Root Cause of the Financial Crisis

[xsited1]

Brilliant post!

As if Paul Krugman winning the Nobel Prize in economics isn't reason enough for us to be less-than-sanguine about the future, everywhere we look we see well-respected analysts advocating increased government regulation and spending -- effectively the same policies that transformed a financial crisis into a drawn-out depression during the 1930s -- while completely ignoring the root of today's problems.

 

[Truthmatters]

The SEC is the security and exchange commission is the foremost expert on these issues in the country.

They say it was deregulation as in the Gramm-Leach-Bliley Act.

They were forced by this law to try and get the industry to police itself.

As you can imagine that didnt go well.

 

[Truthmatters]

Brilliant post!

because it says what you want to hear.

Tell me who is this guy you admire so much?

 

[Truthmatters]

1946 and 1964 is the baby boom, Phil Gramm was born in 1942

 

[xsited1]

because it says what you want to hear.

Tell me who is this guy you admire so much?

Because it's what the data says it true.

In God We Trust... All others bring data.

You would be amazed at how many people ignore the data for political gain. Here are four that you may recognize: George W. Bush, Barack Obama, John McCain, Joe Biden.

 

[xsited1]

The SEC is the security and exchange commission is the foremost expert on these issues in the country.

They say it was deregulation as in the Gramm-Leach-Bliley Act.

They were forced by this law to try and get the industry to police itself.

As you can imagine that didnt go well.

That is oversimplifying the problem. If anything the GLB Act didn't go far enough. One of the main problems was the politicization of the regulatory process, which was not covered by the GLBA. And now we let our Congressional leaders pass an unconstitutional bail-out bill that will just make matters worse.

Here's a good explanation of what happened:

The Perfect Financial Storm

What is the likelihood that three things – a lax monetary policy, pressure to expand home loan volume, and the failure to monitor home lending quality – would occur simultaneously? Note that the three factors are logically related. Each contains a rationale for inviting policymaker biases that promote risk-taking by private decision makers. This is primarily a failure of the troika of monetary, fiscal, and regulatory policies all at once.

 

[Toro]

Sorry, my interest faded after this first paragraph.

As if Paul Krugman winning the Nobel Prize in economics isn't reason enough for us to be less-than-sanguine about the future, everywhere we look we see well-respected analysts advocating increased government regulation and spending -- effectively the same policies that transformed a financial crisis into a drawn-out depression during the 1930s

Which is incorrect.

Buuuut, I decided to read the rest of it, and I basically agreed with most of it.

However, the market is also to blame, given that if markets were always efficient in allocating capital, it would have disciplined the excesses long before the wild speculation got out of hand.

For example, CDOs were in extremely high demand, because the yield pigs could get an extra 30-40 bps on a similarly rated bond. Yet, classical economic theory tells us that there is no free lunch, that the extra yield would be accompanied by extra risk, and rational investors would adjust their demand accordingly.

But that did not happen. Instead, demand for CDOs far outstripped the demand for corporate bonds. It can be argued that the housing bubble was created, or at least partially created, by investors demanding the higher yielding CDOs because they believed the super-senior tranches were rated the same as lower yielding AAA bonds. There's a reason, after all, why so many Liar Loans, 0% down mortgages ended up in these structures - because investors demanded them!

Ever wonder how a buyer of a commercial real estate property could finance the transaction with 120% in debt - yes, that's right, 120% - of the sale value of the property? Because investors were clamouring for the loans. They were able to borrow so much because investors were eager to throw money at them for the higher yield!

In fact, demand skyrocketed while spreads did not come down, or at least did not come in to the extent one would have thought, given the voracious demand for CDOs.

This is a curious fact for the efficient market hypothesists. Accelerated demand should have closed the spread between the differences between the so-called AAA-rated securities. But it did not.

And now we know why - because they weren't AAA! The higher yield was because they were inherently risky structures. Yet, the likes of Lehman and Bear Stearns levered up their balance sheets to 30x-40x equity holding this crap.

So, yes, the Fed is the number one cause of this mess. But its also due to market failure.

In fact, market failure is even more prevalent when you consider that the Fed was responding to the tech bubble. The tech bubble was a classic case of what Charles Kindleberger describes in the creation of bubbles as an exogenous event, often a new technology which lowers cost curves for industries and leads to excessive investment, oversupply and then a collapse. Kindleberger cites that historically, excess creation of money has usually present in a bubble, but exogenous events are often just as important.

 

[sparky]

very true....we've assumed a lifestyle here that can't be sustained via a debt driven gnp

heck, they had to add a digit to the national debt clock just the other day....

that American dream we were sold on is quickly becomming an American nightmare, were we're born into debt instead of properity.....

 

[Truthmatters]

Greenspan is now "shocked" the market didnt police its self.

The market is no magic its like any ohter human endevor ,it needs to be policed.

 

[KMAN]

This Democrat gets to the root cause as well...

Remember this is not some right wing goon... this is a DEMOCRAT!!!! His word should be good as gold!

Newsvine - Would the last honest reporter please turn on the lights

 

[Truthmatters]

Regulators say they made fateful mistakes - MarketWatch

Cox and Greenspans testimony

 

[Truthmatters]

This Democrat gets to the root cause as well...

Remember this is not some right wing goon... this is a DEMOCRAT!!!! His word should be good as gold!

Newsvine - Would the last honest reporter please turn on the lights

I would rather listen to the experts than to some Fiction writer

 

[gonegolfin]

Sorry, my interest faded after this first paragraph.

"everywhere we look we see well-respected analysts advocating increased government regulation and spending -- effectively the same policies that transformed a financial crisis into a drawn-out depression during the 1930s"

Which is incorrect.

While there were other factors at play, government intervention led by both Hoover and FDR did result in a drawn out the depression. As an example, the price fixing (on the upside) of agricultural food stuffs was damaging to the recovery. Which is not dissimilar to the attempt to prop up housing prices today.

Real savings is the way to build a proper economic base and growing a healthy economy. More government spending is not.

Buuuut, I decided to read the rest of it, and I basically agreed with most of it.

However, the market is also to blame, given that if markets were always efficient in allocating capital, it would have disciplined the excesses long before the wild speculation got out of hand.

No doubt the market is also to blame. But the point is that the market was not the root cause of the problem. And if proper regulation and/or common sense was used on the variety of financial instruments employed in the buildup to this crisis, all of the excess money and credit still would have created another bubble elseware.

So, yes, the Fed is the number one cause of this mess. But its also due to market failure.

Yup.

Brian