good podcast on the economic crisis

[Azazello1313]

http://www.econtalk.org/archives/2010/05/r...s_on_the_2.html

 

the last bit he reads at the end:

 

An unpleasant but unavoidable conclusion of this paper is that Wall Street was (and remains) a giant government-sanctioned Ponzi scheme. Homebuyers borrowed money from lenders who got their money from Fannie Mae, Freddie Mac, and banks that borrowed money from investors who expected to be reimbursed by the politicians who took that money from taxpayers. Almost everyone made money from this deal except the group left holding the bag—the taxpayers. There is an old saying in poker: If you don’t know who the sucker is at the table, it’s probably you. We are the suckers. And most of us didn’t even know we were sitting at the table.

 

Many people have placed the current mess at the doorstep of capitalism. But Milton Friedman liked to point out that capitalism is a profit and loss system. The profits encourage risk-taking. The losses encourage prudence. Government policies have made too many markets one-sided. Because of implicit government guarantees, the gains were private and the losses were public. The policies allowed people to gamble with other people’s money, and by rescuing the creditors of Fannie Mae, Freddie Mac, Bear Stearns, AIG, Merrill Lynch, and others, policy makers have further weakened the natural restraints of the profit and loss system. This isn’t capitalism—it is crony capitalism.

[Perchoutofwater]

The last paragraph pretty much says it all.

[Azazello1313]

this paper is really good

 

There are two major competing narratives for the financial

crisis. One narrative focuses on moral failure, in which the

compensation structure for executives at financial institutions

encouraged them to place their own and other firms at risk to

reap short-term gains. The other narrative focuses on cognitive

failure, in which executives and regulators overestimated the

risk-mitigating effects of quantitative modeling and financial

engineering. It is important to sort out which of these narratives

deserves more credence.

 

Those who emphasize moral failure have highlighted a

number of distortions between private and social benefits, including:

that executive pay at financial institutions is not tied to

long term viability, the “originate to distribute” model of

mortgage financing gives the originator an incentive to make

bad loans that are passed down the line in the system of structured

financing of mortgage securities, and rating agencies are

overly generous in granting AAA and AA ratings because they

were paid by the issuers of mortgage-related securities.

Under the moral failure theory, the essential problem is the

misalignment between the incentives of executives to maximize

their own salaries and the long-term best interest of the financial

firms they led.6 In this narrative, regulators were either stifled

by ideological faith in markets or hampered by organizational

flaws—most notably, the alleged absence of anyone

charged with monitoring systemic risk.

 

The other narrative is one of cognitive failure. Under this

view, key individuals believed propositions that turned out to

be untrue. Propositions that were falsely believed included:

that a nationwide decline in housing prices, having not occurred

since the Great Depression, was impossible; increased

home ownership rates were a sign of economic health; the use

of structured finance and credit derivatives had reduced risk to

key financial institutions; monetary policy only needed to focus

on overall economic performance, not on asset bubbles; banks

were well capitalized; and quantitative risk models provided

reliable information on the soundness of mortgage-backed securities

and of the institutions holding such securities. In hindsight,

these propositions were wrong. Policymakers were

caught up in the same cognitive environment as financial executives.

Market mistakes went unchecked not because regulators

lacked the will or the institutional structure with which to

regulate, but because they shared with the financial executives

the same illusions and false assumptions.

 

Under the narrative of moral failure, the financial crisis was

like a fire started by delinquent teenagers, with the adults in

charge not sufficiently inclined or positioned to exercise adequate

supervision. The solution is thus to reorganize and reenergize

the regulatory apparatus.

 

Under the narrative of cognitive failure, it is as if the authorities

supplied the lighter fluid, matches, and newspapers used

to start the fire. In particular, housing policy encouraged too

many households to obtain homes with too little equity. Bank

capital regulations steered banks away from traditional lending

toward securitization. Moreover, these regulations encouraged

the banks’ use of ratings agencies and off-balance-sheet entities

to minimize the capital held to back risky investments. If this

narrative holds, then financial regulation itself is inherently

problematic. Regulators, sharing the same cognitive environment

as financial industry executives, are unlikely to be able to

distinguish evolutionary changes that are dangerous from

those that are benign. It may not be possible to design a foolproof

regulatory system.

....

VI. THE ISSUE OF NARRATIVE

 

The ultimate outcome of the financial crisis will be visible in

the high school history textbooks of the future. If those books

convey the causes of the crisis only in terms of moral failure,

then as a society we will have entrenched a historical narrative

that is excessively skeptical of markets and excessively credulous

of the effectiveness of regulation.

 

The narrative of moral failure is attractive for many reasons.

First, for those who are inclined to distrust markets and support

vigorous government intervention, the narrative provides

reinforcement of those prejudices. Second, it is a narrative with

clear villains, in the form of greedy financial executives. Such

villains always make a story more emotionally compelling. Finally,

the narrative provides a comforting resolution: Once we

reorganize and reinvigorate the regulatory apparatus, we can

rest assured that the crisis will not recur.

 

The narrative of cognitive failure is not so comforting. Rather

than identifying villains, this narrative sees the crisis as the

outcome of mistakes by well-intentioned people, including

both financial executives and regulators. Moreover, this narrative

carries with it the implication that human fallibility will

persist, and so we cannot be confident that regulatory reform

can make our financial system crisis-proof.

 

The narrative of cognitive failure suggests a need for greater

humility on the part of policymakers. They should perhaps rethink

the push for greater home ownership, particularly to the extent

that the push encourages people to borrow nearly all of the

money necessary to finance the purchase of a home. They might

even want to reconsider the corporate income tax, which penalizes

equity relative to debt, creating an incentive for banks and other

firms to look for ways to maximize their use of debt relative to equity.

Above all, the public should not be deceived into believing

that regulatory foresight can be as keen as regulatory hindsight.