The 2008 near-meltdown of major financial institutions, and Alan Blinder’s ten lessons for fellow economists

[Multicolored Lemur]

Alan Blinder - Wikipedia

en.wikipedia.org

5) Fraud and near-fraud can rise to attain macroeconomic significance.

“ . . I think most of us thought that fraud and near-fraud were in the rounding error . .”

6) Excessive complexity is not just anti-competitive, it's dangerous.

“ . . When the crash comes, losses may therefore be much larger than investors dreamed imaginable. Markets may dry up as no one knows what these securities are really worth. .”

7) Go-for-broke incentives will induce traders to go for broke.

“We had to learn this? Apparently so. .”


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I think Wikipedia does a good job summarizing three of his lessons from the middle.

 

[Multicolored Lemur]

https://spia.princeton.edu/system/files/research/documents/Blinder_What_Did_We_Learn_from_the_Financial_Crisis_the_Great_Recession_and_the_Pathetic_Recovery.pdf

published Nov. 2014:

1) It can happen here.

“ . . . Other “impossible” things have also happened. Sharp housing bubbles and crashes were supposed to be only local-market events, but in the 2000s we suffered through a nationwide boom-bust cycle. Financial system meltdowns were supposed to happen only in less-developed countries with weak financial institutions and inadequate regulation, yet the US narrowly escaped experiencing one in 2008. . . ”

2) Minsky was basically right

“ . . . In his paradigm, financial fragility and recurring cycles of boom and bust, not equilibrium, are the central concepts. People forget the past and go to extremes. . . ”

3) [the intellectually difficult lesson]
.
.

4) Self-regulation is oxymoronic.

“ . . . Regulators must regulate, not delegate. Financial firms must upgrade their risk management systems and have them examined by regulators. We didn’t know this beforehand?”

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His ten lesson for fellow economists start on page 6.

No, I’m not going to understand all of it. He’s writing for his fellow economists! But actually, I like the fact that it’s at the challenge level. Some of it is quite readable. Other parts I need to mull over, and I might need to just accept the fact—

That I might not understand it any time soon!

 

[Multicolored Lemur]

And if people really insist . . .

Lesson # 3: Reinhart-Rogoff recessions are worse than Keynesian recessions.

Okay, a Keynesian recession is a normal, “run of the mill” recession. And it’s one which responds to the normal Keynesian tools of monetary stimulus (such as cutting the prime interest rate) and of financial stimulus (such as tax cuts and infrastructure spending).

A Reinhart-Rogoff recession is named after two fellow economists who described it, and Blinder writes, “Reinhart-Rogoff recessions destroy parts of the financial system and leave much of the rest reeling—and needing to deleverage.”

I wish Blinder had more simply written “de-leverage.” It’s more readable.

He continues, “All of that stunts and delays recovery. Reinhart-Rogoff recessions also leave large buildups of debt — financial sector debt, corporate debt, household debt, and public debt — in their wake.”

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And there you have it. That’s as far as I understand.

 

[Multicolored Lemur]

The Lehman Brothers bankruptcy is typically dated Monday, September 15, 2008.

And even more specifically, it happened as late Sunday night flowed to very early morning Monday, and it became apparent that a last minute deal was not going to be able to be put together.

 

[Multicolored Lemur]

The sign coming down in ‘08.

Ten years on, the Fed’s failings on Lehman Brothers are all too clear | Laurence M Ball

The key policymakers have always maintained they had no choice but to let Lehman collapse. That’s simply not true, says author Laurence M Ball

www.google.com

This is an editorial in UK’s The Guardian newspaper saying the U.S. should have provided bridge loans to Lehman. Maybe the United Kingdom should have helped, too! I mean, since the UK’s a major player on the financial scene and all.

 

[AgnosticBoy]

4) Self-regulation is oxymoronic.

“ . . . Regulators must regulate, not delegate. Financial firms must upgrade their risk management systems and have them examined by regulators. We didn’t know this beforehand?”

This one is probably my favorite. I believe bad risk taking was a big factor in the recent bank failures. As for the "we didn't know this beforehand" part.. to bring a psychological spin, i attribute that to greed. That will usually steer people away from doing what they know they're supposed to do.

 

[Multicolored Lemur]

i attribute that to greed. That will usually steer people away from doing what they know they're supposed to do.

I think that might be an example of what’s called the “agency problem” in economics.

With the risky investments that led up to 2008, I think it was a case of:

Heads, I win BIG TIME ! ! !

Tails, I just lose a little. Or, I just go get another job!

 

[Multicolored Lemur]

https://spia.princeton.edu/system/files/research/documents/Blinder_What_Did_We_Learn_from_the_Financial_Crisis_the_Great_Recession_and_the_Pathetic_Recovery.pdf

8) Illiquidity closely resembles insolvency.

Alan asks, Was the case with Bear Stearns, which the U.S. Fed bailed out in March 2008, really so different from the case of Lehman Brothers, which the Fed allowed to fail?

And he answers, No, it was not.

9) [the morally hard lesson]

10) Economic illiteracy can really hurt.

“ . . . People don’t understand the natural cyclicality of the deficit, the foolishness of trying to fight that cyclicality, the difference between policies that raise or lower the deficit temporarily versus permanently, and certainly not the notion that it’s natural to have some deficit in a growing economy. . . ”

 

[Multicolored Lemur]

and if people really insist!

9) Moral hazard isn’t a show-stopper, it’s a tradeoff.

A moral hazard is where we let someone get away from being punished. We may even help them avoid punishment. No, they haven’t learned their lesson.

They may even do it worse next time!

And yet, Alan writes:

“ . . . in the midst of a crisis, with the house on fire, it may be imperative to douse the fire first and try to persuade the occupant not to smoke later—time inconsistency notwithstanding. Yes, bailouts set bad precedents, but letting a crisis spin out of control may be far worse. . . ”

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Look, we’re social monkeys, or technically apes. We very quickly perceive cheating on the part of others. You might even say that we have a “highly-attuned cheat detector mechanism” in our brains [Ive read this before] . And although not technically true, I think it’s a good analogy for what happens.

We detect deliberate wrong-doing or “in your face” cheating in a flash. And we’re usually right. We view it as disrespect, and it really sticks in our craw. And we’re usually right about the disrespect.

And then, punishment can feel like the most important thing in the world. We want to teach the person a lesson, teach them good, and squelch them down hard!

Alan is saying, Take a deep breath.

Moving forward in a positive way may be more important. And in this particular case, allowing the economy to keep moving forward in a positive way might well be more important. A modern economy is a lot like a shark — it has to keep swimming forward!

So, take a chance for Rock & Roll. Do the bailout. The chance you’re taking is that you may or may not get the later reforms. In the U.S., we passed Dodd-Frank in 2010. And the fact that major players want to get out from under it shows that it might be doing some good.

But, we didn’t bring down the Hammer of the Gods onto Wall Street like the public really wanted.

And that’s the part you, I, and all fellow citizens might have to be okay with. Or not, I guess.