My views on the crisis — a summary statement

A few inattentive malcontents are complaining that I haven’t stated my views.  I have, but if you want them, or some of them, in one neat place, devoid of subtlety or explanation, here they are:

1. Glass-Steagall repeal was not a major cause of the financial crisis, nor was government-induced "minority lending."

2. We should use regulation to move more of the currently unregulated derivatives markets to the clearinghouse model.

3. The crisis represents a massive conjunction of both market and governmental failure.

4. I would not nationalize banks as ongoing concerns, at least not short of a far more extreme emergency than the current status quo.

5. The modified Paulson plan was better than nothing — especially after the market had been scared — but far from my first choice.  In any case the plan would have been revised almost immediately.  The Paulson and Dodd plans were never that far apart.

6. My first choice is to induce and if need be to force more information revelation, identify the insolvent banks, close them up, and give the battle-tested FDIC a much greater role in the whole process.

7. In the meantime the Fed should not worry much about inflation.

8. The critical deregulatory mistake was allowing excess leverage.  Many deregulations get blamed but in fact contributed little to the problem.

9. Everyone says that letting Lehman die was a big mistake but I’m not yet convinced.  Maybe a bracingly high TED spread is what we need.

10. Libertarians are overrating the moral hazard argument, as many equity holders have been wiped out.

11. If someone is pushing conclusions and not identifying the potential weak points in his or her arguments, be suspicious.  Also beware of anyone pretending to offer you simple answers.

12. I have a long and complicated view on the relevance of Austrian Business Cycle Theory which resists easy summation, but markets could have and should have been more cautious in response to Greenspan’s easy money policies.

13. Insolvent hedge funds and the commercial paper market remain outstanding issues which are not easy to address.

14. I agree with Arnold Kling about relaxing capital requirements though at this point I don’t expect it to help much.

15. The crisis is complex and has many causes; there won’t be a simple or quick solution.

If you wish you can google to the details.  Also, I don’t believe I had offered #9 before on this blog.


Point #8 is particularly important: by allowing 30:1 leverage ratios, combined with the moral hazard of an implied "rescue", we were creating incentives for investing in risky financial instruments.

I'm glad you finally offered point number 9; TED spreads are fine this wide. But it seems to contrast your government-as-clearinghouse model.

The reason people are calling you out is because you've been slippery as an eel and late to the party. Remember when subprime was just a minor 250 billion issue which could be dealt with by being straight and recognizing some losses? It's helpful for you to post this. I'd make just a couple of quick points.

As for 3, 8 and 10, you are wrong on market failure, leverage regulation and moral hazard. These are closely linked. Banks (broadly defined) were able to become massively over-leveraged because their counterparties (not just shareholders) all assumed the government would stand behind as ultimate counterparty and also that the government would back the insurance on defaults. Otherwise, you'd never do business with someone with 30-40x leverage.

As for 1, and your post yesterday, it may be that minority borrowers don't default disproportionately, holding other factors constant, but its very true that in order to make lending widely available to them you needed to massively increase availability exotic (ie risky) loans and to lower standards and to make those products non-discriminatory (ie available to everyone). That's what happened and Congress and the Fed pushed it through policy and easy money.

As for 9, I am thrilled that Lehman was allowed to fail. Only thing the Government has done right in months.

As for 12, of course you do. If you came out and said it had any validity, you might lose your precious peer (and NYT) credibility. Much better to stick with the conventional wisdom that Greenspan's Fed was just a little too loose and people should have been more cautious, but was just one factor in a complex set of issues. Just because the dirty old man has dumped white lightning in the punch doesn't mean you should keep drinking. Of course, I am reminded about David Spade's joke about grain alcohol and co-eds: "you gotta be real careful with this stuff; give her this much and she'll do anything you want; give her THIS much and she'll die!"

The reason people are calling you out is because you've been slippery as an eel and late to the party.

Especially since Tyler was elected President to lead us out of this mess. And don't forget he runs Treasury, the Fed and is the majority leader in Congress.

You are overwrought. Consult his Dining Guide, then get a good meal and then, most importantly, some much needed rest.

THEN you can go back to yelling at your TV.

In his every ending search for acceptance by the liberal establishment, I predict within three years Tyler will accept a position in the Obama administration and shutdown MR.

JJRG certainly brings to mind that old WB Yeats soundbite "The best lack all
conviction, the worst are full of passionate intensity."

I don't doubt that if TC were setting policy we'd be better off now than we are. And, I enjoy about 75% of TC's dining recommendations - thanks! But, I don't think that changes the validity of my points. I think TC has missed something important about moral hazard and how that interplays with the leverage issue, that so many of you keep raising. I also think he's missed a big part of the story on minority lending - see above.

Letting Lehman die keeps the moral hazard aspect of the problem in play, if only partially. It increases the uncertainty around the moral hazard aspects of the problem. It means an individual banker can not be sure this his bank will not be the one that is too big to fail.

I don't understand how you can speak of Austrian economics and simultaneously state that "markets should have been more cautious." Markets can't be cautious, they are aggregates. The individuals that create the markets have no incentive to be cautious.

Thanks for the summary. Lots of good points, IMO, especially those stressing the complexity of the problem. I'm suspicious of the virtue of a "bracingly high" TED spread. Do we really want a system where a three-month loan to a bank is that risky?

So, a masochist walks into a bar and says "beat me." The sadist answers "no."

Lame and Brothers: This is an example of the schizophrenic government policy (with apologies to schizophrenics).

Even though there is plenty of pain (this libertarian doesn't hype the moral hazard argument) and panic abounds, the government chose poor Lehman to make an example of, but what they got was the problems that they wanted to avoid. So, they successfully inflicted pain, caused moral hazard, and didn't fix anything. When you can't tell if someone's actions are purely sadistic, that's a problem, even if you are a masochist.

A few points related to (8):
- Before being allowed by regulators, excess leverage was allowed by bondholders and shareholders. Why?
- You can always blame excess leverage when there is a default. This does not mean that a leverage restriction
would help. Banks can circumvent the problem by moving risks outside their balance sheet or increasing
the risk intensity of their balance sheet.
- Optimal leverage depends on balance sheet riskyness - > on the business model of the bank. How should
regulators define maximal leverage?
- Risk-weighed capital requirements have their weakness but they are better than any leverage restriction.
The problem is that they are pro-cyclical and underestimate some types of risks.
- If the banks' risk managers are not able to assess the risks of their bank, is it not too
demanding to ask regulators to be better at it?

My understanding is that Sweden nationalized park of it's banking industry when they suffered a similar problem. A few Europea counries are now doing the same in response to the current crisis. Brad DeLong has advocated Bank nationalization too on his weblog.

People, I can assure you that neither administration would have me, nor do I have the kind of emotional stamina required to accept such a job. You can expect MR to continue.

I work on proposals to address real, existing policy problems, rather than write compelling, rigorous arguments about them. Also, it is very probable that I am not as smart as Tyler. However, my experience is *always* that there are many causes, and no silver bullet. Tyler's review of his views reflects a similar sense, I think, and does him credit. It is, for example, a useful if preliminary guide to what *not* to do in the months and years ahead.

11. If someone is pushing conclusions and not identifying the potential weak points in his or her arguments, be suspicious. Also beware of anyone pretending to offer you simple answers.

So we shouldn't trust anything coming out of congress then?

Seriously, government cannot process complex solutions. The solution has to be simple because thats all its capable of implementing. If it (or the median voter) could produce works as complex and subtle as the economics profession, we wouldn't be in this mess in the first place.


I think you are missing the moral hazard point. It is the moral hazard induced in the bondholders that is most important, not the equity holders. We actually have almost no history of shareholders being directly bailed out in the US, but lenders have been and are being bailed out left and right. How do you think 30 or 50 to 1 leverage arises in the first place? Why would rational person lend money to such an entity?

Some people interpret any presentation of a complexed truth as an attempt to evade truth. If one prefers a quick and easy classification of a car as a fast-running turtle for the purpose of making an action. We can't stop him, but we can always say no to his turtle soup.

1. Glass-Steagall repeal was not a major cause of the financial crisis, nor was government-induced "minority lending."

I'm confused as to why you put the word minority in quotations. It seems to me that, since the government outlaws discrimination, relaxing rules in an attempt to help one minority would unintentionally help many other minorities, and that all of these minorities bundled together might even make a majority.

What did you mean by minority? Why did you put it in quotes? Why was it your #1 point?

Hi Tyler,

Where are you on:

- Spanish style countercyclical regulation (pulling VaR out of Basel or adjusting) of bank capital requirements?

- Degree of Impact of Fannie/Freddie, both in inflating the bubble and crowing the rest of the industry out of the prime credits?

- Banning of SIVs & other off balance sheet items unless their sponsors explicitly refuse to take them back on to their balance sheet (or even if) should funding dry?

I'm sure you've addressed these before but it seems that you wanted to this to be as exhaustive as possible.


"The critical deregulatory mistake was allowing excess leverage."

I'm glad to see that my relatively uninformed (24 undergraduate econ credits, but that was a long time ago) instincts (regarding the extent to which too much leverage is a large part of the problem) are vindicated.

Sheetwise: "It seems to me that, since the government outlaws discrimination, relaxing rules in an attempt to help one minority would unintentionally help many other minorities"

Let's not try to hide reality, OK? Housing discrimination laws were not working. Community Reinvestment Act was definitely about ending redlining, and redlining has been used for several decades to get around racial discrimination laws.

Subprime loans certainly benefitted not just low income blacks and hispanics but also low income whites. However, the effect on the overall black and hispanic populations was far greater. Many who promoted the expansion of subprime lending the past decade did so with the specific intent of increasing minority home ownership.

If this is truly a credit crunch affecting Main Street business then:
For every financial institution regulated by the Federal Reserve that meets the current capital adequacy standards for its investment risk - lower its reserve requirements by half.
This does not save bad banks, it does not reward risky behavior. Banks that have adequate capital will be able to double the lending that their existing reserves will support. If the reserve requirement reduction is set for 5 years or until the bank fails to meet the capital adequacy standards based on risk the bank will avail themselves of the opportunity to make more money but will continue to do so prudently.
Voila! no more credit crunch.

Thanks much for your opinions in one collected spot. I appreciate your willingness to opine without snark and partisanship. Your scenario of multiple causes makes the most sense. If anyone in the chain had performed properly, this all could have been averted. I still think that the people who had the job of rating the risks, should shoulder more of the blame. AAA ratings on bundles of bad loans was hard to understand. Large leverage ratios are a setup for failure almost by definition.


As someone pretty young and with $15,000 or so to invest (not much, but everything I've got), can anyone tell me where I should be putting it right now? If capital is so valuable right now, how can I make lenders compete for my cash? Shouldn't this be a totally badass time to buy some CD's, especially at places like Bank of America?

Noob question, I know, but I'm just looking for someone to tell me why I'm wrong here.


Where do I sign? Also, can I deposit additional funds to promote green initiatives at your institution?


1. Glass-Steagall repeal was not a major cause of the financial crisis, nor was government-induced "minority lending."
How about just government-encouraged lending? a.k.a., "Everyone American Should Own a Home"?

7. In the meantime the Fed should not worry much about inflation.
Can they? Isn't it all they're supposed to do?

This thought came up during a lunch conversation that George Will started to talk about on Sunday: Is the market fundamentally different now that we're a handful of months in from the first batch of Boomers retiring with laptops, 401k's and a hundred ways to sell funds from their bathrooms? Clearly there's going to be some bailout, but shouldn't the market have known that?

Brandon, If you invest with me I will offer you something better than a high intereste rate. My new carbon offset program allows you to buy my carbon offsetts and 30% of face could end up making a killing AND saving the planet.

Tyler's summary makes sense to me. I would add one more point. Apply the same accounting and financial oversight regulations to Freddie and Fannie that are applied to all other financial institutions.

My first choice is to induce and if need be to force more information revelation, identify the insolvent banks, close them up, and give the battle-tested FDIC a much greater role in the whole process.

Yes to that. I would only add that we should resist the Paulson Plan proposal to require all banks to be federally chartered. The dual banking system of state and federally chartered banks has worked well to diversify the risk. Wachovia and IndyMac were both federally-regulated institutions.

What? I this was the blog for the Vaginal Revolution?!?

WATCH THIS and repost....its all you need to know about the economic crisis:

"markets could have and should have been more cautious in response to Greenspan's easy money policies."

I agree with you that it would have been better if markets were more cautious, but I am uncomfortable applying "should" to the actions of thousands upon millions of individuals. "Should" really only applies to individuals. As individuals, the people involved would have been better off if they weren't seduced by the easy money. But when we talk about the decisions of so many people, then we need to focus on the policies and policymakers and institutions. You can't change the people, and if you create policies that would work wonderfully if everyone acted exactly as they should act, but end up having terrible consequences when everyone actually acts as they do act, you shouldn't blame the people. Blame the policymaker who misunderstand how people are. That doesn't mean that all those individuals aren't blameworthy for their mistakes--their each to blame for their individual mistakes--it's just that in the policymakers and institutions get a small share of blame for all of those many mistakes, and thus in the aggregate bear by far the greatest burden of blame.

I'm interested in hearing your "long and complicated view" of the Austrian Business Cycle theory. Most people I've read who criticize it don't really understand it or even what Austrian economics is saying (i.e., that it's more akin to mathematics/logic than it is to physics, as neoclassical economics aspires to be). Even Brian Caplan's "Why I'm not an Austrian" is full of very poorly reasoned arguments - Walter Block has pointed out many of them in various papers.

And yes, reducing the rate of interest on money is going to cause economic actors to behave differently. This is why the criticisms of Wall Street and "reckless" speculators is mostly misdirected nonsense. People are just acting rationally given the incentive structure imposed on them.

I must say, what amazes me is the number of prominent libertarian economists who barely mention the role of the Fed in this crisis, as if Glass-steagall is the salient factor. Sheesh.

Why does it matter if hedge funds are insolvent? OTC derivatives and counter party risks?

Speaking out against the fed is not politically correct. Would you want TC to lose his mainstream appeal? Then stop bugging him about reality!

This is why the criticisms of Wall Street and "reckless" speculators is mostly misdirected nonsense.

Not really. To give just one example, many major investment banks engaged in a carry trade where they borrowed funds in order to invest in AAA-rated, senior tranches of mortgage-backed securities. Since these supposedly safe CDOs carried a slight yield premium, banks were able to make huge profits on this carry trade in 2006 and the first half of 2007. And were able to make huge losses in the second half of 2007 and through 2008.

The existence of this carry trade can show one of two things: that the market as a whole was irrational for allowing AAA-rated CDOs to trade at a premium thus allowing investment banks to profit off the irrationality of others or, investment banks were simply reckless in how they chose to trade on their own accounts.

I don't think the former view will get any takers.

CJS is spot on.

Also, some of the commentators here are whiny babies and ignorant asshats (E. Barandiaran and JJRG for instance). Tyler *explicitly* stated he'd give his opinion *without* an indepth explanation. That is what an opinion is (and most blogs are). They aren't academic papers with tons of data.

If your tingling sense of self-righteousness becomes activated at the slightest opinion that doesn't match up to your worldview, then perhaps you should log yourself off the internet and chill out for a bit.

The moral hazard thing is interesting because the losers weren't engaging in risky behavior, they made extremely conservative behavior risky with leverage.

The Fed is either still worried about inflation or they are LYING. Of course they are lying, and of course they don't misdirect investors.

Inflation is bad and de-leveraging are good, but they don't have to be addressed in fire-sale fashion when all the buildings are still on fire. Preserving a few good institutions will be a good thing.

Why should markets have been more cautious? As I see it, markets are reacting to the information available and the potential this information has (f.e. wall-street dropped after the bail-out failed, but recovered the days after). So a certain part of the market is psychologically driven by the news media and the "experts" and seeing the quality of those experts, I ask again: Why should markets have been more cautious?

Do you have a more a detailed post on the question why "minority lending" wasn't a problem? WhatI gathered from the news-ether, is that part of the problem was the idea that house-prices could only get up, which meant it was a lucrative deposit for money, even if you had to get a short-time loan. So, more and more people followed this "expert advice" and hoped they weren't the ones to foot the bill, when someone thought the prices were too high...

As I see it, markets are places for risk taking, but that doesn't discount the possibility to actually LOSE in the process, if your information basis was poor. So, I'd say this pretty normal?!

Just on your Point No.4

"I would not nationalize banks as ongoing concerns, at least not short of a far more extreme emergency than the current status quo".


Here in Australia we had a very successful though old-fashioned banking system until two decades ago. We had several private banks balanced by a ubiquitous government-owned bank, the Commonwealth Bank, and especially by it's personal savings arm, the Commonwealth Savings Bank.

The hoodlums had no choice but to behave themselves because if they tried to dream up a fresh way to swindle the public, the Commonwealth Bank was there in the background, always available to give the suckers a real alternative to being fleeced.

What happened? We got that mirror-image of Communism: Thatcherism/Reaganism, that crazy cult that declared that all publicly-owned entities to be absolutely evil and the work of the Devil. The Commonwealth Bank was "privatized" .... and the rest is history. The hoodlums got control of our finance system so now we have all the joys and delights of "complex' financial instruments and of almost unrestrained predatory lending.

I suggest you Americans can help get yourselves out of this mess by setting up a ubiquitous federal government owned bank so that so that citizens in any town in the whole U.S.A. have a viable, fair competitor to your private banks and to your loan sharks. Such a national bank would have to be reasonably profitable so as not to be burden on the taxpayers .... it would need to be diectly competitive with the private banks but not be so hog-tied as to allow the private banks, other lenders and finance market manipulators to resume swindling the public as before.

"7. In the meantime the Fed should not worry much about inflation".

If, instead of fundamentally reforming the whole economy, the easy way out is taken and BailOut [Mk.II] is allowed to slip through, inflation is inevitable.

Inflation is unlikely to be as bad as in Germany during the Weimar Republic in 1923, nor as bad as in the Republic Of China [Nationalist China] in 1948~1949, nor as bad as in Zimbabwe today .... but you might be up against the levels of inflation the Russians had to endure when the Soviet Union broke up.

The important thing is, as an alternative to crying in your beer over it, how are you going to rearrange your own lifestyle so as to cope with the new situation .... and maybe, if you are both clever and lucky, benefit out of it?

I think the principal causes are:
a) mortgages are long-term assets that havew been initially financed on a short term basis (warehouse lines and repos, pending securitization); which means there was always a small risk of a collapse in the market;
b) said collapse would have been short term itself but for the fact that the largest parties in that market were themselves highly leveraged and relied on shortterm funding.
c) mark to market, not only in GAAP, but that is how the collateral margin in warehouse lines and repos is valued, triggered a chain of fire sales.
d) decades of success bred culture of entitlement among consumers and complacency among lenders/investors.
And three compensation scheme failures:
1) mortgage brokers and employees compensated at time of loan;
2) myopic focus of wall street and particularly buyside of publicly traded financial companies on quarterly and annual profit encouraged, a "flipping" model which turned MBS market into a game of musical chairs.
3) the regulators failed to rein in the moral hazard of FNM and FRE executives who were able to use a government guarantee of debt to speculate on the equity value of those companies and passs the downside risk to the govt.

LMAO@"Tyler Cowen is now dead to me. As Tabarrok does not post often enough, I have deleted Marginal Revolution, one of the first blogs I began reading, from my RSS feed."

Someone takes the Internet WAAAAY too seriously.

I have deleted Marginal Revolution...from my RSS feed

That will save them having to tell you to "Cancel your own ***damn subscription!"

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