Friedman and the credit crunch

[Hennessy]

Just in reference to the credit crunch and it's ongoing effects. Do you think Milton Friedman has been discredited/proved wrong? I still hold this guy in high regard and a lot of what he says reflects my own views. I'm leaning towards Friedman not being disproved by the 2008 credit crunch and subsequent recession, especially philosophically, but I'm interested to hear your ideas.

[DACrowe]

Americans opposed to regulation in the states (Friedmanites and others) have blamed the crisis on the manipulation of interest rates and legislation to encourage lending to people who can't necessarily afford to pay it back, so take it as a vindication of their world view. They also blame the compound debt packages derived from these mortgages being dodgy on the central bank (the Federal Reserve there, the Bank of England here) guaranteeing by precedent that it would bail out banks which failed (moral hazard). Another view might be to blame the lack of regulation in general as to what compound packages there can be, the lack of competition amongst the rating agencies (I was told yesterday that the three rating agencies are guaranteed no further competition by a law Nixon passed) and the fact that mortgage lenders have been operating as investment banks (in this country since Thatcher permitted building societies to trade as banks) meaning a) that a crash in the housing market causes a crash in the stock market and visa versa, whereas in the past you might have been able to rely on one sustaining the other and b) allowing investment banks to fail would cause massive amounts of foreclosures etc for ordinary citizens thus making institutions 'too big to fail' politically. This last point would in effect be a claim that sub-prime mortages are a sort of red herring; they were the particular cause of this crash but the more general problem is with the financial setup in the country. So it's not that Freidmanites are wrong it's just they're only looking at part of the picture (preventing building societies trading as banks is, in effect, a form of government intervention). The preferred Freidmanite solution would, I suppose, be to prevent central banks from bailing out (or be perceived to be in the business of bailing out; it's the perception of a safety net which encourages institutional risk-taking).

Thankfully a guy who's particularly interested in preventing the 'too big to fail' problem is now in charge of financial regulation: http://www.youtube.com/watch?v=QY8z2qjcKZY

[Senethro]

Eh, at that level its too waffly to engage with. If you provide a counter-example then you're informed that the cause is insufficient capitalism, not an abuse or that somehow the government is still to blame, all no true scotsman on you etc.

[Hennessy]

Eh, at that level its too waffly to engage with.

You are joking, right? this is the sinner! Let's get a religion thread going if you want to see waffly!

[JPJP]

http://www.youtube.com/watch?v=d0nERTFo-Sk

This is all you need to know. I've learnt more from that 6 minute video then a whole semester of macroeconomics.

[RedCelt69]

I've learnt more from that 6 minute video then a whole semester of macroeconomics.

I did a search for a YouTube video mocking people who don't understand the difference between the words "than" and "then". Sadly... nothing.

[DACrowe]

I rather liked this video, myself;

http://www.youtube.com/watch?v=VlvVumYdMGs

Oh and there's this too: http://www.youtube.com/watch?v=UC31Oudc5Bg (notice however that they get colateralised debt wrong; it's not all dodgy debt and they do know what's in them, but when there's a housing crash what's in them starts being worthless)

Worth remembering of course that sub-prime mortgages are only the particular cause of this crisis. The underlying causes would appear to be (perhaps depending upon who you ask): (a) human intellectual limitations; if it were transparent to everyone that this was, in the long run, a very bad idea they probably wouldn't have done it but it wasn't because the degree of thought required is too great and the incentives not to think too hard about something which is driving profit, and is being pursued by one's competitors, is too great and (b) there is not enough of an incentive to avoid risk taking and engage in costly internal scrutinize because (bi) large financial institutions can rely on the federal bank bailing them out if they risk bankruptcy and arguably (bii) the federal bank is right to do so because the government has an obligation to protect e.g. the pensions of the citizens who use those banks and as far as this crisis is concerned there's no additional 'lack of disincentive to take risks' effect of not bailing the banks out when disaster has already happened (though it might have that effect on future behaviour).

To deal with (b) there are proposals to separate investment banking from retail banking (pensions etc) which the coalition is going to look into and in America some people are suggesting a cap on the financial size an institution should be allowed to grow to whereas others are demanding the federal reserve declares that it will no longer act to bail our institutions which are set to go bankrupt in the future. This might create incentives for the banks to deal with (a) themselves, alternatively there is work underway on how to more effectively regulate and scrutinize what the financial sector is engaged with externally. Vince Cable is on the case! Transatlantically it would be hard not to improve on the status quo. I've already mentioned the apparently strange status of the ratings agencies. The three ratings agencies were protected from additional competition by Nixon, so far as I can see for the same reason we limit university accreditation - so punters won't be bamboozled by phony agencies - but it was felt that three agencies was sufficient competition for them not to get lazy. In practice however it seems that they largely just copied the judgment of each other and didn't rock the boat in a way that, if ratings agencies were competing properly to get favoured status or were otherwise motivated to 'take risks' e.g. by declaring CDOs to be suspect and the housing boom to be dangerous as a lot of financial journalists were doing they might be willing to. Meanwhile one body responsible for financial regulation in the states was... er... http://abcnews.go.com/WN/sec-pornograph ... d=10451508 Reminds me of this: http://www.youtube.com/watch?v=O5yQNwu0kTc

[macgamer]

This also did not help the country:


Thanks Gordon!

[DACrowe]

This also did not help the country:


Thanks Gordon!

Actually what I assume is the main point of interest in your graph, the rapid escalation of spending after 2007 almost certainly did help the economy. The problematic spending is that which takes place prior to 2007 (prior to Northern Rock in other words). And you'll probably find that the areas of the country (Scotland and the North of England) where growth was driven by an expansion of the public sector are going to be the worst hurt during public spending cuts*.

I'm surprised the Eurozone spending 2000-2006 is so high. I thought the whole point of the ECB guidelines was that this didn't happen.

*Making an interestingly self-fulfilling prophecy. Thatcher & co engage in massive cuts of subsidized industry which because the impact is so sudden causes significant damage to the local economy in Scotland and the North of England. The Tories then try to stimulate private sector and unsubsidized growth in those areas but progress is slow. Labour get in power and build up those areas of the country by increasing public spending and, as it were, attempting to use public sector jobs to generate private sector e.g. retail based growth. There is an economic crisis and public spending will have to be cut. Labour wars voters 'if the Tories get in they will do what Thatcher did!'. And now of course the coalition kinda will... not because they're ideologues like Thatcher but simply because public spending needs to be cut and the areas where local economies have been propped up on the back of the public sector are going to be the worst hit which naturally were the exact same areas which were hardest hit under Thatcher because if they hadn't been they wouldn't have (arguably) needed the stimulus of increased public sector spending. Funny old world.

[David Bean]

My concern with regulatory regimens in general is that they have the awful tendency to convince people that if they comply with them to the letter, tick all the right boxes, everything will be all right and they can cease to engage common sense. In this particular case, it's true that the regulatory regimes failed, but they were only 'insufficient' if you want banks to be able, when things go wrong, to shrug their shoulders and say to the regulators and the governments, "well, we did everything you said we should do, so what happened afterwards was down to you".

Ideally, I'd have a situation where banks could do whatever they wanted, provided they knew that they would live and die by their own actions, and neither public money nor the functioning of the economy would be put at risk by their failures. Sadly it seems that governments across the world are hell bent on stitching the banks up in ever-tighter suits of statutory clothes, instead of addressing the real problem, which is how to free the global economy from the devastating results when they burst.