Tornado Alley (PROG)

[fuagf]

The Real Cause of the Crash of 2008 .. grist for the mill .. linked here to "Fault Lines" ..

By John H. Richardson
Jun 8, 2010 at 12:11PM



What if the financial crash of 2008 was really caused by income inequality? Not greedy
bankers, not reckless homeowners, but the ever widening-gulf between the rich and the poor?

And what if the lack of social services — like health care — made things much, much worse?

This is the startling new theory from Raghuram Rajan .. http://en.wikipedia.org/wiki/Raghuram_Rajan , the University of Chicago economist who became famous for standing up at a Federal Reserve meeting in 2005 and warning that Wall Street was out of control and headed for a global crash. As Edmund L. Andrews remembered in a recent post .. http://tiny.cc/k8m5rw .. on the Capital Gains and Games financial blog: "I was there, and I can confirm that Raghu was greeted almost with scorn. As Justin Lahart later remarked in the Wall Street Journal, people reacted as if he were some kind of Luddite. But Raghu was right, and many of his criticisms are now conventional wisdom."

Now Rajan has a new book called Fault Lines .. http://tiny.cc/99m5rw .. that analyzes the structural reasons for the crash, and it's another "aha" moment, especially fascinating because it mixes free-market Chicago School economics with good-government ideas straight out of Obamaland. His thesis is expressed in one of his chapter titles:

Let Them Eat Credit.

This is how he explained it to me in a recent interview. "What I'm trying to say is there's immense pressure emerging from income inequality. Losing jobs is a very, very painful thing, so there's immense pressure to stimulate the economy at that time to bring back jobs because safety net is inadequate, with unemployment benefits lasting only six months and health care that isn't adequate."

This isn't a heinous capitalist conspiracy — or a socialist conspiracy either, for that matter. It's the structure of the system, he says, a design flaw thrown up by the conflict between the rules of capitalism and the limits of democracy. "Politicians are there to do something about the pain and suffering people have, and my sense is that home ownership and housing credit was in some ways a path of least resistance — it seemed to be working, and if you pushed it there were lots of positive consequences. It gives people a stake in society, it increases as society does well to give them a share in the growth and helps them borrow to enhance their lifestyles."

This isn't an attempt to absolve the greedy bankers, he says. "But we have to ask why did the financial sector suddenly want to lend to low-income housing?"

Ditto Fanny and Freddie, the quasi-government housing lenders right-wing ideologues like to blame for the crash. And the low interest rates set by the Federal Reserve. "I think we should recognize that this is a systemic crisis. This is not one bank gone crazy. This is many banks."

The larger problem is global, he says. "The U.S. is a country that tends to over consume and over stimulate in bad times, and as a result it tends to be a net absorber of goods from rest of the world. A counterpart to that is countries like Germany and Japan and some of the emerging markets like China and Malaysia, which have benefited hugely by exporting to the U.S. — so I'm arguing that there is this pressure both from within the U.S. and from outside to support over consumption, and that is something that gives the financial sector an incentive to go overboard."

Consider Greece. The conventional wisdom, especially among conservatives, is that Greece is a classic example of the danger of overspending on government social programs. "But the fact that Greece overspent is not totally unrelated to the fact that Germany needs to export — some of what Greece was doing was buying German goods."

So Greece buys off its people with early pensions and great services, and the U.S. buys off its people with easy credit.

But the conservative idea that the social safety net just makes people lazy isn't the answer either — that if you increase unemployment insurance, Americans will turn into Europeans and kick back in their Lay-Z-Boys?

There's some truth to it, Rajan says, as we can see from Europe's high long-term unemployment rates. "I understand that market incentives work — if you tell people they will be shot three weeks from now if they don't get a job, they'll go find a job. But is that the kind of psychological pressure we want to create?"

Again, the underlying problem is structural: when the U.S. economy was producing a lot of jobs, we didn't have to worry about long-term unemployment insurance. There was a "balance of incentives and safety net. But if the economy is going to mean that we have long-term joblessness, we need to think if we're being overly harsh."

So, to sum up the problem:

"There are three big fault lines — one is rising inequality, which pushes inappropriate spending such as encouraging households to buy houses subsidized by government lending. Second is the inadequate safety net which causes a whole lot of inappropriate stimulus in bad times, and I'd say especially stimulus coming from the Federal Reserve in the form of low interest rates. Third is the fact that many countries have grown in a way that emphasizes exports, which leads to over consumption in countries like the U.S."

For Rajan's detailed and specific answers to all these problems, many of which seem extremely
smart, you'll have to go to the later chapters of Fault Lines. But here's a thumbnail version:

"Let's certainly do reforms in the financial sector, get bankers to own up the risk they're taking and penalize banks that take more risks. But we need to go beyond that, because if we don't fix this underlying source of income equality in the U.S., we're going to have a lot more people falling behind ..."

The popular panacea is the return of manufacturing jobs, which Rajan says will not happen. And trying to ride class resentment to an attack on the superrich isn't the answer either — for all his talk of income inequality, Rajan is still a Chicago School economist who believes that steep hikes in the "marginal" tax rates paid by the rich will stifle innovation. "The people who focus on the Bush tax cuts focus on income inequality at the very top, like the hedge fund guys who make billions. But I'm not so worried about that as the mass of people who can't afford a decent living with a high school education."

Instead, we need to focus on education, which, he admits, implies even
larger underlying social efforts like "fixing communities and fixing families."

"I like to say, 'Let the free market operate when people reach 20 — but before
that, you have to make sure they have the same access to the playing field.'"

He wants to raise taxes a little bit to bring down the public debt, also to cut expenditures a bit. "I'm not in the camp that sees a tax hike and redistribution as the answer to every problem, nor am I in the camp that says cut them to the bone, that taxes should never rise and just focus on reform — there's room for action on both sides but let's tackle the deep problem. Because if we don't try and solve them now, if we continue to rely on ad hoc measures, things will only get worse."

http://www.esquire.com/blogs/politics/2008-recession-causes-060810

===== .. related to the Raghuram Rajan of that one .. Paul Krugman comes in ..

The Sarah Palinization of the financial crisis

Posted by Edmund L. Andrews - 04 Jun 2010

Of all the canards that have been offered about the financial crisis, few are more repellant than the claim that the “real cause’’ of the mortgage meltdown was blacks and Hispanics.

Oh, excuse me -- did I just accuse someone of racism? Sorry. Proponents of the above actually blame the crisis on “government policy’’ to boost home-ownership among low-income families, who just happened to be disproportionately non-white and immigrant. Specifically, the Community Reinvestment Act “forced’’ banks to make bad loans to irresponsible borrowers, while Fannie Mae and Freddie Mac provided the financial torque by purchasing billions worth of subprime paper.

The argument has been discredited time and again, shriveling up almost as soon as it’s exposed to sunlight. But it keeps coming back, mainly because the anti-government narrative gives Republicans a way to deflect allegations that de-regulation allowed Wall Street to run wild. It’s the financial version of Sarah Palin’s new line .. http://www.huffingtonpost.com/2010/06/03/sarah-palin-blames-enviro_n_598977.html .. that “extreme environmentalists” caused the BP oil spill.

Paul Krugman .. http://krugman.blogs.nytimes.com/2010/06/03/things-everyone-in-chicago-knows/ .. caught a whiff of it in a recent commentary by Raghuram Rajan .. http://tiny.cc/xdp5rw .. in the FT, and quickly denounced it.

But far more outrageous is this working paper .. http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2010/05/27/000158349_20100527154732/Rendered/PDF/WPS5324.pdf , which Bruce Bartlett brought to my attention, published last month by no less an authority than the World Bank. What galls me isn’t the argument per se; what galls me is that the World Bank would cloak a piece of political drivel with fixings of a serious economic analysis.

more: http://capitalgainsandgames.com/blog/edmund-l-andrews/1773/sarah-palinization-financial-crisis

~~~~~ .. a 2nd article in continuance of that one ..

The Sarah Palinization of the financial crisis (cont'd)

Posted by Edmund L. Andrews - 06 Jun 2010

Since my last post, venting over those who blame the financial crisis on the government policies to help low-income people, Raghuram Rajan .. http://blogs.chicagobooth.edu/n/blogs/blog.aspx?nav=main&webtag=faultlines&entry=4 .. has fired back at Paul Krugman over how much blame should go to Fannie Mae and Freddie Mac.

Since I mentioned Krugman's criticism of Raghu, I want to clarify a couple of points. For starters, I think Krugman was over-the-top toward him. Rajan is most definitely not a member of the right-wing fantasy history campaign. He may be at the University of Chicago, but he is not an ideologue and he is an outstanding scholar.

As many people know, Rajan gave a courageous paper at the Fed's Jackson Hole conference in 2005, in which he argued that short-term incentives on Wall Street were corrupting the financial system and posing potential big risks to the world. This was two years before the crisis got underway, and the main theme of that particular retreat was to celebrate the legacy of Alan Greenspan (prematurely, it turned out). I was there, and I can confirm that Raghu was greeted almost with scorn. As Justin Lahart .. http://blogs.chicagobooth.edu/n/blogs/blog.aspx?nav=main&webtag=faultlines&entry=4 .. later remarked in the WS Journal, people reacted as if he were some kind of a Luddite. But Raghu was right, and many of his criticisms are now conventional wisdom.

Second, Rajan's views are moderate and thoughtful compared to those of the true wingnuts.

more: http://capitalgainsandgames.com/blog/edmund-l-andrews/1775/sarah-palinization-financial-crisis-contd

===== .. the debate continues .. that fact in itself is testament to the
complexity of it all .. note: there is more in every link after the top one
.. some recap follows .. hope it refreshes some things for some .. enjoy ..

Causes of the Great Recession

Debate over origins

The central debate about the origin has been focused on the respective parts played by the
public monetary policy (in the US notably) and by private financial institutions practices.

2003 .. economists led by Mikhail Khazin .. book .. "Sunset of the Dollar Empire and the End of the Pax Americana" .. root cause

* the inevitable decrease of the accumulative US consumers' demand

due to the fact that the gradually decreasing (since late 1970s) Federal Reserve's interest rate will one day reach nearly 0 (happened by 2008) and could not allow for debts' refinancing anymore.

October 15, 2008, Anthony Faiola, Ellen Nakashima, and Jill Drew .. The Washington Post .. "What Went Wrong" .. authors claim ..

Board Chairman Alan Greenspan, Treasury Secretary Robert Rubin, and SEC Chairman Arthur Levitt vehemently

* opposed any regulation of financial instruments known as derivatives. .. further

* Greenspan actively sought to undermine the office of the Commodity Futures Trading Commission, specifically under the leadership of Brooksley E. Born, when the Commission sought to initiate regulation of derivatives. Ultimately, it was the collapse of a specific kind of derivative, the mortgage-backed security, that triggered the economic crisis of 2008.

[ that is disputed .. others claim not trigger (see below), but contributory factor ]

.. Greenspan's role .. (the main point of controversy remains the

* lowering of Federal funds rate at only 1% for more than a year which, according to the Austrian School of economics, allowed huge amounts of "easy" credit-based money to be injected into the financial system and thus create an unsustainable economic boom)

.. also the argument that

* Greenspan actions in the years 2002–2004 were actually motivated by the need to take the U.S. economy out of the early 2000s recession caused by the bursting of the dot-com bubble — although by doing so he did not help avert the crisis, but only postpone it.

.. Some economists—including those of the Austrian School and those predicting the recession such as Steve Keen—claim that the ultimate point of origin of the great financial crisis of 2007–2010 can be traced back to

* an extremely indebted US economy.
* collapse of the real estate market in 2006 was the close point of origin of the crisis.
* failure rates of subprime mortgages were the first symptom of a credit boom tuned to bust and of a real estate shock. But large default rates on subprime mortgages cannot account for the severity of the crisis. .. rather ..
* low-quality mortgages acted as an accelerant to the fire that spread through the entire financial system.

The latter had become fragile as a result of several factors that are unique to this crisis: the

* transfer of assets from the balance sheets of banks to the markets ..
* creation of complex and opaque assets ..
* failure of ratings agencies to properly assess the risk of such assets ..
* application of fair value accounting ..

To these novel factors, one must

* add the now standard failure of regulators and supervisors in spotting and correcting the emerging weaknesses.

Causes of the Great Recession

* excessive debt levels
* subprimes
* deregulation
* over-leveraging/CDS/collateral debt obligations
* credit creation
* oil prices
* emigration - Mexicans going home -
* overproduction

http://en.wikipedia.org/wiki/Causes_of_the_Great_Recession

=====

2008–2012 Spanish financial crisis

The 2008–2013 Spanish financial crisis began as part of the world Late-2000s financial crisis and continued as part of the European sovereign debt crisis, which has affected primarily the southern European states and Ireland. In Spain, the crisis was generated by

* long-term loans (commonly issued for 40 years),
* the building market crash, which included the bankruptcy of major companies, and
* a particularly severe increase in unemployment, which rose to 24.4% by March 2012.
http://en.wikipedia.org/wiki/2008%E2%80%932012_Spanish_financial_crisis

=====

Greek government-debt crisis

The Greek government-debt crisis is one of a number of current European
sovereign-debt crises and is believed to have been caused by a combination of

* structural weaknesses of the Greek economy coupled with the
* incomplete economic, tax and banking unification of the European Monetary Union.

In late 2009, fears of a sovereign debt crisis developed among investors concerning Greece's ability to meet its debt obligations due to strong increase in government debt levels. This led to a crisis of confidence, indicated by a widening of bond yield spreads and the cost of risk insurance on credit default swaps compared to the other countries in the Eurozone, most importantly Germany.

The downgrading of Greek government debt to junk bond status in April 2010 created alarm in financial markets, with bond yields rising so high, that private capital markets practically were no longer available for Greece as a funding source. On 2 May 2010, the Eurozone countries and the International Monetary Fund (IMF) agreed on a €110 billion bailout loan for Greece, conditional on compliance with the following three key points:

1. Implementation of austerity measures, to restore the fiscal balance.
2. Privatisation of government assets worth €50bn by the end of 2015, to keep the debt pile sustainable.
3. Implementation of outlined structural reforms, to improve competitiveness and growth prospects.

[...]

Causes

In January 2010 the Greek Ministry of Finance highlighted in their Stability and Growth Program 2010 these five main causes for the significantly deteriorated economic results recorded in 2009 (compared to the published budget figures ahead of the year):[16]

* GDP growth rates: After 2008, GDP growth rates were lower than the Greek national statistical agency had anticipated. In the official report, the Greek ministry of finance reports the need for implementing economic reforms to improve competitiveness, among others by reducing salaries and bureaucracy, and the need to redirect much of its current governmental spending from non-growth sectors (e.g. military) into growth stimulating sectors.

* Government deficit: Huge fiscal imbalances developed during the past six years from 2004 to 2009, [ tiny partisan .. have to note here, during a conservative government ] where "the output increased in nominal terms by 40%, while central government primary expenditures increased by 87% against an increase of only 31% in tax revenues." In the report the Greek Ministry of Finance states the aim to restore the fiscal balance of the public budget, by implementing permanent real expenditure cuts (meaning expenditures are only allowed to grow 3.8% from 2009 to 2013, which is below the expected inflation at 6.9%), and with overall revenues planned to grow 31.5% from 2009 to 2013, secured not only by new/higher taxes but also by a major reform of the ineffective Tax Collection System.

* Government debt-level: Since it had not been reduced during the good years with strong economic growth, there was no room for the government to continue running large deficits in 2010, neither for the years ahead. Therefore, it was not enough for the government just to implement the needed long term economic reforms, as the debt then rapidly would develop into an unsustainable size, before the results of such reforms were achieved. The report highlights the urgency to implement both permanent and temporary austerity measures that - in combination with an expected return of positive GDP growth rates in 2011 - would result in the baseline deficit decreasing from €30.6 billion in 2009 to only €5.7 billion in 2013, finally making it possible to stabilize the debt-level relative to GDP at 120% in 2010 and 2011, followed by a downward trend in 2012 and 2013.

* Budget compliance: Budget compliance was acknowledged to be in strong need of future improvement, and for 2009 it was even found to be "A lot worse than normal, due to economic control being more lax in a year with political elections". In order to improve the level of budget compliance for upcoming years, the Greek government wanted to implement a new reform to strengthen the monitoring system in 2010, making it possible to keep better track on the future developments of revenues and expenses, both at the governmental and local level.

* Statistical credibility: Problems with unreliable data had existed ever since Greece applied for membership of the Euro in 1999. In the five years from 2005–2009, Eurostat each year noted a reservation about the fiscal statistical numbers for Greece, and too often previously reported figures got revised to a somewhat worse figure, after a couple of years. In regards of 2009 the flawed statistics made it impossible to predict accurate numbers for GDP growth, budget deficit and the public debt; which by the end of the year all turned out to be far worse than originally anticipated. In 2010, the Greek ministry of finance reported the need to restore the trust among financial investors, and to correct previous statistical methodological issues, "by making the National Statistics Service an independent legal entity and phasing in, during the first quarter of 2010, all the necessary checks and balances that will improve the accuracy and reporting of fiscal statistics".

http://en.wikipedia.org/wiki/Greek_financial_crisis

Note: i read somewhere that some suggest revised figures may have been
exaggerated to facilitate the implementation of greater austerity measures.

===== .. to those who castigate Greek workers as bludgers, also please note ..

Economy of Greece .. one bit ..

The Greek labor force, which totals approximately 5 million, works the second highest number of hours per year on average among OECD countries, after South Korea. The Groningen Growth & Development Centre has published a poll revealing that between 1995 and 2005, Greece was the country whose workers worked the most hours/year among European nations; Greeks worked an average of 1,900 hours per year, followed by Spaniards (average of 1,800 hours/year).

http://en.wikipedia.org/wiki/Economy_of_Greece

Note: 40h/wk x 49wk = 1960 hours

=====

FACTBOX-Scandals rock Greece's conservative government
April 29 | Wed Apr 29, 2009 8:42am EDT
http://www.reuters.com/article/2009/04/29/greece-scandals-idUSLT86754720090429