{"id":411,"date":"2008-10-09T17:29:24","date_gmt":"2008-10-09T06:29:24","guid":{"rendered":"https:\/\/calltoreason.org\/?p=411"},"modified":"2008-11-10T14:00:12","modified_gmt":"2008-11-10T03:00:12","slug":"financial-meltdown","status":"publish","type":"post","link":"https:\/\/calltoreason.org\/?p=411","title":{"rendered":"Financial Meltdown"},"content":{"rendered":"

This is as good a time as any to post a link to Sad Guys on Trading Floors<\/em><\/a>, a photo collection of traders’ reactions to the continuing financial meltdown. The U.S. Federal Reserve just dropped the federal funds rate by 0.5 percent to 1.5 percent, while central banks around the world followed suit, and the markets still dropped<\/a>. The U.S. Treasury stated that it might have to take ownership of U.S. banks<\/a> and U.S. House Speaker Nancy Pelosi has just announced a proposal for yet another stimulus package worth US$150 billion to be spent in a Keynesian attempt to jump start the American economy. All of that is just today’s news.<\/p>\n

Remember how AIG was bailed out by the U.S. government to the tune of US$85 billion just a couple of weeks ago and needed another US$37.8 billion yesterday? A report<\/a> today details a week long “conference” organized by the world’s largest insurer for its top agents at a five-star resort in California costing more than US$400,000.00 just a few days after the first bailout. As the saying goes, we live in interesting times.<\/p>\n

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Earlier today, I posted a brief explanation<\/a> behind the causes of the meltdown at Jed Yoong’s blog, so I might as well repost it here:<\/p>\n

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The roots of the current financial turmoil in the United States lies with the rapid, and with hindsight, unjustified rise in house prices, i.e. a bubble. This happened for mainly two reasons as far as I can tell:<\/p>\n

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  1. A relaxation of the regulations governing bank lending and greater risk taking by financial institutions in the belief that that modern financial techniques of cutting up huge bundles of loans into different tranches representing different levels of risk effectively sanitized enough of the risk for even rock solid institutions to invest in previously untouchable loans. For this, blame the U.S. Congress for repealing parts of certain laws meant to curb such behavior, the banks for pushing for this through lobbyists in the hopes of greater financial returns and the SEC for being asleep at the wheel and allowing these derivatives to continue being bought and sold even though no one really understood the risks they represented.<\/li>\n
  2. Historically low interest rates set in the belief that inflation was historically very low without accounting for inflation in housing prices and then Fed chairman Alan Greenspan\u2019s willingness to set interests rates as low as necessary to revive the economy in the wake of the 2001-2002 recession from the pricking of the dot-com bubble. Greenspan refused to acknowledge that there was a bubble in the housing market until it was far too late and famously argued that bubbles are identifiable only in hindsight and after they have been pricked by the market and that the role of government isn\u2019t to identify and prick bubbles but to manage the economy after the bubble has been pricked.<\/li>\n<\/ol>\n

    In a way, this represents a general dilemma of how governments should respond to market ups and downs. If a government identifies a bubble and tries to prick it, it would be hugely unpopular, \u201cleaning against the wind\u201d as Greenspan put it. If everyone is profiting from an inflating bubble, the financial authorities face immense pressure not to do anything even if they think that growth is \u201cfake\u201d, or \u201cirrational exuberance\u201d, another of Greenspan\u2019s terms, as the previous few years of economic growth in the United States may turn out to be, not actual gains in productivity and production, but simply unrealized paper gains derived by manipulating figures on a balance sheet.<\/p>\n

    On the other hand, if a government tries to act after a bubble has already been pricked, using public money to rescue distressed institutions, it becomes a moral hazard, as one commentator on a forum I frequent put it, \u201cprivatizing profits and socializing losses\u201d. Everyone will be screaming for action but it is already too late and becomes simply an exercise in damage mitigation.<\/p><\/blockquote>\n

    Yes, the above represents a very gross overview of the situation only and I’d recommend anyone truly interested to read some of the Wikipedia articles on the subject. They’re surprisingly detailed and up to date.<\/p>\n