The Economist on the GFC

The Economist magazine has started a five part series on the Global Financial Crisis, and the lessons from it.  Should be a lot of fun.  Part one is here.  They conclude:

The regulatory reforms that have since been pushed through at Basel read as an extended mea culpa by central bankers for getting things so grievously wrong before the financial crisis. But regulators and bankers were not alone in making misjudgments. When economies are doing well there are powerful political pressures not to rock the boat. With inflation at bay central bankers could not appeal to their usual rationale for spoiling the party. The long period of economic and price stability over which they presided encouraged risk-taking. And as so often in the history of financial crashes, humble consumers also joined in the collective delusion that lasting prosperity could be built on ever-bigger piles of debt.

A lot of what they say in the article is true, although I will be honest that I don’t fully agree with their description of the lead up to the crisis … and as a result, will probably have some differences of opinion in terms of what I view as appropriate lessons.  However, I will leave all this for another time ;) [Note:  Many of these things involve markets - but then many of the explanations involve only looking at "one side".  This is common, but always a touch disingenuous IMO]

Feel free to discuss the GFC, and the description of the causes by the Economist, in comments below!

  • Blair

    I think that was an amazingly fair whack at a complex issue by the Economist. Not sure the US housing

    One thing that wasn’t quite clear (and probably doesn’t need to be for a schools brief) is that Wall St was hedged the wrong way in 2007. They were retaining the super senior tranche of the CDOs they were selling to overseas pension funds and insurance companies. In theory, this was the most secure tranche, but in fact the most vulnerable to sudden loss of market value if default correlation spiked. Regulators can’t keep up with this stuff, which makes is very important that systemic banks hold lots of equity.

    I disagree with this bit: “Central banks could have done more to address all this. The Fed made no attempt to stem the housing bubble. The European Central Bank did nothing to restrain the credit surge on the periphery, believing (wrongly) that current-account imbalances did not matter in a monetary union.” I don’t think the housing “bubble” or intra-European imbalances were central banks’ problems. Making banks hold lots of equity before the GFC, and maintaining growth in NGDP (slash keeping the natural rate of interest above zero, whatever you want to call it) by all means necessary; these are proper functions of central banks.

    • Matt Nolan

      Agreed, I think some of the views we are getting from economists are wrongheaded – eg

      Not trying to play a bubble has nothing to do with rationality, it has to do with predictability and the appropriate scope of a central bank. Even if these things were predictable, transfers (which shifting a bubble is) have nothing to do with a central bank. Active policy has to have an idea of “what the welfare function is” – and a lot of people chasing bubbles appear to be ready to throw normative economics out the window when making normative policy conclusions >:(

      The cynic in me thinks this stems from some economists having “smartest man in the room syndrome”. The non-cynical part of me broadens that to “smartest person in the room syndrome” recognising that it is not just men that do it ;) .

      All in all, I find it a bit strange when economics training involves constantly illustrating how little we know, and respecting the heterogeneity of preferences among individuals and imperfection of information associated with choice … I’m guessing spouting those lessons may not earn a mention in the newspaper, or a central role in policy – if you are wondering why I’m being so cynical I have a cold :P