Friday, October 31, 2008

Greenspan On the Crisis

6 comments:

Maggie said...

If the subprime mortgages would have not pooled, we could be in a better situation. The consequent surge in global demand for U.S. subprime securities by banks, hedge, and pension funds supported by unrealistically positive rating designations by credit agencies was the problem. Then, how can we fix it? This could mean that the securitizers and lenders didn’t really know the value of credit they had to sell. Is it as simple as just imputing the data into the risk management models over the historic period instead of the last two years? There must be more to it, I don’t think this would have solved a lot but it could have solved some. The likelihood of the US Congress and Senate could possibly ban the sale of securities backed by mortgages. Also, with "Big Brother" dipping its hands into re-writing laws that pertain to the trading of securities on the open market, we could be headed for a longer recession that first thought. When the federal government interferes with the open market by adding regulation, taxes, and more severe penalties, the entire market is hurt because free trade is inevitably hindered.

Rafe A. Schaefer said...

Alan Greenspan’s testimony brought to mind an interesting dilemma for me. In a perfect (equilibrium) world, we wouldn't need a Federal Reserve Bank or a government that thought it should interfere in the market. Consumers would have all the information needed to make decisions about the products they want to buy and the producers they want to purchase from. This would involve the integration of information involving supply, demand, price, and resource allocation. Thus, the decisions made by consumers would translate to decisions about what uses they "approved" of for the allocation of the scare resources of the planet. If this were the case, markets would police themselves by weeding out the producers of the goods that customers chose not to buy and allocating more resources to those items that customers desire.

We do not live in a perfect world. Our customer actions are based on a mixture of information (price, demand, supply), consumer sentiment (the popular items in the local/state/global economy), and misinformation propagated by customers, producers, and third parties. In this world, price controls don't move perfectly in response to real customer demands. Government regulation attempts to mitigate the problems involved with an imperfect market, but that seems to just create more issues.

Perhaps the solution to this problem could be found in a neo-liberal model? A neo-liberal, like Milton Friedman, would surely say that mankind is naturally self-interested, but doesn’t understand how to act properly for his own self-interest. He must be taught. Game theory suggests that the individual acts for himself and his best interest over and above the needs of others, but, after many “prisoner’s dilemma” type interactions, wouldn’t the players on the economic stage learn to cooperate? Surely the notion of a “controlled” free market has proven that intervention dilutes price controls. Also, the notion of a “controlled” free market, in and of itself, is a laughable contradiction in terms.

So, what then should be done? I argue that what is needed is a truly free system of economics. Banks accountable for their own loans without the backing of a lender of last resort would make banks hold more reserves. Banks would be more careful about the individuals they loan to and the extent to which they are becoming overleveraged. Customers putting their money into those banks would be more likely to research the uses of their funds by the institution and would diversify their savings to mitigate their risk. This wouldn’t work perfectly at first. As neo-liberals say, man must learn how to interact with his fellow man. There would be corruption, deception, and loss in this market while consumers made the necessary adjustments to their modes of thinking and researching. Banks and other firms (both financial and non-financial) would be acting in their own self-interest by providing customers with a plethora of information regarding their products. They would learn how to act in a long-term self-interested state, as opposed to acting for short term gains.

WestonD. said...

It seems like Greenspan is not driectly talking about the issue at hand but dancing around the subject. Greenspan doesn’t talked about the mortgage backed securities issued by Fannie May and Freddie Mac. They carried the same implicit federal guarantee as the implict guarantee for their own borrowing. Thus the minimal historic spread between trasuries and GSE issued debt. There was heavy demand for Fannie and Freddie MBS because of the imagined minimal risk. If they could of advised everyone to stop back then it would have been a lot better off then what we are dealing with now.

T. Rowland said...

I agree the mortgage backed securities that were sold as prepackaged deals are inspiration for the crisis. These "steals" put investors around the world in a difficult circumstance. I got to thinking about a how these investors were led to believe they were buying good investments and thought about an article read previously about ratings agencies. These ratings agencies are not doing their research apparently. If they would have dug a little deeper, I believe they would have come to realize, maybe these subprime mortgages are not the steal they appear to be. This is alto common though, people get in a hurry, believe they can make a great deal and end up broke. Boy does money play an intricate role in the lives of Americans and people abroad.

Jason Dunn said...

I think that the government has really gurt themselves in backing up some of the huge loans that they have bailed out in the recent past. Going along with a little bit of what Rafe said, if banks could not depend of the Fed to back them up, they would be a lot more careful about the loans they make, who they make them to, and how many of these risky loans they make. This might mean a larger risk premium on some loans, or even not making the loan at all. Making banks more careful about who they are lending would decrease the number of defaults, and help these banks stay alive longer without the support of the federal government.

Kevin T said...

When the banks back all these loan companies, the companies become less careful and more risky when issuing loans. The moral hazard they use has caused some of the crisis that we are in right now. The loan comapnies know if they issue too many loans that may default or fail they will be bailed out by the government. The government is hurting themselves and the people by doing this. The loan companies need to see how this is affecting the people and the economy and develop a better way to issue loans. With being more cafeful on who they issue loans to, banks would have less of a chance of having their loans defaulted on and in return would stay alive a lot longer.