The Financial Crisis

17 September 2008 at 10:20 am 5 comments

| Peter Klein |

A regular reader asks why we haven’t written much on the US financial crisis. What, he asks, do organizational economics, strategic management, Austrian economics, entrepreneurship theory, and the new institutional economics say about the events of recent weeks?

I can’t speak for Nicolai, Dick, and Lasse, but I personally have avoided talking about it because, well, I’m too depressed — not so much about the crisis itself, which I view as a necessary corrective to two decades of potentially ruinous malinvestment, but about the political reaction to it. I agree with Larry White that the general level of discourse not just among laypeople but also among the political and financial elites, top journalists, and academics, has been shockingly vapid and vacuous, even by the usual standards. Listening to government officials, pundits, and analysts analyzing the crisis is like listening to my son’s first-grade class discussing the finer points of postmodern French literature. It was too much deregulation! (Huh?) The free market broke down yet again, just like in the 1930s! Market failure! Thank goodness the government is “stepping in”! Excuse me while I blow my groceries.

My view, in brief, is that the current crisis is the predictable result of a massive credit bubble that began under Greenspan in the 1990s and spilled over into the housing market, following the general outlines of the boom-bust cycle described by the Austrians, along with moral hazard encouraged by the financial “safety net” and the implicit (and, increasingly explicit) guarantees of the “too-big-to-fail” mentality. Of course, the US government’s reaction — spending taxpayer money like candy to bail out favored groups and institutions — can only exacerbate the problem. You can do your own Googling like this or this to find informed commentary. I have little to add but will highlight a few favorite comments:

  • I like Alex’s summary: “Thank goodness we bailed out Bear Stearns back in March. If we hadn’t we might have lost Fannie Mae and Freddie Mac, Lehman Brothers, Merrill Lynch and who knows what else.  Oh wait. . . .”
  • Bob Higgs: “The failure of Fannie Mae and Freddie Mac, setting in motion the biggest government bailout/takeover in U.S. history, brings a grim sense of fulfillment to competent economists. After all, what did people expect, that water would flow uphill forever?”
  • Peter Wallison is one of the few who understands Freddie and Fannie: “Recent statements by Barney Frank (D., Mass.), the chairman of the House Financial Services Committee, and Chuck Schumer (D., N.Y.), a powerful member of the Senate Banking Committee, make clear that Congress will never let them be privatized, broken up, slimmed down, nationalized or any of the other options hopeful reformers are putting forth today. Fannie and Freddie in their current form are just what Congress wants: an inexhaustible source of campaign contributions and funds for favored groups.”
  • Lew Rockwell makes an excellent political point, namely that the nationalization of Freddie and Fanny (and now, this morning, AIG) was accomplished by executive fiat. The treaury secretary in the former case, and the Fed chairman in the latter case, simply decreed that the state would take over these multi-billion-dollar enterprises. No discussion or debate, no Congressional deliberation, no court rulings. Simply the stroke of a pen. Imagine the reaction among the punditariat if, say, Hugo Chavez did such a thing. (Of course, we don’t use the word “nationalization.” Lew wittily suggests reissuing Marx and Engels under a new title, The Conservatorship Manifesto.)

Entry filed under: - Klein -, Austrian Economics, Bailout / Financial Crisis, Classical Liberalism, Corporate Governance, Institutions, Public Policy / Political Economy. Tags: , .

Testing for Bias in Peer Review Spawning: The Small-Firm Effect

5 Comments Add your own

  • 1. Per Bylund  |  17 September 2008 at 10:53 am

    A great example of this is Stiglitz’s commentary written for CNN (published today), where he lists six points on how to make future crises less severe. I find two things about Stiglitz’s commentary interesting.

    One is that all the six points begin with “we need” and that all of them call for state regulation of the financial markets.

    The other is his ending paragraph in which he states, basically, that the problem is that there is a market:

    These reforms will not guarantee that we will not have another crisis. The ingenuity of those in the financial markets is impressive. Eventually, they will figure out how to circumvent whatever regulations are imposed. But these reforms will make another crisis of this kind less likely, and, should it occur, make it less severe than it otherwise would be.

    The market has a way of getting around the rules set up for their own good, so no regulations can work indefinitely or perfectly. All “we” can do is to have the state regulate as much as possible so that the market doesn’t cause too much trouble.

    There’s no such thing as “government failure,” I guess.

  • 2. David Hoopes  |  19 September 2008 at 12:33 am

    Good post Peter. I find the presidential candidates’ inclination to blame these things on greed and evil people depressing. By the way, doesn’t Obama have close friends who got rich working at Fannie Mae? Doesn’t he have close friends that worked at Lehman?

    All the populism that surrounds these difficult issues makes things seem hopeless.

  • 3. Araglin  |  19 September 2008 at 5:59 pm

    Professor Klein,
    Thanks for this post. One question I have: Have you found any good articles dealing with the infintessimal-short historical memory and heard mentality of the commentariat re: this financial crisis? That is, is there evidence that the same pundits who all (with great respectability and seriousness) denied the existence of a problem 3, 4, or 5 years ago, and dismissed dissenters as cranks, are now the same pundits being turned to explain the “root causes” of the problem now that it’s existence is no long deniable and suggesting “practical” solutions?


    P.S. When can we expect your new book with Professor Salerno to make it to market?

  • 4. Peter Klein  |  21 September 2008 at 8:53 pm

    Araglin, I know exactly what you mean! I don’t recall seeing anything on this, though I imagine it would be easy to write with a little Googling.

    The book won’t be out until early or mid 2009. (For those who don’t know, Joe Salerno and I are writing an advanced textbook, “Fundamentals of Economic Analysis: A Causal-Realist Approach.”

  • 5. Charles Hill  |  22 September 2008 at 3:10 pm

    Democrats in Congress and Bill Clinton relaxed lending stardards years ago so low income people with bad credit could buy houses with no downpayment, poor credit and no proof that there income was enough to afford the house.
    Just Google old newspaper articles or the Congressional Record.

    “A brief history of the Fannie Mae and Freddie Mac mess is in order. Back in the days when a Bank or Savings and Loan approved a home loan, they did so with lending standards that had historically led to only safe loans. They had to because they kept the loan and were responsible if it failed. These standards included 3 major parts.

    First, the mortgage payments could be no greater that a set percentage of your income, usually about 40 percent.

    Second, a down payment was required of about 10 percent or above so the new owner would immediately have some equity in the home.

    Third, A good credit rating was required to prove you had a history of paying your bills.

    Some adjustments could be made, for example people that had poor credit could get a loan with a larger down payment so if the loan failed, the bank could still resell the house and cover the loan.”

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