The meltdown of 2008 was misdiagnosed, mostly by those with an ideological barrow to push. Thus have we been treated to sermons about greed, derivatives and, of course, the sins of capitalism itself. Wrong, dead wrong. To a large extent it was the product of government interference
Depending on how you date it, on or before the collapse of Lehman Brothers in September, 2008, it is now ten years since the start of what most of the world called the Great Recession and we called the Global Financial Crisis (GFC). For no other reason than it is ten years on, so far as I can tell, forebodings of another meltdown currently abound, from JPMorgan and Warren Buffet, for example, among many. Well here’s hard news: something like it will happen again.
Something like it has always happened at irregular intervals. The trick is to predict the next cause and its timing. Simply predicting a recurrence is banal, even for talking-head economists and other assorted financial experts.
All economic meltdowns have a common factor. Assets held by broad segments of market participants turn out to be worth much less than their book value. But that is rather like attributing all deaths to organ failure. True, but not very illuminating.
The GFC, like its predecessors, was not definingly salutary. Each financial or economic crisis, however you want to refer to it, is very unlikely to repeat itself. Each one, in other words, is differently formed. And the nature of each beast is that it creeps up all unbeknown. If its menace was on open show beforehand it would likely be thwarted.
Take the GFC. First it is necessary to dispel the myth. The myth is that capitalism imploded in 2008. So-called neoliberalism was laid bare, plunging the world into despair. Kevin Rudd had much domestic and international leftist company in pushing this line. Nice line. But not true.
The GFC was completely misdiagnosed. It is hard to find any account of it that doesn’t attribute importance to greed, to the complexities of derivatives and, of course, to capitalism itself. Greed is a common human trait not peculiar to the GFC. Derivatives are fine if the underlying security is sound. And capitalism, the least-worst economic system ever devised, can’t be blamed for being capitalism and having its ups and downs.
However, the severity of this particular ‘down’ was not the product of untrammelled capitalism. To a large extent, it was the product of government interference. Its starting point was the generation in the United States, over more than a decade, of vast numbers of mortgage loans to people who had little or no chance of being able to repay them. From there it is a question of identifying what caused this to happen. As in most catastrophes, a number of mutually-reinforcing factors can be identified:
- The Community Reinvestment Act (signed by President Carter in 1977 and subsequently strengthened by President Clinton) systematically induced banks into lending into poorer communities.
- This process was reinforced by ability of banks to get these loans, and the risk of their default, off their books by selling them to the government-sponsored mortgage companies Freddie Mack and Fannie May.
- And this all occurred within a pervasive spending and borrowing culture promoted by years of loose monetary policy.
The common thread throughout these factors is the offending hand of government, not the free market. It is imaginative fiction in these circumstances to blame greed; or derivative trading; or, most particularly, to blame capitalism. But I want to get back to the innate difficulty of predicting the causes and timing of the next crisis.
No economic models predicted the GFC. While perhaps one or two commentators can be found years before warning of an impending sub-prime mortgage predicament, model builders and their models were oblivious to the danger. And why wouldn’t they be. How exactly do you model bankers making bad mortgage loans en masse under the influence of vote-seeking politicians and their creature, the Community Reinvestment Act?
Barney Frank (chairman of the US congress House Financial Services Committee) earnestly, right up to the last, vouchsafed the financial health of Fannie Mae and Freddie Mac; though they had engaged in buying junk for a decade or more. How do you model Barney’s blarney? And then how do you factor in rating agencies awarding triple-A status to derivative securities consisting of packaged junk? The answer is that you can’t and you don’t.
So, what is ticking away now and when will it explode? If any notable knew they probably wouldn’t be telling. First, they would have already positioned themselves to earn squillions. Second, and consequently, they would not want to give warning of the impending meltdown in case it was thwarted.
My own (grain of salt) view is that we are not close to another serious meltdown. Too many people are talking about one a-comin’. This is a fair sign that one ain’t a-comin’ soon. But let me bold. Sell if Donald Trump looks like being beaten in the 2020 presidential election by Pocahontas or Spartacus or by any of the new breed of socialist Democrats. Otherwise enjoy the Trumpian ride.