A Baker's Dozen of Fairly-Recent Links

Nicola Gennaioli and Andrei Shleifer: Two Myths of the 2008 Meltdown: "The 2008 financial crisis was not the result only of moral hazard; nor was it unforeseeable. While too-big-to-fail banks believed–rightly, it turned out–that they would be bailed out, consumers, rating agencies, and policymakers all bet on housing as well, destabilizing the system.... Two misconceptions in the current retrospectives of the crisis. These misunderstandings may seem purely academic, but they are not. They have major consequences for the ability of policymakers to prevent future crises...

...The first misconception is that the crisis was all about moral hazard.... It is surely the case that the banks, along with rating agencies, mortgage underwriters, investment banks, and others, engaged in unsavory practices. But the moral hazard view misses the central point: as we document in our book, households, banks, rating agencies, investors, and policymakers all believed in the housing market, and all failed to see the risks. The banks believed what consumers believed as well–that housing was a good bet. The stock market rewarded banks that made that bet. The first-order cause of the bubble and the crisis was neither trickery nor hidden risk taking. It was a belief about housing that most market participants embraced....

The second misconception is that the crisis could not be anticipated. This argument is most popular with policymakers who acknowledge that they failed to see what was coming. As Timothy Geithner, President Barack Obama’s Treasury Secretary, put it in his memoir, “Financial crises can’t be reliably anticipated or preempted.” Likewise, Hank Paulson, Geithner’s predecessor under President George W. Bush, recently said, “my strong belief is that these crises are unpredictable in terms of cause or timing or the severity when they hit.” One version of this view holds that the Lehman failure resulted from an unpredictable run.... The evidence does not support this view.... Deflating asset bubbles, particularly in housing... pose a serious danger.... When highly leveraged banks and other institutions face the abyss of massive losses, the probability of a panic rises sharply. In this respect, the 2008 crisis looked very much like all the others.... The Lehman failure did precipitate a fast and furious run that was hard to stop once it started. But its occurrence was a growing possibility for months. It did not come out of the blue....

The two misconceptions about the crisis have the unfortunate effect of preventing us from learning a key lesson: economic policy prior to Lehman Brothers’ collapse should have been more aggressive. Moral hazard claims excuse inaction because “it was the bad banks taking and hiding extravagant risks.” Likewise, claims of unpredictability excuse passivity. In reality, the fragility of the financial sector had been building up for more than a year before Lehman. The continuing optimism of Fed forecasts, and the reluctance to force banks to shore up their capital–often clothed in too-big-to-fail-rhetoric–amounted to serious policy failures. Policymakers showed great courage and skill in acting after the Lehman catastrophe. But we should not forget their failure to act before it. Stopping financial bubbles is difficult. Acting early and aggressively to protect the system once the bubbles start deflating would help contain future crises...


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#finance
#greatrecession

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