September 6, 2019

NOT WHETHER, BUT HOW:

Lest We Forget: 2008 financial crisis, Ben Bernanke, Hank Paulson, Tim Geithner (ALEX J. POLLOCK, 9/06/19, Law & Liberty)

Here is the authors' confession: "Even in the months leading up to it, we didn't foresee how the scenario would unfold"--how it would "unravel" would be a better term. This was not for lack of effort. "All three of us established new risk committees and task forces within our institutions before the crisis to try to focus attention on systemic threats. . . calling for more robust risk management and humility about tail risks." But "none of us recognized how they were about to spiral out of control. For all our crisis experience, we failed to anticipate the worst crisis of our lifetimes."

This experience leads the authors to a reasonable conclusion: such a lack of foresight is likely to repeat itself in the future. "For us," they muse, "the crisis still feels like yesterday," but "markets have short memories, and as history has demonstrated, long periods of confidence and stability can"--I would say almost certainly do--"produce overconfidence and instability." So "we remain worried about the next fire." This is perfectly sensible, although the book's overuse of the "fire" metaphor becomes tiresome.

Failed foresight and future financial crises and panics are possible or probable. With that expectation and their searing experiences, the authors believe that it is essential to maintain the government's crisis authorities and bailout powers. This includes the ability to invest equity into the financial system when it would otherwise go broke, and they deplore the Dodd-Frank Act's having curtailed these powers.

To correct this, "Washington needs to muster the courage to restock the emergency arsenal with the tools which helped end the crisis of 2008--the authority for crisis managers to inject capital into banks, buy their assets, and especially to guarantee their liabilities." This would hardly be politically popular with either party now, because it would be seen as favoring bailouts of big banks. It would increase moral hazard, but would also reflect the reality that government officials will intervene in future financial crises, just as in past ones. 

No one could have forseen the degree to which quants and the institutions they worked for were fraudulently disguising higher risk debt in supposedly lower risk instruments.  But when it came time to put equity back into the banks, they should have done so by using the cash to retire debt of the citizenry.

Posted by at September 6, 2019 7:03 AM

  

« SOVEREIGNTY IS SOVEREIGN: | Main | AT LEAST LET HIM KEEP THE KNEE PADS: »