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Smith
Faculty Opinion Article
The 30
Seconds Outlook
January 15, 2009
“We have
involved ourselves in a colossal
muddle, having blundered in the
control of a delicate machine, the
working of which we do not
understand.” -- John M. Keynes,
at the onset of the Great
Depression.
Keynesian economics is getting a
re-run in our current crisis, but so
far it has not “saved the day.”
Concerning what was learned from the
Great Depression, but not applied
during the years leading up to the
current crisis, Professor Krugman
states it best:“. . . [T]he basic
principle should be clear: anything
that has to be rescued during a
financial crisis, because it plays
an essential role in the financial
mechanism, should be regulated when
there isn’t a crisis so that it
doesn’t take excessive risks.”
There are numerous examples of
huge mistakes leading up to the
current financial crisis. Four such
major errors are: (1) Repeal of the
Glass-Steagall Act that allowed
banks to enter the investment
banking business (“shadow banking
system”) and take on additional
unregulated risks, including more
risky bank “off balance sheet”
operations. (2) The “irrational
exuberance” of the implicit general
belief that housing prices would
continue to rise, which led to
sub-prime mortgages, and, then,
housing prices declined and continue
to do so. (3) Sub-prime mortgages
were created by loan originators and
sold to financial institutions that
“sliced and diced” them into
“collateralized debt obligations,”
which were sold to investors. (4)
The Fed’s failure to raise interest
rates and stem the prior “stock
bubble” was repeated by failing to
stem the “housing bubble,” which
eventually broke with the sharp fall
in housing prices.
John A. Haslem
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