for the crisis-specifically, the 1999 repeal of the Glass-Steagall Act, which allowed commercial banks to get into the investment banking business and thereby take on more risks. In retrospect, this was surely a move in the wrong direction, and it may have contributed in subtle ways to the crisis-for example, some of the risky financial structures created during the boom years were the "off balance sheet" operations of commercial banks. Yet the crisis, for the most part, hasn't involved problems with deregulated institutions that took new risks. Instead, it has involved risks taken by institutions that were never regulated in the first place.
After that, I'd argue, is the core of what happened. As the shadow banking system expanded to rival or even surpass conventional banking in importance, politicians and government officials should have realized that we were re-creating the kind of financial vulnerability that made the Great Depression possible-and they should have responded by extending regulation and the financial safety net to cover these institutions. Influential figures should have proclaimed a simple rule: anything that does what a bank does, anything that has to be rescued in crises the way banks are, should be regulated like a bank.
In fact, the Long Term Capital Management crisis, described in Chapter 6, should have served as an object lesson of the dangers posed by the shadow banking siystem. Certainly many people were aware of just how close the system had come to collapse.
But this warning was ignored, and there was no move to extend regulation. On the contrary, the spirit of the times-and the ideology of the George W. Bush administration-was deeply antiregulation. This attitude was symbolized by a photo-op held in 2003, in which representatives of the various agencies that play roles in bank oversight used pruning shears and a chainsaw to cut up stacks of regulations. More concretely, the Bush administration used federal power, including obscure powers of the Office of the Comptroller of the Currency, to block state-level efforts to impose some oversight on subprime lending.
Meanwhile, the people who should have been worrying about the fragility of the system were, instead, singing the praises of 'financial innovation.' 'Not only have individual financial institutionsbecome less vulnerable to shocks from underlying risk factors,' declared Alan Greenspan in 2004, ' but also the financial system as a whole has become more resilient.'
So the growing risks of a crisis for the financial system and the economy as a whole were ignored or dismissed. And the crisis came."
Pages 163-4
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