Don’t blame interest rate policy?



Dave is a part-time blogger that writes about whatever suits him at the time.

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9 Responses

  1. Avatar Art Deco says:

    we should not ignore the fact that interest rates did play a role in setting the wheels in motion.

    Yes we should. Your correspondent lists ten factors of which this is just one. I light a cigarette and drop the smoldering match in a puddle of water, no problem. If Joseph Cassano and Franklin Raines drain the puddle while I am distracted and replace the contents with denatured alcohol, problem.

    The notion that monetary policy has been to blame is quite attractive to economists (e.g. S.H. Hanke) promoting their pet projects (in his case, replacement of discretionary monetary policy with a currency board).Report

  2. Avatar Dave says:

    Art Deco,

    The notion that monetary policy has been to blame is quite attractive to economists (e.g. S.H. Hanke) promoting their pet projects (in his case, replacement of discretionary monetary policy with a currency board).

    If, for example, Austrian Business Cycle Theory is true, the personal agenda of those making that argument is meaningless IMO if ABCT is solid on its merits (which I think it is).

    Ritholtz’s list does not apply to your analogy. Consider it a sequence of events where one triggers the next, and I think he is dead on right when he describes how interest rate policy influenced the behavior of yield-seeking bond investors, which led us to Wall Street, the ratings agency, soaring securitization volumes, etc. I think the roadmap is pretty clear but if you have an alternative, I’m all ears.

    No one is saying that it is the sole cause and I would agree if someone told me that monetary policy had little influence at the height of the bubble for the reasons I explained above.Report

    • Avatar Art Deco in reply to Dave says:

      I would not doubt that Dr. Hanke adheres to his theories quite sincerely; I read his column on occasion and was, once upon a time, a student of his. That does not mean that he or Dr. Krugman or whomever else does not look at the world with distorting lenses. Others are emphasizing public subventions to home ownership, the community re-investment act, regulatory failure, and what not. His is a far more informed assessment than, say, Steven Sailer’s (who gives his readers a rerun of his ‘race realist’ act).

      Personally, I am not familiar with Austrian theories. He did not used to teach them. As I understand it, they are not presented in models akin to those other economic theories are.

      As is, I cannot see any sort of deterministic relationship between one step and another in Ritholtz sequence, which is to say of how nos. 2, 3, 5, 7, and 8 were a function of the Federal Funds rate.

      I am not a sophisticate in these matters. I cannot help noticing that in real terms, the Federal Funds rate was abnormally low during 2002-04, not later. These rates were not unprecedented. The real rates prevailing in 1975-76 were even lower but were not succeeded by an asset bubble or banking crisis. Monetary policy during the years running from 1966 to 1980 was much more unstable and expansionary that was the case during the years running from 2001 to 2007. The only Depression we were facing was in Paul Erdman’s imagination.Report

      • Avatar HTNarea in reply to Art Deco says:

        Dear Art Deco,

        I am Paul Erdman’s son-in-law and of course a great reader of his financial fiction (‘fi-fi’ as he called it). As we’ve lived the past year and more of our financial upheaval, I too have been made to often think of his plot lines where the worst (economically speaking) happens or is just barely averted. In fact at a gathering last year (not inappropriately enough at the world headquarters of JPMorgan Chase, the single largest player in derivatives), I asked a senior official (the number two to be exact) of the Federal Reserve if indeed the government had been trying to write their own version of a Paul Erdman novel by allowing Lehamn to fail that late Sunday night. The official chuckled as did others on the auspicious panel, after which he responded that there just weren’t enough assets to lend against in the case of Lehman. As I looked in from the outside that fateful weekend in September ’08 as the government played a game of chicken with the market, I didn’t seem to think there was much behind all the other institutions that were leaning against the ropes either.

        Paul Erdman was born in 1932 — missing the actual crash of 29, and passed away April 2007 — before the whispers of liquidity started in late August 2007, the Bear Sterns firesale in March ’08 and the full force of the Great Disruption thereafter. He lived his life fully between two events the nature of which in fiction shaped his successful literary career. Nonetheless, from a perch elsewhere, I’m sure he had some interesting discussions with the likes of Joseph Schumpeter.Report

        • Avatar Art Deco in reply to HTNarea says:

          If I understood the news reports at the time, Lehman Brothers retained at the time of its failure a positive net worth and was sitting on a huge wad of cash. One financial columnist looking through the rubble estimated that its creditors would have to take haircuts of 10% to 23%. I cannot figure what the ‘not enough assets to lend against’ remark means; I do recall that Henry Paulson et al offered ever evolving and inconsistent explanations of what they did do and did not do. Given what happened in the succeeding weeks, it appears that what happened was a panic induced by anxieties over the credit default swaps on Lehman bonds and by the implosion of two money market funds which had invested in Lehman paper.Report

          • Avatar HTNarea in reply to Art Deco says:

            I’m certain everything you write is correct – it certainly leans more to the facts than anything that those at the financial helm in DC or down at the NYFed were saying at the time and afterwards. The NYFed was playing chicken with the market. I recall watching as they announced that weekend a special 2-hour trading session for the derivatives dealers so they could untangle that big ole bowl of pasta — and then, to my dismay, they announced an additional 2 hour extension. Somehow Mr. Geitner, who had spent the major part of his tenure at the NY Fed crying about derivatives exposures to no effect, now had convinced himself that a 4-hour extraordinary trading session would fix that mess. They lost the bet and we all ended up with a useless bowl of overcooked pasta. No one was more shocked by the outcome of this than Paulson — his ‘deer-in-the-headlights’ stare to the TV cameras in the ensuing days said it all.

            Having witnessed and survived several economic crises in Emerging Markets, it occurred to me that in those early emergency days we could have used an ex-Latin finance minister who had seen these type of wars before. Unfortunately, our government folks at the helm were absolutely convinced that Paul Erdman’s plots were only existed in fiction. They think differently now I’m sure. And though they would never admit to it, I’m sure in hindsight they would find each and every way to save Lehman. Maybe Mr. Geitner will deliver a memoire mea culpa in a few decades…if the book deal is sweet enough.Report

            • Avatar Art Deco in reply to HTNarea says:

              I cannot help noticing that Drexel, Burnham, Lambert went bankrupt in 1990 without the world falling apart, and that (per the former chairman of the FDIC) not one of the ten largest banks in this country would have been deemed solvent in 1982 had mark-to-market accounting been in effect at that time (due to non-performing loans to foreign governments). It seems that changes in institutional arrangements and practices (e.g. credit default swaps, the disaggregation of mortgage lending, securitization of receivables, the return of universal banking, unrestricted consolidation in deposits-and-loans banking, cross-border deposits-and-loans banking, and accounting rules which confound liquidity with solvency) are not working out for us.

              For my own part, I would hope that in the future they would devise institutional arrangements which would allow firms like Lehman to be rolled up rapidly with little collateral damage. We have the FDIC for deposits-and-loans institutions. Might it be possible to devise a receivership agency which could do the same for institutions with “a complicated trading book”?Report

              • Avatar HTNarea in reply to Art Deco says:

                Agreed — all you write is completely sensible and shouldn’t be hard to execute. I did say ‘shouldn’t be’. The problem, Art Deco, it seems to me is that humans will be human. Greed has a way of taking over and sooner or later a loophole is found that while at first is only the size of a pinhead is very soon opened to fit an entire market stampede, on four hooves screaming “moo!”. While that creates great opportunity for creative minds to write best-selling plot lines, it also presents a challenge for lowly-paid government regulators, who may often have the thought of crossing over to the promised land of the private sector in the back of their minds. How much can they bite the hand that may eventually feed them? Not too much, I would estimate. Think teacup Poodle, not Doberman.Report