So how did we get to this dark place in the economy, and who is to blame? What drove us to this strange juncture where, as happened Tuesday, investors felt almost giddy after stocks closed only 128 points lower because the Fed had stepped in with the steepest one-day interest rate cut in history to prevent far bigger losses?
Who or what is responsible for the recession that may already have begun, and for spreading turmoil in the world’s financial markets?
Financial Times columnist Martin Wolf offered two explanations.
One is that the financial system is fundamentally broken; that it’s dominated by greedy, immoral, solely self-interested and self-delusional decisions made by flawed human beings at the top of the financial food chain. In a system that offers opportunities for extraordinary profits, there’s a parallel capacity for generating self-feeding mistakes, Wolf said.
He described this familiar cycle: innovation and an appetite for risk-taking produce rapid increases in credit, which drive up asset prices and justify even more credit expansion and still higher asset prices until panic selling, a credit freeze, mass insolvency and recession set in. An unregulated credit system is, perhaps, inherently unstable, he suggested. It allows borrowers, lenders and regulators to be swept away in tides of human euphoria and panic.
Wolf summarized his first explanation: “The financial deregulation and securitization of the most recent cycle merely encouraged an unusually wide circle of people to believe they would be winners, while somebody else would bear the risks and, ultimately, the costs.”
His second perspective has more to do with U.S. monetary policy. It was too loose for too long after the dot-com bubble burst in 2000. This is the version favored by the financial firms, Wolf wrote. Its theme runs something like: “It isn’t our fault; it’s the fault of Alan Greenspan.”
Was it Greenspan’s inattention or his intention?
One variant of this view is that Greenspan, the former Fed chief who attained the stature of a financial mystic, was merely inattentive; he didn’t use the Fed’s regulatory powers because he didn’t recognize the problem that the bundling of questionable loans into “respectable” securities would bring to the markets. The other variant is that Greenspan’s mistake was intellectual and intentional. He didn’t believe in regulation and wanted, ultimately, to force the world back to the gold standard.
Billionaire investor George Soros, also writing in the Financial Times, offered a less nuanced, more political and even apocalyptic explanation.
He blames the “market fundamentalism” ideology that overtook U.S. economic thinking in the 1980s. It was essentially the idea that self-interest produced the common interest. President Ronald Reagan called it “the magic of the marketplace,” the notion that the market could do no wrong. That, wrote Soros, was “an obvious misconception, because it was the intervention of the authorities that [repeatedly] prevented financial markets from breaking down, not the markets themselves.”
When markets went global, the U.S. began to run a trade deficit, allowing the U.S. to “suck up the savings of the rest of the world and consume more than it produced.” The markets, meanwhile, encouraged consumers to borrow by introducing ever more complex instruments on generous terms. Authorities abetted the process by intervening whenever trouble appeared — but mostly the regulators disappeared, Soros added.
The party got out of hand, he wrote, when new investments got so complicated that no one, neither the banks nor the regulators, could calculate the risks. “It was a shocking abdication of responsibility,” he said.
The ensuing cascade will amount to the greatest financial crisis in 60 years, he predicted, along with “a radical realignment of the global economy [including] a relative decline of the U.S. and the rise of China and other countries in the developing world.
“The danger,” Soros concluded, “is that the resulting political tensions, including U.S. protectionism, may disrupt the global economy and plunge the world into recession or worse.”
David Leonhardt, writing in today’s New York Times, adds hubris to our list of explanations.
By separating and spreading financial risk around the world, financial experts thought they had greatly reduced the chance of meltdown, Leonhardt wrote. In 2004, Fed Chief Ben Bernanke, then a Federal Reserve governor, even gave it a name – “the great moderation.”
But now all of that confidence seems to have depended “on a huge speculative bubble, first in stocks and then real estate, that hid the economy’s rough edges,” Leonhardt wrote. “Everyone from first-time home buyers to Wall Street chief executives made bets they did not fully understand, and then spent money as if the bets couldn’t go bad.”
Are Wall Street banks to blame?
Indeed, more scrutiny is being placed on the Wall Street banks that provided a willing market for the risky real estate loans. It’s an avenue pursued by state and local prosecutors, most notably New York Attorney General Andrew M. Cuomo. According to the New York Times, charges are expected soon against several investment banks for failing to tell credit rating agencies and investors about their misgivings about questionable mortgages.
The inquiry involves so-called exception loans and how lenders, with Wall Street’s blessing, routinely waved their own credit guidelines. As the Times noted, Wall Street banks bought many of those loans from unscrupulous lenders, mingled them with “good” mortgages and pooled the resulting debt into securities for sale to investors around the world. This “securitization” works as long as there’s a steady flow of cash. But when the flow stops, as when people who should not have qualified for loans in the first place default on their mortgage payments, the system begins to fail and failure cascades.
Other imbalances in the U.S. economy exacerbate the situation, according to European policymakers who Tuesday blamed American policy for the worldwide jitters. A Financial Times dispatch from Brussels quoted Joaquin Almunia, the European Union’s monetary affairs commissioner, who named the U.S. deficits in trade and budget as well as Americans’ meager savings rates as additional culprits. He contrasted all of that with Europe’s “solid, sound fundamentals,” the London-based newspaper said. Denying that he was gloating over U.S. troubles, Almunia said that he was only stating facts about the “root cause of the current turbulence.”
Jean-Claude Juncker, chairman of the eurozone finance ministers, agreed, saying that “the deficiencies against which we have warned repeatedly are taking bitter revenge” on the U.S. economy.
Steve Berg, a former Washington Bureau reporter, national correspondent and editorial writer for the Star Tribune, reports on urban design, transportation and national politics. He can be reached at sberg [at] minnpost [dot] com.