Wednesday, February 18, 2009

The Blame Game.

TIME magazine picked the top 25 people to blame for the financial crisis.

Of course Alan Greenspan is on the list, as are former Presidents Clinton and W. Bush. Phil Gramm took first place.

Bush is often credited with having shred the regulatory system. During the first presidential debate, Obama said: “The Bush administration has shred the regulatory system.” “Senator McCain thinks that regulation is always bad.”

But does Bush really deserve that much credit?

Although Obama sought to connect the current financial downturns to McCain and the Republicans' aversion to regulations with respect to the private sector, there is much evidence to suggest that the regulatory system has been railed against since the 1980s.

In response to the collapse of banks during the Great Depression, Congress passed the Glass-Steagall Act in order to separate the activities of investment and commercial banks. However, as international markets grew, Glass-Steagall became increasingly burdensome as it precluded companies from acquiring both the skills of investment banks and the capital of commercial banks. Under the Clinton administration, the Gramm-Leach-Blilely Act of 1999 was passed, repealing the Glass-Steagall restrictions and amending the Bank Holding Company Act [allowing inter-state mergers]. These, as well as the Commodity Futures Modernization Act [which allowed single-stock futures], allowed for banks to acquire significantly larger amounts of capital that could then be invested in mortgages. However, Gramm-Leach-Bilely had little effect on firms such as Bear Stearns and Lehman Brothers which continued to function solely as investment banks. The fact that they were the first to collapse suggests that the financial sector has been affected by factors other than the regulatory system, or lack thereof.

Furthermore, when capital income on corporate debt is taxed once while equity returns are taxed twice, firms are more likely to take advantage of this asymmetry by issuing more debt than they normally would. These highly leveraged firms, and their inability to "self-regulate," made the financial sector more fragile and more vulnerable to falling asset prices. Eliot Spitzer observes: "The reality is that unregulated competition drives corporate behavior and risk-taking to unacceptable levels. This is simply one of the ways in which some market participants try to gain a competitive advantage. As one lawyer for a company charged with malfeasance stated in a meeting in my office (amazingly, this was intended as a winning defense): "You're right about our behavior, but we're not as bad as our competitors." [also, does the last paragraph of the Eliot Spitzer article not make you really sad? it makes me really sad...]

However, more regulation has not necessarily proven beneficial to the financial system as Obama might suggest. Contrary to Obama’s claim that the Bush administration shred the regulatory system, the Bush administration was responsible for the Sarbanes-Oxley Act of 2002 which includes the much abhorred Section 404. This law requires companies and their auditors to assess the companies internal controls, and although the costs of abiding by this law have been high, the benefits are not easily measurable. As a result, foreign firms withdrew from American markets; the number of the top twenty public offerings in the U.S. dropped from eight to one between 1996 and 2006. Furthermore, although Sarbanes-Oxley attempts to eliminate a certain degree of risk, the decline in short term equity premiums might have induced firms to seek higher returns in riskier investments. Mortgage-backed securities may have been further proliferated by firms seeking to hold their advantage under SOX which already caused U.S. firms to realize a lower rate of return than foreign firms.

So was it all Clinton and Gramm's fault?

De-regulation under Gramm-Leach-Bliley may have allowed for such "sophisticated" and risky products to be created. However, as previously mentioned, the first banks to fall, Bear Stearns and Lehman, were little affected by GLB. Furthermore, as Bernanke stated the other day, such processes as securitization provide about half of the liquidity in our financial system.
Also, I would just like to point out that the President does not have control over the federal funds rate. The Fed is independent. As Professor Johnson tells us, when you say your prayers at night, give thanks for the independence of the Fed.

So maybe it was all Alan Greenspan's fault for keeping interest rates so low for so long?

Greenspan set the fed funds rate so low in order to avoid a "lost decade" similar to that of Japan in the '90s. Or similar to the Great Deflation [1870s-1890s] in the U.S.

"Too little money chasing too many goods."
Deflation is when you can get more goods per dollar than before. [opposite of inflation]
So during deflationary periods, debtors are hurt and creditors are helped. Debtors are repaying loans in deflated dollars [dollars that are now worth more]. Creditors are being repaid in dollars that are worth more. Debtors tend to already be poorer than creditors, so the poorer are screwed even more.
The wealthy also tend to have smaller propensities to consume [they're more likely to save than those who are poor. b/c if you're poor, you're living hand to mouth, spending whatever you earn on necessities.] Ceteris paribus, [all else constant], this would lead Y to [output, or aggregate GDP] to fall.
Japan addressed its "lost decade" with inflation targeting.

Ben Bernanke is really hoping for some inflation right now. Something like Dorothy's silver slippers...

Random thoughts
So my mom left for the Dominican Republic with her friends on Monday and it was her first trip without the fams and with a U.S. passport. Needless to say, she was really excited. I travel a lot more than my parents do - in planes, in cars. And my mom always tells me to call when I reach my destination. Usually I'm pretty good about remembering, but sometimes I forget and my mom will call me to yell at me. Then I get annoyed and say, "well, of COURSE I'm safe. What do you think happened, my plane crashed? Jeez." But the night before my mom left, I pretty much prayed my ass off [which means a lot coming from me b/c I'm not one of those ppl who believes prayer is a legit method of birth control or anything] and I couldn't fall asleep because I was so worried. And then I thought, it must be SO much worse for my mom when I travel, because I'm sure she loves me more than I love her. And I thought, OMG. I am NEVER forgetting to call my mom EVER again. So kids, call your parents when you get to your destinations. It takes 2 seconds.

The end.

Edit: Professor Johnson just assigned this reading for this week's p-set!
This sentence makes me sad: "[Fisher] was prominent among the 1,028 economists who in vain petitioned Herbert Hoover to veto the infamous Smoot-Hawley tariff of 1930."

Hindsight is 20/20.


  1. wow, you like econ a LOT. i only read the random thoughts section.

  2. ha. it's okay. prolly more than what susan read. i need to write about things so i won't forget! i'm trying to get evelyne to start a biochem blog.

  3. i'm going to have to read thsi three times.

  4. this would be so much better than a single-paged resume. you should refer prospective employers to your blog. oh and i hope your mom has fun in dr! teheeheh