Was It The Banks Fault?
As you go to the polls today, it might be helpful to read this post by Professor John Cochrane. It talks about the financial crisis ten years later. The financial crisis spawned a lot of really bad legislation and policy. It also created a lot of falsehoods that permeate the dialogue and discourse.
Cochrane lays it bare.
He talks about the causes, and the fixes. He talks about leverage and being over leveraged. It’s a calm and academic breakdown. You should read it because you won’t find David Stockman talking about a 40% decline in the stock market and you won’t find a permabull case for Dow 50,000.
The reason I started blogging was because I knew Dodd-Frank was a terrible response to the financial crisis. Sarbanes-Oxley was a less terrible response to Enron, but Dodd-Frank was exactly the wrong thing to do and doesn’t protect us at all from a future financial meltdown. We are no safer today than we were in 2006.
Leverage is interesting because it’s not just the private banks that are leveraged.
Unsafe at Any Speed, and the limits on bailouts
The banks failed because they could. And they could fail because they were leveraged. They falsely promised to make repayments regardless of the circumstances.
The overall level of leverage is way too high. This reinforces my earlier interpretation of Larry’s comment about leverage not being the problem — there was way too much leverage, but its increase did not directly cause a crisis.The next part is really interesting.
The Federal Reserve is also leveraged. In the aftermath of Lehman’s collapse, the Fed effectively insured not just checking and saving accounts, but also money market funds. These obligations were officially and, respectively, FDIC and Treasury obligations. They ran to some $6 trillion. But neither institution had $6 trillion in ready cash to make good on its insurance. Hence, the Fed would have been on the hook. Indeed, had things gotten worse, there would surely have been a run on the life insurance industry’s cash-surrender value policies, which, at the time, also totaled roughly $6 trillion.
Now imagine, as discussed in Kotlikoff (2010), that the government’s explicit and implicit pledges of insurance had been called by the public. I.e., suppose the public had, despite the promises of government insurance, headed straight to the banks, money market funds, and insurance companies to empty out their accounts and cash out their cash-surrender value policies. In this case, the Fed would have had to print $12 trillion virtually overnight. The M1 money supply at the time was just $1.5 trillion. Hence, this would have produced fully-justified fears of hyperinflation leading everyone to run for their money before prices soared
The U.S. has yet to experience a run on its central bank. But this is common in countries like Argentina, …
The conclusion is that we can end the possibility for any banking crisis to occur forever. We have to put the right policy in place and let the market do its work.
Source: http://pointsandfigures.com/2018/11/06/was-it-the-banks-fault/
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