The Financial Crisis of 2007-2009: Causes, Consequences--and Possible Cures

The Financial Crisis of 2007-2009: Understanding Its Causes, Consequences—and Its Possible Cures

J. Bradford DeLong

University of California at Berkeley and NBER

brad.delong@gmail.com
http://delong.typepad.com
+1 925 708 0467#####

MTI-CSC Economics Speaker Series Lecture

Civil Service College Auditorium
31 North Buona Vista Rd.
Singapore
http://www.cscollege.gov.sg/cpe/events.html#top
January 5, 2009 3:30PM#####

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DeLong: The Financial Crisis of 2007-2009: Causes, Consequences--and Possible Cures [Slides]

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DeLong: The Financial Crisis of 2007-2009: Causes, Consequences--and Possible Cures [Text]

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Comments

[Alexander McCloskey]

Do you have any plans to be speaking in Hong Kong on this trip?

[Alon Levy]

Sometimes, your writing talks too much to Westerners and not enough to Singaporeans. I didn't study economics at the National University of Singapore, but I studied other things, ranging from math to history, and I'd guess that some of the analogies you used in your talk were completely foreign to them. The main example is in the story of how the economy went from having consumable capital stock to having mostly illiquid capital. Consider the following sentences:

1. "Cast yourself another 250 years back to the docks of Venice where Antonio, the merchant, is loading the goods for a venture onto one of his ships: the spices of the Indies, the silks of Cathay, and the intoxicants of Araby." This is a good description when the people in your audience are Westerners, but not so much when they're Singaporeans, for whom Cathay is just the national airline of Hong Kong, and Venice 250 years ago was just a European city. Worse, 19th century Singapore was a lot like 18th century Venice, but by then European capital stocks was already nothing like Antonio's spices.

2. "The capital stock of our economy consists of the semiconductor fabs of Applied Materials, the patents of Merck, [and] the roadbed of CSX." I've never heard of Applied Materials, but at least its function is self-explanatory. Merck and CSX, which aren't so self-explanatory, I've only heard of after participating in American forums and debates relating to health care and rail transit. If I hadn't, I'd have had no idea who Merck is and what their patents signify, or what CSX is and why it would have a roadbed; I'd probably guess they're both finance corporations with finance-related patents that had repossessed roadbeds, and conclude that the problem right now is that capital is owned too much by finance. It would've been a lot clearer to just say, "The capital stock of our economy consists of semiconductor fabs, medical patents, and railbeds."

[christofay]

Applied Materials doesn't own semi fabs, they make the equipment that goes into the fabs. The business is currently cratering. Based in Santa Clara.

CSX, the Wal-Mart warehouse on wheels economy.

Friedmanesque

that's okay, I make mistakes about stuff that I should know better too

[christofay]

From two men that understand markets & finance

"SAY what you will about our government’s approach to the financial crisis, you cannot accuse it of wasting its energy being consistent or trying to win over the masses. In the past year there have been at least seven different bailouts, and six different strategies. And none of them seem to have pleased anyone except a handful of financiers."

Michael Lewis & David Einhorn

How much patience will we owe Pres-elect Obama who ran on change? Change that we can believe in.

Bush too ran on that buzz word or something similar, didn't he? Something along the lines of I will restore honor & integrity.

[Alon Levy]

I know what CSX is; my point is that most people don't, especially outside the US. I'd say the average Singaporean knows what CSX is to the same extent the average American knows what Toei is.

[Tomas]

Totally off topic, but Brad, take a look at what the demon walrus and the berkeley babyball-crushing carpenter is writing in the times: http://www.nytimes.com/2009/01/05/opinion/05bolton.html?_r=1

Now we know how many warcriminals it takes to make my ironymeter explode. "OH WONT SOMEONE THINK OF POOR THOMAS JEFFERSON?". Was it 3 years the NYT had left?

[Alex Tolley]

If the Rx must be to support the financial system, doesn't this create an asymmetry that ratchets up the size of the pool of risky assets. How can this be deflated if those assets truly are losing value?

[Reader]

It is a nit, but Lawrence White is not at Washington University (St. Louis). He is F. A. Hayek Professor of Economic History at the University of Missouri St. Louis.

The mistake is understandable given the mental queues: Lawrence White is a right-wing bozo, and WU is home to a number of them; and Lawrence Meyer, the former Fed Board of Govenors member, is at WU.

[Nathan Kaufman]

in addition to people not getting credit who should get credit, it may be a repricing of credit and entities paying higher interest. This could be due to increase in volatility and uncertainty, as well as as signals not trusted or reliable, or something else. It also may be that people who could borrow for a project do not want to borrow due to lack of confidence or depressed activity levels making payback less certain and riskier.

[christofay]

What is Toei? A quick goggle and I can only find a Tokyo subway line and a Japanese animation studio.

My impression of the Singapore economy is two-faced. The govt has succeeded in jumping through hoops in generating a rising economy improving the standards of living. On the other hand it is basically statist. Isn't the President-for-life's wife the head of one of two state SWFs? The destruction side of the creative-destruction coin is always to crush any political opposition. It is democratic in name as it helps brand the country to win investment European and American SnP500 type companies.

If China was a potential source of investment and employment, perhaps it would be communist in name especially due to the Sinophile aspect of its heritage.

[Daryl Sng]

Prof DeLong - long time follower of your blog, and had the great pleasure to be at the speech. I asked the question about how the Marx-Hoover-Hayek axis of ideas had gained so much currency among the American right wing, and I thank you for your very comprehensive answer to the question. Just a thing I would add that I suppose was implicit in your answer to my question - you had mentioned the very Christian nature of America in many respects, and the importance of the notion of being punished for sins, which in turn led to a certain feeling that the crisis was a necessary purgative response to the "sins" of excess, even when the importance of punishing the financiers that were held responsible for the crisis could have brought with it the unemployment of millions. I think to that you can add that very Christian view that as long as you have sinned, there is no question of degree - you may be in one of the circles of hell, if you like the Dante formulation, but you are in hell, nonetheless. And such a worldview makes it hard then to deal with questions of degree and magnitude - i.e. to use pragmatic means to say "well, we've made mistakes, but that doesn't mean the punishment is eternal damnation; the fallout can be contained and the pain people feel can be minimised".

[hartal]

The Marxist position is of course dialectical: it would welcome Keynesian full employment policies not of course because the Marxists share the anarchist paranoia that such policies would actually stabilize the capitalist economy sufficiently that the better would become the enemy of the good (utopia) but because they believe that full employment and redistribution policies in the context of Depression would actually exacerbate class tensions to the point of collapsing the capitalist mode of production and making a change in the mode of production actually possible. Marxists are not part of the Hoover-Hayek axis to the extent that they do support humane full employment policies, coupled with strong unions, but they are not Keynesians to the extent that they do not believe that the policies recommended by the underconsumptionists Krugman and Jared Bernstein (and before them, one Leon Blum, also the first ethnic outsider to become the leader of his country) will actually stabilize capitalism. On the contrary.
I hope that the Keynesians (Wolf, DeLong) are right...

[Mason Louie]

I don't feel that inhibiting the financial crisis is an inherent Christian weakness or it is to say. I don't think the idea of "sin" is unique to Christians and its role is small in dealing with the problem. The real problem is size.

As a non-Christian but being raised American and watching Christians go on and on and on about it, my interpretation of "sin" is "religiously laced mistake". When seen from this POV, this means either individuals or whole species may "sin". Although the point of righteousness (and progress) is to not make these mistakes, it is also to make systems which can withstand them. Yeah, good sense will tell you to stay warm when it's cold outside, but it's sure nice to have an internal exogenic heat source to keep the old metabolism going when you're ousted from your sleeping quarters on a frosty night.

However, there are some mistakes, sins if you're feeling evangelical, which are bigger than even built-in failover systems can handle. In these cases, individuals, groups, or even whole species do one thing. They die. This is such a useful mechanism that some units even have a specific self-destruct program. Cells will kill themselves if they deem themselves too damaged and poisonous for their peers. Highly socialized humans may do this as well, see the Japanese's famous hari-kari business. In western societies, this usually is taken to a lesser degree by resigning.

Sometimes, the self-destruct program doesn't work either cause it too has been corrupted or the individual in question is deficient. Cancer. That I feel is the source of the current issue. The individuals responsible for this mess are too poisoned to not only fix their problems, but also to bow out gracefully. Here's the part where Christianity makes things messy. In Christianity, the cure for sin is suffering be it here or elsewhere either before God or the Devil or Brian Boitano. It is thought suffering alone will cut it.

But suffering is no cure for cancer. Keynes had the nerve to point out that although the suffering makes the self-righteous feel better, it won't necessarily get people anywhere. There are many who feel he was a dangerous radical because he questioned the unquestionable godliness of suffering.

However, Keynes present followers like the professor, Janet Yellen & Paul Krugman are forgetting the elephant the present advisors Paulson & company are also furiously ignoring, the malfunctioning individuals remain and the poisons they produce continue. The thinking is that the structure, even if damaged and corrupted, can be forced to serve. The megalithic US Federal govt does this every 4-8 years, so why can't the whole US, nay world, banking system do the same?

More materially, the systems based on those individuals are corrupted. The banks are dead. They're insolvent beyond academic, financial, political, or religious decree. Furthermore their deadly non-breath is suffocating every business they touch, every nation which houses them, and every sorry individual who depends upon them. The poison has fully trickled down; the consumer is dead too.

But rather than burying the dead, this govt is half-heartedly trying to fill the banks' shoes to keep the producers from dying too. The next govt will attempt to revive the consumer, but it is troubling that the source of today's poisons will linger as they continue today and kill any would-be recovery. The govt is big, but the problem is bigger! So great are the obligations of the banks that it would destroy even the government to fully cover them. It may have already commited too much; California is half dead already and uses its remaining energies to finish the job.

What do you do when there simply isn't enough to cover the obligations? When the obligations are so far beyond even the incredible Panglossian productivity we've already seen? You deal. You ration. You gauge who pays and who doesn't and, in bad cases, who lives and who dies. You know those old hard questions, utopians thought we outgrew decades ago. These questions must be answered, be it politically, economicly, or ultimately militarily.

One thing I do agree with Christians is that debt is a sin because, on an individual or a global scale, taken too far, it is fatal. I agree it is best to deal with the fallout as painlessly as possible, but I fear that even the most ambitious programs of the next govt are but shiny trinkets in the big hole. That hole's going to be filled be it production, tears, or blood.

[picked the wrong week to stop tipping moose]

"The framers of the Constitution designed the treaty process with a bias against “entangling alliances,” as Thomas Jefferson described them in his first inaugural address. "

Apparently, there should also have been language against "entangling antagonisms"

[Slocum]

The 'magneto trouble' viewpoint has the advantage of avoiding the fallacious moral analogy that views recessions as 'purifying'. But it introduces other problems -- it suggests that there is a single faulty part that our technicians can diagnose with certainty and fix expeditiously. None of which is true. The problem with the 'magneto' framing is the economy is much more like a complex ecosystem than a Model T engine with bad magnetos.

Does DeLong include Tyler Cowen in his Marx-Hoover-Hayek 'Axis':

"The answer to Krugman's #1 is a combination of (perceived) wealth effects, downward nominal and real rigidities, and, during the boom workers at least thought they knew what they should be doing but now they do not. The coordination problem on the upswing is not symmetric with the coordination problem on the downswing. In any case it is correct that real sectoral shift theories do not explain all facets of a recession or depression; it is incorrect to conclude that therefore, in light of sectoral shocks, fiscal policy will be effective."

http://www.marginalrevolution.com/marginalrevolution/2008/12/i-am-initiated.html

It's one thing to propose to minimize and mitigate the effects of the recession and try to prevent the panic feeding on itself during the time it takes for a new economy to emerge. That's fine -- it's not purifying for people to suffer. But it's another thing to believe that of course we can fix things if only we commit to a large enough stimulus package.

[MattYoung]

OK, there is one thesis implicit here that I accept, monetary systems have an enforcement structure. That would lead us to national central banks, under all the smooth bell curve assumptions with distribution tail and incomplete market problem.

Being unstable does not imply being very much out of equilibrium that we have this sudden shift, absent a technology shock.

[mike]

A random thought on stimulus:

Tax cuts don't seem especially effective stimulus right now because everyone will just save them not spend them.

Government spending is tough for political and time-to-implement reasons.

How about subsidized private spending? For example, the government could pay 25% of any new car purchase over the next 12 months? Wouldn't that do way more for Detroit and the macroeconomy than all this silly bailout business?

[Alon Levy]

Christofay: Toei is one of the two systems that comprise the Tokyo subway. It gets used by about 1 million people daily, which is more than use CSX. Still, I don't think anyone who's neither Japanese nor an urban rail buff has heard of it.

Singapore's economy isn't exactly statist. Its policy of development is somewhere between pre-1987 South Korea and Hong Kong's. Like Hong Kong, it puts a premium on attracting foreign capital and foreign corporations, and has low taxes and minimal social spending. The Gini index is the second highest in the first world, after Hong Kong's. Unemployment benefits don't exist, and retirement money comes only from what you saved when you worked. Social security is semi-privatized: there's a high payroll tax, which goes to a mandatory savings account held in a government trust fund, providing the government with ample investment cash while ensuring the middle class can retire at 65 (the poor can't).

Conversely, like Park's South Korea, it has a classic mercantile attitude and heavy state involvement. It promotes free trade, but that's because free trade is in the mercantile interest of entrepot cities; at the same it amasses huge surpluses from the social security accounts and invests them in various shady deals in developing Southeast Asian countries. It is also heavily militarized - its per capita military spending is the second highest in the world, after Israel's, and its education system is geared toward convincing people the country's under continuous threat from Malaysia and Indonesia (it's not; the last time the country was attacked was WW2).

The issue of authoritarianism is different. In terms of civil liberties, Singapore is far better than China, or how South Korea and Taiwan used to be. The real autocracy comes in the government's power concentration, which has ensured there's no alternative power structure. In every other city, there are local interests like neighborhood associations, labor, business, and religious groups, which voice their concerns about various government projects, and propose solutions of their own to problems. Even in Shanghai, the government had to cancel a maglev extension because the residents near the right-of-way protested over radiation concerns. In Singapore, not only does the government not listen, but also these interests don't even exist as organized groups. In principle, a liberal politician could topple the government and win an election, but in practice he'd have nowhere to attract a base of support, and nowhere to prove his bona fides to the people.

Mike: bad idea. Republicans dislike everything with the word "subsidy" in it, so politically it's no different from infrastructure spending. Besides, every dollar spent on shoring up the car industry now is an additional dollar that the government will have to spend later on fighting climate change.

[MattYoung]

OK, will refine my stimulus proposal.

Allow us to deploy automated drone delivery vans in residential neighborhoods.

Electric wagons, looking like school lockers. They meander onto the block and we run out of the house with our ATM cards to open the locker containing the stuff we ordered. Lightweight, intelligent, safe, low power; and they perform neighborhood watch for free.

Seriously, it solves the problem.

[MurrayR]

After falling 35% in 2008, US stocks are now trading at only 10.6 times forecast earnings, well below the historical average. But are they good value yet? Martin Hutchinson says it will depend on the sector and country. He offers his financial advice by picking the biggest bull and bear markets for 2009.

http://www.contrarianprofits.com/articles/the-top-bear-and-bull-markets-for-2009/10756

[P.M.Lawrence]

"Leon Blum... the first ethnic outsider to become the leader of his country".

He was hardly the first. It has happened frequently in history, e.g. William III (Dutch), James I (Scots), Henry VII (Welsh), William the Conqueror (Norman) - and that's just some among the rulers of England in the last millennium. The precedent goes back at least as far as some Egyptian pharaonic dynasties. Even if you insist on democratic leaders, even though Leon Blum wasn't one, you still get William the Silent (Provencal) in the United Provinces of the Netherlands and Disraeli (Sephardic) in the UK.

[Whammer]

The ongoing trouble I keep having with the Keynesian approaches that have been advocated lately is that they feel unconstrained. This might be because I was originally an engineer, but I don't understand how you set reasonable limits on the proposed actions.

Another way of saying this is, I suppose, there are a set of assumptions around taxation that are baked into the idea that we should deficit spend countercyclically in order to fight deflation/depression/whatever.

So, what does this really mean in practice? Why should we have taxes at all, if we're going to spend in excess of our revenues? Why don't we just drop taxes to zero and spend spend spend?

Are we truly not constrained by the overall debt that we are accumulating? Was Dick Cheney right when he said that "Reagan proved that deficits don't matter"?

I'm not as convinced as I would like to be that there is a coherent economic philosophy in play here. And I'd hate to say that Dick Cheney was right about anything.

[Thorstein Veblen]

Question for Brad: I thought we were all Keynesians now. Doesn't Obama's stimulus plan look a bit small?

[Thorstein Veblen]

Um, can you tell us, Brad, why the Republicans and the Germans are the main entities that "don't get it". What about Larry Summers and Christina Romer? The stimulus package as-is looks like it's been low-balled...

[MattYoung]

Why do we call this a financial crisis?

Is it not true that the financial community agreed that it is time to restructure, and that we agreed over a few moths time.

That seems to be an amazing feat of synchronization and agreement. No only have we agreed to restucture, but we have the most amazing information technology available to use about which we cna restructure.'

The problem is more a problem of supporting the retrenchers, the Keynes who want to restore the old system. These folks seem to be in a very small minority, the rest of are going along with the plan,

The fact is we do not need baks in their currett form, successful restructuring cn sel-finance y going outside the financial system.

Whats wrong retucturing all at once, we wold see enormous auction savngs.

[guthrie]

Alon Levy just described the UK in his comment about Singapore. The last few gvts have consciously dismantled all possible opposition to themselves, and are trying to put in place programs to ensure that this continues, with police repression of opponents and the listing of everyone on various databases.
And most of the people driving it forwards seem to sincerely believe that it will make the country a better place to live.

[Alon Levy]

Guthrie, Britain has two and a half viable parties. Singapore has one. Britain has at least one powerful office independent of the central government, the Mayor of London. Singapore has none. Britain allows people to publicly air the grievances they have against the government. Singapore uses legal tricks to ban them: for example, a few years ago somebody in Singapore made a movie much like the Wire, realistically depicting housing projects controlled by criminal gangs; the government banned it on the grounds that it was in Hokkien, rather than the official Mandarin.

[MostlyAPragmatist]

I'm curious whether the Keynesian fiscal stimulus naysayers (cf. Tyler Cowen, Greg Mankiw, Arnold Kling, et. al.) have falsifiable opinions about the effectiveness of fiscal stimulus. For any complex historical science (like macroeconomics) isn't it possible to find an explanation of events that reinforces your biases/notions? In such a field, it takes a lot of experience, knowledge, and expertise to know whether you are basing your opinions on the data or whether you are interpreting the data to support your opinions.