Azazello1313 Posted May 26, 2010 Share Posted May 26, 2010 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. Quote Link to comment Share on other sites More sharing options...
Perchoutofwater Posted May 26, 2010 Share Posted May 26, 2010 The last paragraph pretty much says it all. Quote Link to comment Share on other sites More sharing options...
Azazello1313 Posted June 9, 2010 Author Share Posted June 9, 2010 this paper is really good There are two major competing narratives for the financialcrisis. 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. Quote Link to comment Share on other sites More sharing options...
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