Monday, August 30, 2010


The conventional wisdom is that the financial crisis led us into the severe depression we are experiencing. Guy Sorman's survey of free-market economists suggests another possibility:
that the recession triggered the financial crisis, not the other way around. [Economist Eugene] Fama argues that the recession started as early as 2007, with consumers starting to spend less, borrowers falling delinquent on their loans, and homeowners who lacked a vested interest in their houses beginning to walk away from their mortgages. So the complex financial derivatives at the heart of the financial meltdown were not its cause but its victims. “For 25 years, before the current recession,” Fama points out, “the derivatives worked well in lowering the cost of capital. . .

James Hamilton, at the University of California at San Diego, agrees that the recession provoked the financial disaster, but he submits that energy costs had much to do with the initial downturn. Energy expenditures as a percentage of total spending in the U.S. had fallen from 8 percent in 1979 to around 5 percent in 2004, he notes. By June 2008, though, the price of gasoline had reached $4 per gallon, blasting the energy share of spending back up to 7 percent. (The massive demand from emerging economies like China and India spiked the prices, a shock comparable with the 1973 energy crisis.) “While some people were ignoring $3 gasoline in 2007, $4 definitely got their attention,” Hamilton says. The subsequent shift in spending patterns was disruptive for key economic sectors. The number of light trucks sold (including SUVs) plummeted by 23 percent from the second quarter of 2007 to the second quarter of 2008, with auto manufacturing hemorrhaging 125,000 jobs over the same period. The rising energy costs likely had an impact on commuting and hence on housing, Hamilton adds, since they made suburban homes less attractive—and thus less valuable. Widespread mortgage failures began in 2007, in fact—before the financial crisis hit the next year.
Much of the rest of the article's analysis is over my head, but the consensus seems to be that the government and the Fed got too cute. They fooled themselves into thinking they had it all figured out and proceeded to mismanage us into a crisis. "Hubris," one of the economists called it.

This sounds right to me, as I believe so many of our problems result from the "cures" government imposes on us to "solve" our problems (which were usually created by government to begin with). There are just too many working parts in an economy to believe that a small group of people, no matter how smart, know enough to keep it running smoothly. I have much more faith in the additive wisdom of 300 million private citizens deciding for themselves what their priorities are and how to achieve them than I do in a small group of experts continually tweaking the rules because they "know" what's in our best interests.

But while I agree with the charge of "hubris" leveled against the government and the Fed, it sounds to me like the economists quoted in the article favor something that might be called hubris-lite. I won't attempt to summarize the ideas they propose, but as I read through them all I keep hearing is: Those guys weren't as smart as they thought they were. You can't just grab a tiger by the tail like that and expect it not to turn on you. But if you plant your feet like this and grab the tail just a little farther back...

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