The incentives in capitalism "crash the economy". Yes, there was bad behavior. However focusing on individual behavior misses the forest for the trees.
Here's how it works.
Banks start off conservative. Banks only offer loans that pay themselves off. There's a run of good years. The incentive in capitalism is to make more money, and based off the recent history of good years, Bank A realizes they can offer more aggressive loans (e.g. interest only), take market share, and make more money. So Bank A does that.
Bank B now has the choice of matching Bank A, or losing market share (and maybe their business). So Bank B matches and maybe also offers less money down. This cycle continues with progressively more aggressive loan offerings until there's a run of bad years and things and people are stuck with too aggressive financing.
> During and after the economic collapse of 2007-2009 I wondered who was at fault; who to blame. I kept waiting for a clear answer to "THE root cause".
Well, there can be a difference between "who is at fault" and "THE root cause". Quite a large difference, potentially.
In the case of '07-'09, maybe nobody was at fault (seems plausible) but there was a very neat root cause. The government handed out a lot of money to people who shouldn't have gotten it, the people responsible were largely protected from bankruptcy and the system forced to reform largely as it was. The people who took excessive risk earned an excessive reward - they should have all gone bankrupt. The financial system should actually have changed, and people who made productive investments and didn't take risk should have become ascendant. Instead we have the same old crowd playing the same old game.
Disabling the major feedback mechanism of capitalism is about as root-causal as can be gotten. Nobody in particular chose to disable it though, it was a consensus decision among the powerful.
> Why would it crash hard unless interest rates go up by a significant amount?
The 2008-era crisis in theory should have resulted in a whole heap of financial managers taking their companies bankrupt/to a place of horrid returns and being blacklisted from ever managing a lemonade stand. But they were bailed out, so now they got promotions instead for record returns or whatever it is they've been doing since. Since the finance industry has substantial control over what everyone else does, that leaks out into the real world.
So, the intuition is that the system is being corrupted and people with no ability to make good decisions are being put in charge. At some point that should boil over. You can fit math models to that and guess which metric will blow out first.
I'm not sure how much I buy that argument; people have an incredible ability to put up with suboptimal circumstances. But when you put idiots in charge there is always a risk that they do something spectacularly stupid so my personal guess is at some point the pensions crack and trigger something. It is a spectator sport in a way. Maybe America is productive enough that they can cope with a few bad eggs in the financial markets. Maybe the taxpayers can shoulder all burdens!
My interpretation is that something went wrong with bank regulation in the late 70s or early 80s. That is when the too-big-to-fail snowball started rolling; since then the stresses in the system seem to have been building. 2008 was a nasty blow.
Yes, it's absolutely partly the people's fault. There were tons of people taking massive loans they should not have. People cannot abnegate personal responsibility there.
A lot of things had to go wrong in the banking system for the crash to happen, but that was one of them.
There’s a strong argument to be made that the Fed caused the crash in 08 too. First by keeping rates too low for too long after the dot com crash, then aggressively raising them right up until things started breaking. Sound familiar?
The Fed did a great job after 08 convincing everyone it did a great job managing the crisis, which I think is fair. But there’s also an argument to be made that they played a role in causing the crisis too.
> Centeral banks turned everything like a Ponzi scheme. How the heck borrowing and spending is a better option than saving.
Central banks are just playing a larger game, they aren't causing it, the game is: ever increasing growth capitalism. Borrowing and spending creates "growth", saving doesn't. While we exist in this system we can try to pinpoint the blame at different actors but they aren't the cause of it, they are just playing along.
The incentives for growth don't align with what's best for society, they align with making people indebted so companies can grow their revenues.
He works in the financial sector and his argument after his sociopath colleagues tank the economy is that its someone else's fault. That's fantastic.
Banks are supposed to be experts in assessing risk and financial products. If an expert sells a bunch of bad loans knowing he is going to fraudulently sell them on to others anyway its the experts fault for tanking the economy.
At worst the buyers are stupid. There certainly was no crisis of faith and values.
>recent bank failures are a result of the free market running amuck on easy credit and dumb investments (home loans without income verifications)
Easy credit was the deliberate goal of the federal government starting in the early 2000's. There was a very mild recession and the government pulled out all the stops to prevent it from getting worse by subsidizing borrowing to keep interest rates well below free market levels. They killed a fly with a cannon and spawned a giant financial bubble.
In the free market, people that lend money have the incentive to make sure it gets paid back. This calculus becomes complicated when the subjective factor of the government's whims for the credit market is added in.
As far as "dumb investments" go, loans to homeowners were made in the environment of an unprecedented price bubble that was spawned by the loose monetary policy of the federal government. Many "dumb" mortgages are not dumb to make when the value of the underlying collateral is increasing by 30% every year.
I know it is the standard line that we need more regulation, but I don't see how any regulator could have been more inclined to make good decisions in such unprecedented circumstances than the market. In hindsight it is easy to say that the Government should have restricted the supply of mortgages, but this is directly the opposite its goals to increase home ownership. Personally, I wish they would stick to the goal of protecting our rights and property and butt out of everything else.
>The 30s were a lot less regulated and the great depression was a result of a free market moving without any government oversight or interference
I know this is the standard line, but many government actions worsened the Great Depression in the United States and compounded its misery. The two major monetary events of the Great Depression were directly caused by the government - 1) the contraction of the money supply and 2) massive bank failures. 1) was the policy of our wonderful omniscient technocrats at the Federal Reserve and 2) was the result of unitary branching laws and other laws meant to punish "big banks" and prevent them from forming. Anti-bank populism is nothing new in the United States. I don't have the numbers on me, but I seem to remember that the United States (with many anti-bank laws) had thousands of bank failures while Canada (with few such laws) had like 4. The fact is, "big banks" weather hard times easier, and restricting capital flows in the industry make misery for all when unexpected events happen.
On top of that, the government acted to institute a price-floor for labor at a time when prices in general were falling, thereby creating massive unemployment. In an attempt to remedy the deflation caused by monetary restriction, the government burnt food and passed a massive tariff which ended up restricting the supply of consumer goods and food.
The general problem was a fall in the price level. In the Free Market, the price of labor would have fallen to match other goods and business as normal would have resumed. However, the government decided restrict the supply of labor and other goods, like food, to increase the prices of these goods. They succeeded in this, but they did not drive up the general price level. Instead, they increased the price of these goods relative to everything else, causing shortages in both (unemployment and food shortage). Then the government instituted more programs to fix the problems it had caused, including massive government hiring programs, subsidies, and a war. Noone suggests to this day that maybe they shouldn't have gotten their grubby little ignorant fingers so deep into the economy in the first place.
I am not an expert in the Great Depression, just an interested amateur. Still, it is obvious from a cursory glance at the facts that explaining it as a morality tale on the failure of Free Markets is much too simple, although that is the common interpretation taught to High School students. It hurts me to hear the President who presided over the longest, deepest, and most painful depression in US history credited only with "ending it".
> The federal government stepped in to rescue the other big banks and forestall a panic. The intervention worked—though its success did not seem assured at the time—and the system righted itself. Of course, many Americans suffered as a result of the crash, losing homes, jobs, and wealth. An already troubling gap between America’s haves and have-nots grew wider still. Yet by March 2009, the economy was on the upswing, and the longest bull market in history had begun.
This paragraph is conceding a point that should not be conceded. The system did not right itself if many Americans lost homes, jobs, and wealth. 12 years later, not everyone has recovered from the 2008 collapse.
I find the writer's explanation of the main cause of the financial crisis too simplistic and dangerously naive: "interest rates were historically low which made lending cheap, [so] banks had more money to lend than there were responsible borrowers. This created a credit bubble that once over, resulted in banks suffering large monetary losses and an atmosphere of being scared to lend to each other."
IMHO, the structure and behavior of financial firms was a major destabilizing force leading to the crisis.
In the years preceding the crisis, financial firms created a vast network of complex financial claims and obligations of their own that greatly exceeded the real economy’s needs. These financial claims and obligations were at the center of the financial crisis.
Instead of just providing a mundane but critical service to the real economy (interconnecting the real economy's savers with its borrowers), the financial system was driving the real economy – for instance, by pushing up the prices of many assets, particularly residential properties, simultaneously feeding on and magnifying a housing bubble of historic proportions.
IMHO, these nonlinear feedback loops and network-amplification effects -- typical of complex, tightly interconnected, dynamic systems -- were important root causes.
> During and after the economic collapse of 2007-2009 I wondered who was at fault; who to blame
Sometimes it is possible to at least narrow things down to an underlying inherent instability. In the case of your example, a huge underlying cause is an economic system based on debt (backed by interest and usurious transactions). It's for a reason that usury/interest is banned in Islam, Christianity, and Judaism for example. It's a parasitic practice that makes the economy fundamentally unstable. This includes dangerous practices such as selling debt for debt (again part of the same crisis), and things like stock shorting (which, interestingly enough was also banned during the crisis, at least for some critical company stocks).
I would highly recommend you read the book. It's not that simple.
Keep in mind this is not just a question of greedy banks this is a question of politicians allowing for people to buy houses because they know for many that's the only way they will ever be able to save up for retirement. It's also a question of how Central Banks are run and used and attemps to keep the economy stable.
In other words many many many factors are involved in this giant system.
That there are people who were doing fraudulent things is obvious but those things do not explain the crash in itself.
The mistake many do is put the moral analysis in front of the system analysis and yes then you will end up with moral solutions without addressing the underlying systemic problems with keeping a world economy going.
The book dives deep into this and shows how it can be structured differently because it's more concerned with solving the systemic problem which one could argue is a more ethical position than pointing fingers at human nature.
The point of the book is that the crash was not the result of some mastermind but rather a consequence of a lot of good intended decisions which simply had unintented conequences.
>The recent financial crisis was primarily caused by millions of homeowners defaulting on their loans.
Uh, that's a pretty simplistic view. The government-financed loans were an enabler, but people were using over-the-counter CDS' to short those loans (i.e. more than one "insurance policy" could exist per loan and it would be hard to even know who all had them unless the loan defaulted), rating agencies get paid by those they rate so they gave artificially good ratings, etc., etc. It was a perfect storm but to put the blame on those "darn irresponsible poor people" is so simplistic as to be absurd.
>shift regulation from capping what banks and mutual funds can do to making sure they aren't committing fraud.
There are many reason for the regulation on banks and mutual funds. It's not to make the country more socialist, it's to prevent short term focused bankers/fund managers from accidentally destroying the whole economy or pissing away thousands of people's retirement.
>The government exists to protect private property, life, and to prosecute those who commit fraud.
What about dealing with monopolies? If you believe in free market capitalism then you must know about elasticity of markets. Monopolies artificially destroy elasticity in whatever space they're in.
In my opinion what the US government needs to do before anything else is start breaking down monopolies. "Too big to fail" is a big red flag that someone didn't do their job.
> The banks got really creative, a bunch of people made nice bonuses, then when their fancy leveraged mechanisms went bad, we all had to bail them out.
You will have to be a little more specific to discredit the economic mal-incentives created by the government and to spin that simple narrative.
And the amount of paper wealth lost in '07-08 was actually about 10 trillion, not "hundreds of trillions."
Who is "us" in this case? A lot of people lost their homes/savings. The primary entities saved were the same ones that caused the crisis in the first place. I think it's fair to argue that in the short term a collapse of several major banks might have hurt "the working class" worse. But the in the medium to long term I'm not sure that pulling out all the stops to fix the financial industry's fuckups was the right call.
> caused by financial firms selling a lot of crazy mortgages to people who could not afford them unless housing prices went up forever. When the crisis hit, the firms got the blame, not their customers.
This is not totally correct.
2008 was caused by banks giving out extremely risky mortgages (the banks knew they were risky mortgages) and then packaging them up into giant bundles and magically calling them AAA stable real estate investments and selling them forward to other banks/pensions/401ks.
Banks are responsible for assessing the risk on a mortgage, not the customer.
> While Volcker had used high interest rates to engineer a crushing recession at the start of Reagan’s first term, he then allowed the economy to expand rapidly just in time to carry Reagan to a landslide reelection in 1984.
Is it really true that one person controls the whole economy?
And if so, why does Glass-Steagall matter one way or the other?
How could Volcker on the one hand crash the economy himself, and then immediately un-crash it, while on the other hand being the guardian of Glass-Steagall, supposedly the only defense against... crashing the economy?
This story seems to be more mythmaking than science.
>That expectation itself caused reckless behavior of the banks - and it still does. People just don't fully grasp the consequences.
What most people don't grasp is just how regulated the financial industry is.
Silicon Valley loves taking risks (and failing!), but when a bank does it it's unacceptable? This stuff happens in a capitalist economy. I mean, it's not like it was "the banks" in a vacuum. It was governments, mortgage brokers, builders, house-flippers, your neighbour, speculators...everyone benefited from the wealth effect of cheap money and rising home values. Until they didn't; then it became the banks' fault.
https://www.amazon.com/Stabilizing-Unstable-Economy-Hyman-Mi...
The incentives in capitalism "crash the economy". Yes, there was bad behavior. However focusing on individual behavior misses the forest for the trees.
Here's how it works.
Banks start off conservative. Banks only offer loans that pay themselves off. There's a run of good years. The incentive in capitalism is to make more money, and based off the recent history of good years, Bank A realizes they can offer more aggressive loans (e.g. interest only), take market share, and make more money. So Bank A does that.
Bank B now has the choice of matching Bank A, or losing market share (and maybe their business). So Bank B matches and maybe also offers less money down. This cycle continues with progressively more aggressive loan offerings until there's a run of bad years and things and people are stuck with too aggressive financing.
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