{"id":169927,"date":"2010-01-12T10:30:48","date_gmt":"2010-01-12T15:30:48","guid":{"rendered":"tag:business.theatlantic.com,2010:\/\/3.33333"},"modified":"2010-01-12T09:58:22","modified_gmt":"2010-01-12T14:58:22","slug":"blaming-things-not-named-greenspan-for-the-great-recession","status":"publish","type":"post","link":"https:\/\/mereja.media\/index\/169927","title":{"rendered":"Blaming Things Not Named Greenspan for the Great Recession"},"content":{"rendered":"

What caused the Great Recession, anyway? Two years after it began, we don’t know. (Heck, 80 years after the Great Depression, we haven’t decided why it started, or lasted so long, or ended.) So Slate’s Jacob Weisberg went digging for answers. Just about everybody agrees that Alan Greenspan is at fault, somehow. After that, everything is up for debate.<\/a><\/p>\n

Conservative economists–ever worried about inflation–tend to fault
\nGreenspan for keeping interest rates too low between 2003 and 2005 as
\nthe real estate and credit bubbles inflated. This is the view, for
\ninstance, of Stanford economist and former Reagan adviser John Taylor,
\nwho argues that the Fed’s easy money policies spurred a frenzy of
\nirresponsible borrowing on the part of banks and consumers alike.<\/p>\n

Liberal
\nanalysts, by contrast, are more likely to focus on the way Greenspan’s
\naversion to regulation transformed pell-mell innovation in financial
\nproducts and excessive bank leverage into lethal phenomena. The pithiest explanation<\/a> I’ve seen comes from New York Times<\/em>
\ncolumnist and Nobel Laureate Paul Krugman, who noted in one interview:
\n“Regulation didn’t keep up with the system.” In this view, the
\nemergence of an unsupervised market in more and more exotic
\nderivatives–credit-default swaps (CDSs), collateralized debt
\nobligations (CDOs), CDSs on<\/em> CDOs (the esoteric instruments
\nthat wrecked AIG)–allowed heedless financial institutions to put the
\nwhole financial system at risk. “Financial innovation + inadequate
\nregulation = recipe for disaster is also the favored explanation of
\nGreenspan’s successor, Ben Bernanke, who downplays low interest rates
\nas a cause (perhaps because he supported them at the time) and attributes the crisis to regulatory failure<\/a>. <\/p>\n

A
\nbit farther down on the list are various contributing factors, which
\ndidn’t fundamentally cause the crisis but either enabled it or made it
\nworse than it otherwise might have been. These include: global savings imbalances<\/a>,
\nwhich put upward pressure on U.S. asset prices and downward pressure on
\ninterest rates during the bubble years; conflicts of interest and
\nmassive misjudgments on the part of credit rating agencies<\/a>
\nMoody’s and Standard and Poor’s about the risks of mortgage-backed
\nsecurities; the lack of transparency about the risks borne by banks,
\nwhich used off-balance-sheet entities known as SIVs to hide what they
\nwere doing; excessive reliance on mathematical models like the VAR<\/a> and the dread Gaussian copula function<\/a>,
\nwhich led to the underpricing of unpredictable forms of risk; a flawed
\nmodel of executive compensation and implicit too-big-to-fail guarantees
\nthat encouraged traders and executives at financial firms to take on
\nexcessive risk; and the non-confidence-inspiring quality of former
\nTreasury Secretary Hank Paulson’s initial responses to the crisis. <\/p>\n<\/blockquote>\n

Last year, National Journal’s Jonathan Rauch wrote a killer essay on
\nthis very topic that came to an exotic, and fascinating, conclusion.
\nHere<\/a>‘s the quick summary: Financial innovation produced a vast network
\nof
\ncomplicated asset-backed securities traded among what insiders call
\n“shadow banks,”
\nor unregulated banks. Shadow banks looking to park cash where it would
\nhold value and earn interest created a
\nshort-term securities market — much like a checking account. But
\nunlike a regular FDIC-insured checking accounts, these deposits would
\nnot be guaranteed by the
\ngovernment. So investors borrowing from
\nthis shadow depository system had to put up collateral. And they chose
\n…
\ntheir asset backed securities.<\/p>\n

Why is that dangerous? Because in the shadow banking industry, these
\ndeposits, backed by sub-prime mortgages instead of the FDIC, acted as
\nmoney. Banks relied on it for transactions. “Subprime morgage debt had
\nentered the money supply.” But then the
\nhousing bubble burst. Depositors dumped their assets to raise cash and
\ntried to withdraw their money, raiding the shadow depository market,
\nand the
\nmoney supply crashed.<\/p>\n

And here’s Rauch<\/a> in his own words:<\/p>\n

In the so-called Quiet Period, 1934 through 2007, systemic bank runs
\nseemed to become relics of an unmourned past. Why? Because for about
\nfour decades, banks’ activities were restricted to heavily regulated
\nventures that were more or less guaranteed a profit — and, even more
\nimportant, because federal deposit insurance, which began in 1934,
\nassured depositors that their savings were safe.<\/p>\n

Financial innovation, however, could be delayed but not denied.
\nAround the walled garden grew a forest of new competitors and products.
\nMoney-market funds and other investment vehicles took deposits without
\noffering federal guarantees. In a process known as securitization,
\ninvestment banks converted predictable streams of income, everything
\nfrom mortgage payments to health club dues, into securities that
\ninvestors bought eagerly. Derivatives — securities based on other
\nsecurities–arose to spread risk and hedge against volatility. In time,
\nshadow banking, as the new institutions and instruments were
\ncollectively called, rivaled and even eclipsed old-fashioned commercial
\nbanks.<\/p>\n

The firms and major financial players making all these trades needed
\nto park cash where it would hold its value and earn some interest, yet
\nbe accessible on demand. In other words, they needed the equivalent of
\nchecking and savings accounts, the “demand deposits” that banks
\ntraditionally provide and that form the backbone of the money supply.
\nBut no insured depository could begin to cope with the trillions of
\ndollars involved. And so shadow banking developed what amounted to its
\nown depository system, a short-term securities market called the “sale
\nand repurchase,” or “repo,” market. It is immense. Gorton figures its
\nsize at perhaps $12 trillion, but he says no one knows for sure.<\/p>\n

“It’s important to see that this is a banking system,” Gorton says. But it is like a 19th-century<\/em>
\nbanking system, because repo “deposits” are uninsured. Unable to rely
\non a federal guarantee, depositors who park their holdings there
\nrequire that the borrower put up something of value as collateral.<\/p>\n

Treasury bonds, because they are safe and liquid, are the ideal form
\nof collateral, but there were nowhere near enough of them to meet the
\ndemand. So asset-backed securities — those packages of safe-looking
\nincome from mortgages, auto loans, and all the rest — were pressed
\ninto service as collateral. In time, the better grades of subprime
\nmortgage-backed securities were mixed into the blend, and they, too,
\nwon acceptance as collateral.<\/p>\n

All of these asset-backed securities were sorted and re-sorted,
\ncombined and recombined, sold and resold, until, as Gorton writes,
\n“looking through to the underlying mortgages and modeling the different
\nlevels of structure was not possible.” Users could not independently
\nassess the value of mortgage-backed collateral any more than your
\ngrocer can independently assess the solvency of your bank before
\naccepting your check.<\/p>\n

You can see, perhaps, where this leads. Repo is a form of money
\nbecause it acts as a store of value and financial actors rely on it to
\nconduct transactions. But instead of being backed by a federal
\nguarantee, it was backed by, among other things, subprime mortgages. In
\nthis way, without anyone paying much notice, subprime mortgage debt entered the money supply. <\/em>As
\nin the 19th century, the economy had become dependent upon a form of
\nbank-issued money that was not federally guaranteed and that was not as
\nstable as it appeared. Unlike in the 19th century, however, no one
\nunderstood how vulnerable the system was to a panic.<\/p>\n

Calamity then struck, as it had before. First, the unexpected
\ndecline in housing prices tanked the subprime market. Repo depositors
\nknew that most collateral was sound, but they had no way to know if
\ntheir own holdings were safe; so in 2007 they began what amounted to a
\nrun on the repo system, effectively withdrawing their money. To raise
\ncash, repo depositories dumped assets, further depressing collateral
\nvalues and starting a tailspin.<\/p>\n

In September of last year, when the failure of Lehman Brothers, the
\nmighty investment bank, convinced investors that no one was safe, the
\ncrisis turned into a meltdown. As the repo market “virtually
\ndisappeared” (in Gorton’s phrase), the money supply crashed and the
\neconomy began to suffocate.\n<\/p><\/blockquote>\n



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What caused the Great Recession, anyway? Two years after it began, we don’t know. (Heck, 80 years after the Great Depression, we haven’t decided why it started, or lasted so long, or ended.) So Slate’s Jacob Weisberg went digging for answers. Just about everybody agrees that Alan Greenspan is at fault, somehow. After that, everything […]<\/p>\n","protected":false},"author":1534,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[7],"tags":[],"class_list":["post-169927","post","type-post","status-publish","format-standard","hentry","category-news"],"_links":{"self":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/posts\/169927","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/users\/1534"}],"replies":[{"embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/comments?post=169927"}],"version-history":[{"count":0,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/posts\/169927\/revisions"}],"wp:attachment":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/media?parent=169927"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/categories?post=169927"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/tags?post=169927"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}