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24 responses to “GFC: Usual suspects exonerated”

  1. Jarrah

    Puzzling. What could this list of non-causes done to cause the GFC? They have little to do with credit bubbles-and-crashes, which is what the GFC is. This extract seems to show Watt to be under the common misapprehension that the GFC constitutes an “economic ill”, a failure of capitalism in general, or the Washington Consensus, or other such meta-categories. It is nothing of the sort. So showing that anti-capitalist policies didn’t cause the GFC is, as it says, trivial. Government control of enterprises, another that could have made the list, didn’t cause it either. Government control of the money supply and interest rates, however…

    On the other hand, these non-causal policies could well delay or diminish any recovery from the GFC.

  2. Jarrah

    Correction: “…non-causes HAVE done to cause the GFC”

  3. Mark

    So you’d prescribe deregulation of the labour market to stimulate recovery? Good luck with that one.

    The point, surely, is that what finance capital got up to is completely omitted from most neo-classical economic discussion, and in fact, as I understand it, absent from economic models of the macro-economy. So, one interpretation would be that policy makers were blind to the actual problems building, and focusing on the wrong area.

    And that’s where I’d question your logic, as well:

    This extract seems to show Watt to be under the common misapprehension that the GFC constitutes an “economic ill”, a failure of capitalism in general, or the Washington Consensus, or other such meta-categories. It is nothing of the sort.

    Given that “capitalism in general” needs finance capital, I’m completely at a loss to know what you might mean. It almost sounds as if you want to wish away the effects – which certainly constitute an “economic ill”.

  4. Tom Davies

    Shorter Watt: People get hit by buses, so don’t bother giving up smoking.

  5. derrida derider

    It cuts both ways, you know. Its true that labour market regulation, welfare states, etc did not cause the GFC, but its equally true that they didn’t prevent it. On these issues we’re back where we were.

    I’d call that part a draw – there’s just not a lot to learn from the GFC on these particular issues (though it’s possible there may be in the recovery from it). Macroeconomics and financial deregulation are of course a different matter – it has dealt a death blow to the RBC school of macro in particular, while giving a big boost to old-fashioned Keynesians (on the left) and Austrians (on the right).

  6. derrida derider

    PS – Jarrah’s is the classic Austrian view. As noted, the true Keynesians (not neo-Keynesians) and the Austrians are the two groups who have a coherent story of what happened – though the policy prescriptions flowing from each are very different.

  7. John Humphreys

    How has this dealt a blow to RBC? Proponents of RBC don’t claim that every move in GDP is caused by real factors… just that real factors can change at non-linear rates. In layman terms, RBC simply says that if lots of good businesses start around the same time you’ll see higher growth, and if not many good businesses start (and some turn out to be not so good and fail) you’ll get lower growth.

    Likewise, the GFC is an endorsement (not contradiction) of EMH. Proponents of EMH would say that nobody knows when the crash is coming. Opponents of EMH think that some smart planners can predict (and prevent) these things.

    What the GFC has shown is that rhetoric wins over clear thinking every time.

  8. John Humphreys

    Mark — monetary economics is not absent from economic discussion. Indeed, it is one of the oldest parts of economics, which was traditionally split between “price theory” (micro) and “monetary theory” (macro).

    Though I don’t think the GFC was purely a monetary phenomenon. It also involved price distortions (in the property market) and incorrect risk assessment (by everybody).

    As for labour markets, the impact of a price floor is not disputed. There is absolutely no doubt that the price elasticity of demand for labour is non-zero. The normative question of whether unemployment or low wages is a bigger concern is open to debate, but the actual effect of labour market regulation (fewer jobs, better work conditions) is denied only by anti-intellectual zealots.

  9. Jarrah

    Tom Davies, spot on.

    Mark, it’s arguable that more flexible labour markets have given Australia less unemployment than would otherwise have been the case. Superimpose graphs of unemployment rate and hours worked over the last few decades and see for yourself (H/T Alan Kohler).

    It’s a good point that financial markets are not modelled well, if at all, in lots of macro analyses. I would agree that policy makers were not focusing on what are now obvious systemic problems. However, asset bubbles (a key factor in the GFC) were definitely not going unnoticed, but they were being regarded benignly by central bankers. This is government failure, not market failure.

    “Given that “capitalism in general” needs finance capital, I’m completely at a loss to know what you might mean.”

    I mean that the problems of too much credit and too much leverage, combining with inadequate or misguided regulation to bring about the GFC, do not represent a failure of the market economy. Boom and bust are integral to the system – features, not bugs – and idiotic attempts by “economic managers” to sustain booms and alleviate busts simply worsen the cycle, with little benefit and great cost.

  10. David Irving (no relation)

    I have a strong suspicion that the GFC was actually caused by the effects of peak oil, peak phosphorous, collapse of the world’s fisheries, …

    We’re running out of stuff.

  11. Katz

    Whatever may have been the causes of the GFC, as Mark implied, most major western economies are now, as a result of the GFC, like Frankenstein’s Monsters. Unless and until they are artificially stimulated will will lie on their slab, piles of rotting flesh.

    If that lifeless flesh were allowed to sit there long enough, eventually the worm and maggots would stir and life would go on. (Neoliberals call this process “creative destruction”.)

    Yes it would be life, but not as we know it.

    Citizens of western economies aren’t just net consumers. They are also voters.

    Intelligent agents of western capitalism understand that angry voters are very dangerous to their long-term interests. These intelligent agents are prepared to make concessions. The stupid agents, however, continue to adhere to neoliberalism.

  12. Jarrah

    My main point is that “the usual suspects” were never suspected of being GFC enablers to begin with. They are instead persons of interest in lowering growth rates, lowering employment rates, wasting public resources, regressive transfers of public money, etc.

    I still like Tom Davies’ succinct explanation.

  13. Mark

    I’m interested by DD’s comments @ 5 and 6 – does anyone know of a non-technical piece explaining why both Keynesians and Austrians might feel vindicated?

    As to rates of unemployment in Australia, it seems to me we’ve substituted underemployment (through less hours worked) – that probably does indeed have something to do with labour market shifts – though they weren’t particularly deregulatory – but more with the decision of particular economic actors; that is to say, employers, who are choosing, I think it’s fair to say, to retain labour on the basis of past skills shortages and an anticipated return to them. As well as a lot of jaw boning from government. I don’t know that necessarily follows the sort of decision making model usually assumed in labour economics.

    But my broader point would be that while boom and bust cycles are indeed a feature of capitalist economies, it seems to me there’s a sort of artificial separation analytically between the behaviour of financial markets and other aspects of what goes into the macro mix. I’m sure that’s not unrelated to the absence of variables in macro-economic modelling, but that in itself represents an underlying view of things, which I think shows in some of these comments.

  14. Darryl Rosin

    “Proponents of EMH would say that nobody knows when the crash is coming.”

    Proponents of EMH would also say the market valuations of CDOs in early 2007 were the best possible estimate of their future value.


  15. Debbieanne

    A bit ot. I am currently reading Naomi Klein’s “The Shock Doctrine” and was wondering what the posters and commenters here think about this book.
    Is it likely that the GFC will be/is being used as another shock?

  16. tssk

    The problem is with maintening or lowering wages and conditions is that what you really want as a business owner is to be able to lower or restrain the wages of your employees while at the same time having the wages of your potential customers and competition go up.

    It’s the ‘I’m all right Jack” principle in a way.

  17. stuart

    “Proponents of EMH would say that nobody knows when the crash is coming.” This may be true if the financial crisis was an external shock, but it wasnt. Everyone knew that the loans in the CDO’s were low-doc, no-doc, NINJA, hence why they were called subprime. They knew that these loans had resetting interest rates so that initial repayment rates were unlikely to last. Any efficient market should have taken this into account in pricing these assets. They didnt, even though the information was available. EMH is dead.

  18. tssk

    The thing is with those no/low doc loans the banks were quite happy for people to default as they could thanks to the amazing property maret they could basically

    1. Make loan to some poor schmuck who could only keep up with the rates for so long.
    2. Foreclose when said client fell behind.
    3. Flip the property and due to the market rising instantly…
    4. Profit!

    This was fine as long as there was a constant stream of people foolish/naive/stupid enough to think they could make the repayments and as long as the market was bouyant. You essentially had a valuable tulip bulb you could sell and resell every six months to two years while getting about double or triple what you would in rent in the meantime. (And pity the poor rental tenants in this process. I moved three times in eighteen months due to our rental constantly being sold from under us and I wasn’t alone.)

    But something had to give in the end and overdrawn consumers flipped the balance…suddenly the number of people in the market for a house was less than those not moving or already burned and house values slumped.

    It’s a similar concept to what I illustrated with further up. With the “I’m all right Jack” philosophy you really have to hope that everyone will be more reasonable than you while you scoop up as much as possible. Instead all the vampires went on a blood drinking spree and now wonder why there’s nothing left.

  19. David H

    I blame education. seriously. If we encouraged people to learn more then they might think more, if they thought more than blind freddy would have seen that the basic idea of lending people money to buy something they couldn’t really afford simply because credit markets needed to continue growing was going to fail sooner or later.

    Katz @11 hits a nail on the head, governments have been forced to act to maintain order. Another depression with massive unemployment would have been a serious social problem. Unfortunately I think government actions while staving off a wider economic collapse may well soften the lesson, the lesson that the capitalist system is a boom bust system. Avoiding the lesson means we probably won’t take more a proactive path to finding an alternative. The system is only a little bit broken, we can fix it…

  20. tssk

    Yes David H but banks and other institutions kept making the bad loans partially because they could always fall on the rising capital from the house. (And everyone has been taught that real estate is a bet that you can never lose on.)

    Add to that the interesting ways they loans were onsold as AAA rated investments by bundling toxic debt together and playing some bizarre financial game of hot potato.

    The problem we have is that some have leaned how to game the system for short term gains. Again…good for them as long as they bail out in time they can be winners and then snear at the poor sods who lose their home or their pensions.

  21. David H

    tssk, i’m reminded of the joke, if it looks like crap, if it sounds like crap when you stand in it, if it smells like crap when you poke your nose in and if it tastes like crap it’s probably crap.

  22. kollagen

    It’s a good point that financial markets are not modelled well, if at all, in lots of macro analyses. I would agree that policy makers were not focusing on what are now obvious systemic problems. However, asset bubbles (a key factor in the GFC) were definitely not going unnoticed, but they were being regarded benignly by central bankers. This is government failure, not market failure.

  23. Tom Davies

    Debbieanne @15 — Yes

  24. Labor Outsider

    “But it’s instructive to think for a moment about the factors that are generally, albeit implicitly, agreed not to have caused the crisis. Of course at one level, this might seem a trivial exercise: there is an infinite number. But consider the following selective list of non-culprits: rigid labour markets, out-of-control budget deficits, over-generous welfare states, powerful trade unions, too rapid growth of wages and excessive equality.”

    Actually, this point needs to be nuanced considerably.

    These factors are not at the root of the crisis. But in many countries they are propogating mechanisms. For example, countries with higher public debt to gdp ratios have been less able to finance large fiscal stimuli, which is prolonging the recession in those countries. In addition, insufficient fiscal discipline in the US was a contributing factor to the global imbalances that were partially responsible for the GFC.

    Next, let’s move to labour markets. Again labour market rigidities have not been the cause of this particular crisis. However, in countries like Spain, labour market rigidities are helping to turn a recession into a social crisis. Poor labour market policies mean that unemployment rises by more than it should following a shock and stays higher for longer. It also turns cyclical increases in unemployment into increases in structual unemployment. Anybody that thinks that Australia’s more flexible labour market institutions have not contributed to a better social outcome here than in past downturn is off their rocker.

    On wages, again, there are a number of countries that saw their real exchange rates appreciate too rapidly because wage growth ran ahead of productivity growth – Spain, Ireland, Portual, the Baltic countries are all good examples here. The adjustment in those countries real exchange rates will be a long and painful one.

    This lesson is well understood. Sound fiscal policy and labour and product market regulatory policies are framework conditions that can shape the response of economies to shocks. These framework conditions do not have to be responsible for the recession itself to matter for overall welfare.

    On economists and financial markets. There is actually a very large economics literature studying financial crises and noting how credit and asset imbalances can be destabilising for the overall economy. The idea that financial frictions are not taken into account when studying the macro-econoy is a fiction. Ben Bernanke made his name studing the financial accelerator whereby financial markets often amplified the impact of shocks. There are a very good series of papers by Franklin Allen analsysing how the incompleteness of financial markets make them prone to booms and busts. The Bank for International Settlements had been warning for some time that financial and other economic imbalances could lead to an economic crisis.

    Amomg economists it is widely accepted that the market price is not always the right price. However, what is less clear is whether that mis-pricing offers profit making arbitrage opportunities, or whether governments and regulators understand the nature of bubbles well enough to counteract them with effective policy.

    What is true is that many of the global institutions charged with either setting monetary policy or regulating financial markets were excessively complacent about the risks that had developed and web of connections between institutions that turned a somewhat localised shock into a global crisis.

    Just as the economics profession learned from the 1970s oil shock that expansionary fiscal and monetary policy following a negative supply shock was a very bad idea and that there was no long run trade-off between inflation and unemployment, the current crisis will stimulate an enormous amount of further research into the nature of financial market imperfections and how regulators and policymakers can prevent those imperfections from leading to similar crises in the future. This process has already begun.

    On the Keyensian/Austrian/neoclassical/neo-Keyensian debate, the sense in which Keynesianism has received a boost is that there are circumstances in which expansionary fiscal policy can play a useful role in helping economies recover from deep shocks. The sense in which Austrian economics has been boosted is the central role that asset and credit cycles play in driving the overall economic cycle. Note that Keynesianism per se has historically had relatively little to say about asset price misalignments and how policymakers and regulators can minimise their disruptive influence. Neo-Keyensian macro models are increasingly being adapted so that credit and asset market imperfections play a more central role. However, this is a very complicated task. We should not fool ourselves into thinking that we can stop financial crises altogether or that there are fool-proof ways of preventing bubbles from emerging in various asset markets.