Smith
Faculty Opinion Article
The 30
Seconds Outlook
September 15, 2009
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“[T]he malady of commercial crisis is not, in essence, a
matter of the purse but of the mind.”
|
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— John Mills, in a paper to
the Manchester Statistical
Society, 1867 |
The ongoing financial and
economic crisis that followed the
crash of the housing market bubble
revealed numerous serious problems
with financial institutions and
markets, behavioral biases, economic
theory, financial regulation, and
politics. Several selected “Lessons
Learned” from the crisis follow:
1.
Regulatory ease and Congressional
pressure to promote low-income home
ownership provided unintended
consequences when mixed with
politics and money, especially in
the House Finance Committee. This
“push” began in the Clinton
Administration and ended as the
irrational housing market bubble
topped out and began its fall.
2.
Individuals bought homes with
mortgages they could not afford
based on their implicit assumption,
made explicit by realtors and
mortgage originators, that “forever”
increasing home prices will bail
them out. The purchasers exhibited
the psychological propensity to
overemphasize recent experience in
extrapolating it into the future.
The housing collapse again reminded
us that markets are not always
priced rationally (for example,
Nasdaq 100X earnings in 2000), but
can be driven by greed, blinders on
risk, behavioral biases, ignorance,
and government.
3. The
failure of the Fed to “take the air
out of bubbles” more recently has
included the dot-coms (Greenspan)
and the housing market (Greenspan
and Bernanke), and is based on
tradition that goes back to the
Great Depression. The Fed’s stated
job is to control the money supply
to raise interest rates when
inflation threatens. It is not the
Fed’s job to “pop bubbles,” but
rather to ease the economic damage
created when they always ultimately
crash. Unfortunately, this has
resulted in “serial bubbles” of
increasing severity.
4. The
housing market bubble was enlarged
and prolonged by the practices of
bank and non-bank financial
institutions and bonus crazed money
managers. Excessive leverage
(capital ratios) and trade in lower
quality securities were used to
boost returns aimed at beating
benchmarks and profit targets—Black
Swans were no where to be found, or
thought of. The result was a huge
increase in the systemic risk of
financial institutions and
markets—opaque securities including
derivatives, off-balance sheet
vehicles, invalid normal
distribution risk measures, greed
and over consumption, bonus frenzy,
risky “originate and distribute”
mortgage-backed securities, default
swaps, invalid credit ratings, and
more. These behaviors and practices
were facilitated by inadequate and
incompetent regulatory supervision
and too loose laws and regulations.
John A. Haslem
