I would say: "policy was fantastic between Lehman and the trough, grossly subpar after the trough, and —if you believe the Fed—criminally negligent before Lehman": Niccola Gennaioli and Andrei Shleifer: A Crisis of Beliefs: Investor Psychology and Financial Fragility: "Instability from Beliefs...
...1. Excess optimism, excess lending and investment. 2. Correction of expectations (due to bad news or waning of optimism)/ 3. Recession (impaired intermediation or excess pessimism). Crises are due to non-rational beliefs, which may be amplified by traditional mechanisms. See Minsky (1977), Kindleberger (1978)....
Why was Lehman so pivotal? ▪ Tail risks neglected by both investors and policymakers. ▪ Liquidity interventions, but no aggressive attempts to get banks to raise capital. ▪ Markets learn the system was more interconnected–through derivative contracts and fire sales–than believed. ▪ Lehman was a huge dislocation because markets and regulators learned they were wrong. Alternative Theory I: Moral Hazard ▪ Banks are too big to fail and knowingly took risks of housing exposure. Alternative Theory II: Bank Runs ▪ Lehman crisis was the result of a Diamond-Dybvig bank run. In a 2015 speech at the National Bureau of Economic Research, Bernanke stated that “the Diamond-Dybvig model describes what happened in the financial crisis extremely well.”...
Hard to see Lehman as a non-fundamental sunspot. ▪ Need more sophisticated theories like Goldstein-Pauzner. ▪ But then the question of policy passivity comes back. ▪ The fragility of the financial sector cannot be surprising in the summer of 2008. ▪ Errors in expectations are critical.
Extrapolative expectations central to the housing bubble. ▪ Continued neglect of downside risks central to understanding 2007-2008. ▪ Policy was fantastic after Lehman, behind the curve before Lehman. ▪ Hard to tell the story of the crisis without beliefs.
#shouldread
