08 crisis and Great Recession cause

[wufwugy]

With the release of the 08 Fed minutes, Sumner recaps what monetarists have been saying for a while. Maybe you're not interested, but if you are, it's a great overview. If you question Sumner's credibility, well, my answer is he's a PhD who still regularly teaches, relies on quantitative analyses of the data, and references actual textbooks (which is more than can be said for any other popular econ pundits *cough* Krugman *cough*)

Anyways, it was bad monetary policy by the Fed, not phantom non-existent bubbles or the machiavellian wealthy screwing over Joe Everyman. As with all things, it's technical and quantitative

http://econlog.econlib.org/archives/...08_transc.html

[rong]

I don't know if this is really nails the cause of the recession. Isn't it just saying the a flawed approach by the fed didn't help when a different approach could have been far more productive in reducing the severity of the recession.

It doesn't take into account the fraudulent behaviour of banks and ratings agencies and their involvement with subprime mortgage backed securities which led to huge levels of exposure for institutions who by either refusal to acknowledge or stupidity put billions of shareholders money at risk. No matter how quickly the fed reacted it was never going to be able to make these poor investments turn good, nor stop the mass of defaults on these loans. This meant that any way you look at it many people would lose their homes and many investments would lose all value and many financial institutions would have huge sums knocked off their value. Due to the huge level of exposure many financial institutions had to what was essentially poorly analysed investments a recession seems impossible to avert.

This is simply looking at the behavior and actions of the fed given the crisis that the sub prime mortgage market was in. Granted it criticises these actions and notes that a different approach could have reduced the severity of the recession, but it isn't the actual cause.

[spoonitnow]

Does dumb people buying dumb shit with money they don't have come into play at any point? I don't have time to read it at this particular moment.

[a500lbgorilla]

Does dumb people buying dumb shit with money they don't have come into play at any point? I don't have time to read it at this particular moment.

It sure does. Boosts GDP like crazy.

[wufwugy]

Sorry for the big post. I tried to explain it thoroughly

This is simply looking at the behavior and actions of the fed given the crisis that the sub prime mortgage market was in.

Exactly. There would have a been a small subprime recession regardless of what the Fed did. That recession also started long before the 08 crisis hit.

The buildup to the subprime recession is a far more complex issue that I think mostly has to do with moral hazards created by certain laws and institutions (*cough* Fannie and Freddie guaranteeing bad mortgage-backed securities *cough*), not so much the banks. Regardless, after activity in subprime lending decreased, every other sector was doing fine. This continued for months. Even after the assets on the books looked frivolous, the economy was doing okay. It was only after the Fed let it get so bad (*cough* doing nothing about Lehman *cough*) that there were expectations of financial catastrophe, deflation, and NGDP collapse. That is when the crisis hit, not when subprime lending became an issue.

Here are a few important points to put into perspective why the common sense "the banks did it" line doesn't work:

1. If it was true, then it would be more true now. Not just a little more true, but much more true. This is because the one and only thing that stopped and reversed the plummet is Fed stabilization and stimulus. The stimulus has been colossal, the Fed has basically guaranteed trillions in assets. If it was true that we were on fundamentally shaky ground before, it would be game over now. But it's not game over now, so that means the conventional wisdom is flawed.

2. Because the Fed is the sole responsible party in stopping and reversing the plummet through stimulus, it could have done the same thing to prevent the plummet in the first place. The Fed had the opportunity to address the drop in NGDP when it first happened, but didn't. It was only after the drop was so severe, it realized it made a mistake. The fact that the Fed could bring the economy back from -2% NGDP to 4% NGDP (more or less) means it could have much more easily done it before NGDP expectations got so low in the first place

3. If the "bubble theory" and all the bad lending stuff was true, Canada's larger-than-US housing bubble would have popped a long time ago. But it hasn't. China also would have collapsed too, and it would have been so epicly huge that the 08 crisis would have been miniature in comparison. But it hasn't. Australia also would have collapsed. The truth about bubbles is that they don't exist. The only time you will ever see anybody talk about a "known" bubble, is in some vague Captain Hindsight way. That's because they're not real

Which leads me into the fourth point, which addresses what Spoon said

4. The idea of "dumb people buying dumb shit they can't pay for" isn't a macroeconomic reality. Macro is not intuitive like micro, and we suffer from having so few macro experts that micro views take precedence. The "economy" is an illusion. It's a social construct that works only because arbiters within it agree it works. There is no "real" reason why gold is priced how it is, no "real" reason songs are priced the way they are, and no "real" reason underlying the value of a house. The value of all things in an economy is intertwined with other facets, and this demonstrates the value isn't "real". For example, let's say everything is exactly the same tomorrow except President Obama is assassinated. What would happen to the economy? Well, we'd have a small recession, just like we did after 9/11. A great national catastrophe would momentarily change behavior and the economy would adjust. All sorts of goods and services that are "real" would decrease in value. But if it was the case that they're "real", why would something so unaffiliated with the "real" value of those goods and services have an impact on them? Because they're not "real" in the first place. They're a part of a social construct where value is an illusion based on the behavior of its actors. Virtually anything can rise or lower in value for not "real" reason, and that is precisely what has happened in our economies.

What does this mean about the Fed? We went through this same scenario in 08 and 09, just more severe. There was a whole lot of "real" value in all sorts of things, but only after the Fed downgraded NGDP outlook, did that value become less valuable. This has happened before in US history too. Getting more into it involves getting into monetary policy, of which I'm still kind of a newb. But the basics are that monetary policy is king i.e. the exact level of growth or shrinking the economy undergoes is the exact level that monetary policy allows. When policy is such a way that NGDP drops, it will look like a bubble popped and all sorts of things lost their value. We'll say those things never had any true value and we'll not see the culprit was merely the central bank. The details are pretty complicated, but it is well established historically that the Fed's policy is king

[rong]

So it's all the feds fault. Should the Euro countries sue you for this?

[wufwugy]

So it's all the feds fault. Should the Euro countries sue you for this?

No but you should sue the ECB (joking). Australia and Canada barely had any problems because their central banks (and lack of moral hazards) kept things going fine. But the ECB is succubus. The Eurozone is all sorts of fucked because it's a monetary union without fiscal unity, so the ECB's policy is what favors Germany and hurts everybody else

The Eurozone will likely one day be like the US, though, with full fiscal unity and a federal government with the power to tax. I don't see how it can't, unless the Mediterranean countries don't have enough sway over the mainland countries to stop from living in perpetual poverty. Imagine the US where Mississippi doesn't get fiscal kickbacks from the federal government yet still is forced to operate on the federal currency. It would just get worse and worse. That's Greece, Spain, and southern Italy now

[rong]

Has anyone attempted to quantify the effect of the sub-prime crisis and ignore the effect of Fed policy? Because from what I've read the way that mortgage backed securities were spread throughout the financial system meant a huge amount of exposure for a lot of companies. I think laying blame on the Fed is a cop out and fails to hold anyone responsible for the blatant fraud and negligence that went on.

Holding individuals and corporate entities responsible for their actions is of extreme importance and just as valuable in terms of reducing the possibility of a similar occurrence as would be removing say deposit guarantees.

[rong]

Also what are you suggesting the Fed should have done about Lehman?

[ajspiano]

Macro economics is well beyond the scope of my knowledge - though as an Australian, I don't really think we were safe because of reserve bank or gov policy. I could be very ignorant though.

We are a very different animal to the US, given that we have only around 30 banks and just 4 of those have the lions share of the market. They are obscenely profitable institutions that could probably weather twice the storm of the GFC without even blinking. So successful are "the big 4" that our media would like you to think its "un-australian" to not hate them for it. Our banks are the prime target of tabloid television news programs (A current affair, today tonight).

[wufwugy]

Has anyone attempted to quantify the effect of the sub-prime crisis and ignore the effect of Fed policy?

Most already ignore Fed policy. Among popular analysts, virtually none make a distinction between subprime, 08 crisis, and the Great Recession. They also completely ignore that the credit default swap market grew so big because of the moral hazards created by Fannie and Freddie. Basically, the popular analysts paint with a broad brush saying that the banks were deliberately defrauding (they weren't) and they got away with it because of no regulation, and the solution to keep that from happening again is to strongarm the banks and the solution to the bad economy is fiscal stimulus. Recently these popular analysts have lost a big fight on the fiscal stimulus area, where monetary stimulus came out dominant, but they have yet to acknowledge it. The fight was basically on the monetary offset. Keynesians said the sequester cuts would devastate the economy, but monetarists said that if the Fed engaged in continued stimulus (it did), there would be monetary offset and the economy wouldn't suffer. That's what happened.

Because from what I've read the way that mortgage backed securities were spread throughout the financial system meant a huge amount of exposure for a lot of companies. I think laying blame on the Fed is a cop out and fails to hold anyone responsible for the blatant fraud and negligence that went on.

Holding individuals and corporate entities responsible for their actions is of extreme importance and just as valuable in terms of reducing the possibility of a similar occurrence as would be removing say deposit guarantees.

Let's hold the Fed responsible. If we're going to lay blame, it should be on the right people. As far as I can see, those people are the Fed for its bad monetary policy and Congress for its bad regulatory policy. The banks and corporations didn't engage in some crazy or illegal conspiracy to sell bad mortgages, make a killing, then get bailed out. What happened was rather simply the government guaranteed a portion of mortgage-backed securities. This created a banking environment where there was unusually high value in weak assets. Even then, it was all running fine until the Fed let the subprime issue become and existential crisis. The private market already began pulling back on the subprime lending because it appeared so whack. This created a small subprime recession and nothing more, but it was only after the Fed let the NGDP fall from that recession hold course, and this made those subprime assets become shit assets

Also what are you suggesting the Fed should have done about Lehman?

Saving Lehman is tough because Lehman had to fall in order for the populace to accept saving the banks. However, the whole thing could have been avoided if the Fed didn't let NGDP keep falling. If the Fed had a hands-on approach to growth targeting and forward guidance, the subprime "bubble" would have been absorbed, Lehman would have either stayed healthy or been bought by another bank, and everybody would still kept their homes and jobs

[wufwugy]

Macro economics is well beyond the scope of my knowledge - though as an Australian, I don't really think we were safe because of reserve bank or gov policy. I could be very ignorant though.

We are a very different animal to the US, given that we have only around 30 banks and just 4 of those have the lions share of the market. They are obscenely profitable institutions that could probably weather twice the storm of the GFC without even blinking. So successful are "the big 4" that our media would like you to think its "un-australian" to not hate them for it. Our banks are the prime target of tabloid television news programs (A current affair, today tonight).

The Reserve Bank of Australia is probably the most sophisticated on the planet. It effectively (but not explicitly) runs NGDPLT (nominal gross domestic product level targeting), and this means that when nominal growth is more than it likes, it tightens policy to get it back to the level, and when growth is less than it likes, it loosens policy to get it back to level. Think of it like if the parliament passed monthly fiscal stimulus bills depending on growth rate, where the bills scale in size based on how much expansion (or contraction) is needed to keep the nominal growth on level. This example isn't realistic though, nor should it be, but it gives you an idea of what level targeting is

Australia doesn't have deep or lengthy recessions anymore because whenever NGDP falls, it stimulates enough to get it back up. The details are more complicated, but the overview isn't. NGDPLT solves an uncountable number of problems economies experience. The issue with the US is the Fed has a very hands-off approach and is afraid of level targeting because it feels like that's central planning. It's not central planning, but it's understandable that the country that only twenty years ago was toe to toe with the communists would have a hands-off approach to nominal level targeting. The Fed is beginning to come around though. It has engaged in some forward guidance recently, which is very new and is in some ways important for level targeting

[wufwugy]

The more I read about Fannie and Freddie, the more I am baffled at how badly the media has boggled the cause of the housing "bubble". Everybody freaking loves to blame the banks, but then everybody's all hush-hush when it comes to pointing out that the very derivative market for bad loans is created by government sponsored institutions and policy

I mean, I remember Republicans pointing this out in 08 and early 09, but I thought it was bullshit at the time. I thought it had to be bullshit because W was a Republican, so the rest of the GOP should sit down and shut up and let the adults (Democrats) figure out how to fix the catastrophe the Republicans created. Then I doubled down on how inaccurate the GOP rhetoric must be after they went full retard on Obama and opposed him no matter what. I guess that's a lesson that as long as the GOP caters to it's batshit evangelical base, it couldn't elect effective politicians if it tried

Great Yglesias post on the Fed's role in the collapse. He always explains things better than anybody

http://www.slate.com/articles/busine...t_mistake.html

[wufwugy]

Even better Sumner post on the issue.

http://econlog.econlib.org/archives/...shkin_the.html

The only way I can explain why the economics profession shit all over itself is that the US so thoroughly embedded itself in "politics of stupid" and there were no survivors. From the late 90s, federal politics had quickly become about catering to the lowest common denominator, and maybe this seeped into everything federal and political (the Fed) regardless of established academic truths. If that's the case, I don't think significant changes will be made unless somebody like Schweitzer wins the 2016 presidential election

[wufwugy]

Hell, maybe it's fucking Ron Paul's fault. His dumbass was preaching hard money and gaining all sorts of popularity leading up to 08. Hard money sentiments are the kinds that would provoke Fed economists to view the 08 issue the way they did. It just blows my mind that so many professionals could look at falling inflation yet still believe inflation was a risk. The only place you get that sort of idiocy is the Ron Paul types, who think stupid shit like if you expand the monetary base by any measure you just stole money from Mom and Pop and Zimbabwean hyperinflation is right around the corner