Ever wonder what it would be like to have Paul Krugman throw a party and then not invite you? Well that happened to me, today…but since I don’t expect to ever be invited to a party thrown by Krugman, it doesn’t really matter all that much.
In any case, Krugman’s blog post was about six different doctrinaire diagnoses of the crisis, and how they relate to the structure that financial reform should take.
So: what’s the problem? Here are the views I see out there.
– Size: Our largest financial institutions have just gotten too big
– Shadows: The rise of shadow banking, institutions that fulfill banking functions but evade the regulatory regime, has undermined stability
– Opacity: We’ve come to rely on complex financial instruments that neither regulators nor the private sector
– Predation: Financial firms deliberately misled consumers and investors
– Government intervention: Public policy pushed lenders into making bad loans, especially to the poor
– Monetary mismanagement: The Fed did it by keeping interest rates too low for too long, and/or policymakers panicked in 2008 and spooked the markets
I have written quite a bit about the magnitude of salt by which I take claims that the size of banks had anything to do with the problem. I also disagree with the opacity claim on the more shaky ground that increasing the amount of information processing done in a system with homogeneous inputs and outputs doesn’t really have any impact on the structure of the system — it just makes the system larger. And in grand circular logic, see point one.
Judging from the events of the crisis, I think the predation claim falls flat very quickly. Sub-prime lending in-and-of itself was a rather small problem…something that could have (and was) being dealt wiroth under the macro-circumstances of a fairly mild downturn from 2006-2008Q3. Krugman’s interpretation of the government intervention argument is a vulgar characture, as you may have expected. If you would like to read some very intelligent arguments coming from this corner (which I find myself partly in), read Arnold Kling.
That brings me to the final two. Monetary mismanagement and shadow banking. Unfortunately, these aren’t as easy to shoot down…except, wait…one of them is, and then leads into the next. Shadow banking institutions didn’t run into problems until when? You’re correct! 2008Q3, when inflation expectations (or NGDP growth expectations) fell through the floor. Of course, Krugman focuses on John Taylor’s argument about monetary mismanagement. Explicitly absent is Scott Sumner’s. Don’t worry Scott, we can have our own party!
Which brings me to my, absent, doctrine: Too Brittle to Sustain. TB2S takes a view somewhere mashed up with Sumner’s NGDP stabilizing, Kling’s recalculation, and Minksky’s financial instability. Also, throw in a bit of endogenous evolution, and network theory.
One of these days I’ll get around to outlining some math to illustrate how our money system causes instability. Remember, monetary and financial crises are wickedly common…even during what Gorton terms the “Quiet Period”. The Western world has been the glaring exception. The World Bank has documented 96 banking crises of repute (large enough to cause systemic problems) and 176 monetary crises in the last 25 years, alone! Or what we refer to as the “Great Moderation”.
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P.S. This is for Leigh Caldwell (hopefully he catches the reference!):
And it’s worth remembering both that Lehman wasn’t all that big and that the great banking collapse of 1930-31 began at a Bronx-based bank that was only the 28th-ranked bank in America.
Lietaer, “The Future of Money” 2001