That's the new Gary Gorton book and the subtitle is The Panic of 2007. It brings together Gorton's writings on the crisis in one convenient place but it serves up a fascinating afterword in which he asks how people will view this crisis one hundred years from now.
We've already covered Gorton's writings here. As I've already mentioned, for anyone interested in the crisis, or in banking and finance more generally, this is absolutely essential reading. I also take his analysis to suggest (here this is my gloss, not his words) that there is no way to avoid crises since "bank run-like phenomena" can pop up in many different ways in any economy with significant liquidity transformation.
Tyler, you say “that there is no way to avoid crises…”. I assume that you mean “that it will be very costly to avoid crises…” As usual the relevant questions are (a) what price you are willing to pay to prevent damage, and (b) if damage happens, hoy you will deal with it.
I’m afraid many people believe they were not slapped but stabbed in the back by the invisible hand.
Gorton’s book is on my short must read list.
I think he argues that financial innovations, often to defeat government interventions, will often (almost always?) lead to panics.
There is no cost to pay to prevent panics. Government interventions just encourage bigger panics by encouraging innovations around regulations – so they create costs rather then prevent them in the long run..
The best solution is open free markets with informed actors. Panics would still occur from time to time but the markets could quickly adjust to changes in information. The depths of the panics could be shallow and recovery quick.
That does not imply no government regulation, just minimal. You still need to enforce contracts and punish fraud (lower the transaction costs) to encourage trade. THe government as a source of unbiased information, to the degree this occurs, should be encouraged.
Clearly I ahve a limited role for the Fed. See Taylor.
In a world with maturity matched lending, a “bank-run like phenomena” would not “pop up”. So why don’t we try living in a world with maturity matched lending.
Mostly, because we don’t know what the costs and benefits of maturity transformation are. We need better models of the banking system and other maturity-transforming entities. The Diamond-Dybvig literature is a good start but we need more research.
wasting their eggheads on financial tomfoolery, shenanigans and ballyhoo
Phrase of the week.
I think the issue with liquidity matching is that there is strong interest to sell the more liquid and buy the less liquid so it creates a large (at least apparent) return for the intermediary.
Therefore there will allways be institutions trying to fill that gap, because they will be paid lots of money to do so (at least until the crash).
It is almost impossible to regulate the activity out of existence, because financial flows are too hard to control. I am one of those eggheads (in commodities not bonds) and if you tell me the regulatory structure I can tell you within a few minutes how the industry can evolve to get around it.
To me the answer is to let the folks who want to take the liquidity risk bear the cost of thier foolhardy (or prudent) decisions and not bail folks out.
Anyone who wants anytype of government guarantee must match liquidity, everyone else can sink or swim on their own.
If we know that crashes are inevitable and that we will bail out financial institutions, why not just tax the hell out of them? I mean really, anyone have an overwhelmingly convincing argument from empirical evidence that they have added anything of value to the economy in the past ten years? If not, than just tax it as a behavior that creates huge negative externalities.
He notes the irony that a few individual small investors effectively screwed Wall Street firms who normally screw over the individual investor.
If these investors did correctly forecast the crisis, then they didn’t screw over the big firms so much as mitigate the firms’ screwups and profit from them in the process.
Essentially, if these investors had not taken the short position in these trades there would have been no forewarning that a crisis was possible, and the collapse would have been far worse.
Thanks to E. Barandiaran for the link
Without question the economics of information is Hayek’s most important innovation, and he was simply way out in front of everybody and anybody on it. While he did it partly inspired by and as an adjunct to the socialist calculation debate, its implications and usefulness go far beyond that, which is why his influence in this area is actually increasing rather than decreasing, in contrast to Friedman, whose influence is rapidly declining with each passing day.
Comments on this entry are closed.