Sunday, September 21, 2008

who predicted the meltdown?

Have you heard this recently: "This is amazing, incredible, unpredictable, worse than we thought"

Marx said that capitalism was anarchy, that the boom-bust cycle was inevitable and that when it happened the economic experts would describe it as an unpredictable, like a natural disaster and too complicated to explain - not only before the event but also during the event. Marx was right? Who else was right?

Some of the liberal blogs I read, who I don't think predicted this crash, are trying to blame it all on Bush. But more rational commentators are saying that this crisis has been at least 20 years in the making, which included some Democrat regimes.

Unfortunately, economics is not my strong point. Who does get it?

Economic oversteering Mark Shuttleworth, saw it coming in January ("Historians may well lay the real blame for current distress at the door of Alan Greenspan, who pioneered the use of morphine to dull economic pain"). Who else? Point me to their warnings before the crash.


Doug Noon said...

Kevin Phillips (May 2008) "The interaction of reckless finance and failed politics may well be bringing about the great global crisis of American capitalism."

I saw him interviewed on Bill Moyers Journal last night. This was Moyers' introduction: "If you read only one book on the route to this financial meltdown, I recommend this one: BAD MONEY: RECKLESS FINANCE, FAILED POLITICS, AND THE GLOBAL CRISIS OF AMERICAN CAPITALISM. The author, Kevin Phillips, has a history of being way ahead of the curve. As a young man working for Richard Nixon, he wrote THE EMERGING REPUBLICAN MAJORITY, a book that uncannily predicted how the GOP would regain power in Washington. Kevin Phillips saw our current crisis coming a long time ago. And in one book of historical insight after another, laid out the clues he was tracking."

It was a good program.

Tom Hoffman said...

Democrats definitely have a share of culpability, but Clinton's fiscal policy was not liberal.

I would certainly give Krugman and Atrios credit for calling this, although one can quibble about how much specificity is necessary. Kunstler, certainly, although I'm not sure how many years in a row he was predicting it ;-)

Roubini gets a lot of credit for calling it.

Heck, here's a Daily Kos post from Dec. 2006 -


Tom Hoffman said...

Yes, and Kevin Phillips, too.

Anonymous said...

What's the problem with accepting that Marx was right? The property market fall and credit crunch can be viewed as symptoms of a systemic contradiction which would normally have precipitated a recession towards the end of the last century but was artificially postponed through speedy globalisation and expanded credit. As long as market systems prevail the cycle will repeat at various intervals.

Bill Kerr said...

It was meant to be a rhetorical question mark, Andy. Sorry for the ambiguity. I believe Marx was right.

Anonymous said...

The Ludwig von Mises Institute certainly has predicted the ongoing "correction"'s an inevitable consequence (though the timing can be hard to predict) of the monentary policy that has been followed. No Marxism required, just a correct capitalist analysis, not the ridiculous analysis by the pack of mercantilists and monetarists that call themselves capitalists.

Bill Kerr said...

hi Tom,

I've never studied Clinton's fiscal policy (my bad) but did notice how critical Kevin Phillips was of Bob Rubin, Clinton's economic adviser, in the interview that Doug pointed me too. At any rate, Kevin Phillips went to some pains not to let either Republicans or Democrats off the hook. Also, I notice that Bob Rubin is now an Obama adviser.

Bill Kerr said...

hi anonymous,

Thanks for the link to the Austrian school site. Very interesting material there.

Unfortunately, I don't know enough to argue the Marxist case vis a vis the Austrian School, so I have some work to do.

Thanks for the challenge

Tom Hoffman said...


I'm a "Bush Democrat." That is, too far to the left to put up with the Democrats until Bush demonstrated just how badly the Republicans can screw things up and drove me into the arms of the Democratic Party. But yes, the Democrats unfortunately are complicit.

FDominicus said...

I've been quite near

Just a bit later...


Anonymous said...

Suze Orman, a financial advisor who has a daily radio show, and weekly TV show on cable/satellite TV predicted that the real estate market was in a bubble, and was going to burst, about 3-4 years ago. She didn't say anything about how bad it was going to get though. I had some money in a real estate fund at the time, and when I heard her make that prediction I took my money out of it. She was pretty far ahead of the curve. The fund's value continued to go up for another few years.

Ms. Orman tried to steer people away from interest-only loans, which she predicted would get a lot of people into trouble, which they have. What she saw was people were getting interest-only loans because they couldn't afford a traditional mortgage. She knew that interest rates were rising and most people who got these loans wouldn't be able to pay them.

This situation seems similar to me, though more severe, to the dot com bust that happened in 2000. A similar dynamic was going on. Taking advantage of the market and market rules, investors on Wall Street repeated a process over and over again to enrich themselves and leave unwitting investors, driven by their own greed, holding the bag. Like this, it was a Ponzi scheme, where the early entrants who had the most money to begin with, made the most money. It's like they set bait, wait for people to go for it, and then grab the line hard. The trick is seeing the bait for what it is and not going for it. It's hard to resist, because "the word on the street" is that people are getting rich and "you're going to miss out" if you don't get in on it. The news media tends to play into this because it sells magazines, newspapers, and TV time.

From what I've heard this problem began partly out of an effort to help poor people, particularly minorities, buy houses. It was an idealistic program created at a time of easy money, during the 1990s. What exacerbated the problem was when the Fed lowered interest rates drastically in response to the recession of 2001 that was compounded by the 9/11 attacks. This increased the value of real estate, because it opened up the market to more people.

Like with the dot com mania, people saw an opportunity for easy money. I heard story after story of people buying houses, using a mortgage, keeping them for several months, and then reselling them at a profit of tens of thousands of dollars, without even doing anything to them. They could do this because the demand for real estate kept rising. People eventually got the idea in their heads that the market would keep going up. It would never fall (which is never true). It was the same sort of behavior investors displayed during the dot com bubble. Day traders would buy stocks, hold them for a few hours, wait for the price to go up, then they'd sell. They'd do this many times a day.

I think what caused many to lose their shirts was the people who bought houses as an investment kept doing it while the market was peaking. Once the joy ride was over they were left with houses that they couldn't sell for a profit, and they couldn't afford to pay for, since interest rates were rising, the value of their property was falling, and they had bought them using an adjustable rate mortgage or an interest-only loan.

A lot of people have simply abandoned their houses, because they've become "upside down" on their mortgages, paying more for the mortgage than the house is worth, due to its declining value.

Apparently what made this idealistic program possible was this whole idea of selling mortgages to investors, which ended up spreading the risk all over the economy. This created an atmosphere where some banks were no longer responsible for the loans they made. In fact they would love to make loans, because they could sell them at a profit, and they could totally offload the risk.

IMO we've got to stop doing this. Banks need to be financially accountable for the loans they make.

Anonymous said...

Re: Marx's predictions

Marx did predict things like we've seen. I think where he was wrong was, given an economic system with some regulation that prevents exhorbitant abuse, the market can correct itself. In other words it will go through cycles of growth and then decline, but it'll get back to growing again. The thing is, corporations are very capable of influencing government to its advantage. I've heard this is part of what caused the problem. There was a law put in place at the time of the Great Depression, which was weakened in the 1990s. The reason was banks felt they were at a disadvantage in the global economy, because regular banks and investment banks couldn't engage in joint activity. Foreign banks of both types could. It had a certain logic to it. The problem is it's part of what led to the current crisis. I heard about this deregulation years ago and it didn't make me very comfortable.

I haven't read all of Marx's work, but what I have read gives me the impression that he saw the "crash" as a permanent state: capitalism would be dead. This clearly is not what has happened historically.

There have been times where it's been necessary for the government to act as the "insurer of last resort" when there has been abuse. Such was the case this time. The finance experts I've heard from say we dodged a bullet because of it. We really could've faced a depression had the Fed and the government not acted.

Some have made the criticism that America is not really a free market economy, because we "privatize profits and socialize losses". In the small this is not true. In the large, it is. The difference is it's not done as a matter of policy. It's done, some say, to save the skins of political cronies. Others say it's done to be pragmatic, making the best of a bad situation.

I personally don't like it when the government feels compelled to step in and save our collective hides, because I believe that failing systems should be allowed to fail. At the same time, if it saves the life savings of people who had nothing to do with the abuse, then I grudgingly approve.

In some ways bad systems were allowed to fail, example Lehman Bros.

Allowing bad systems to fail gets the dead wood out of the economy, and allows people to face consequences and learn their hard lessons, which serves them later in life.

Bill Kerr said...

hi mark,

Thanks for your comments. One thing you wrote was:
"I haven't read all of Marx's work, but what I have read gives me the impression that he saw the "crash" as a permanent state: capitalism would be dead. This clearly is not what has happened historically."

I don't think that is what Marx said. This account seems reasonable to me. But really there are so many groups historically and now that call themselves Marxist - and most of them disagree with each other - probably almost any position, within reason, could be attributed to him.

To be honest I'm really in a bit of a dilemma between what I believe and what I can argue coherently because I simply don't know enough about the current economic crisis or political economy in general. But I do think this current dramatic moment is one where the veil has been torn away and we see the real workings of the system - government bailing out of Finance capital whilst people who struggle to make ends meet lose their homes; as you said, "privatize profits and socialize losses". Also the extent and depth of this crisis and that it has building for perhaps 25 years or longer. These lengthy time frames (75 years since the Great Depression - a lifetime) lead to complacency, a feeling that those in charge will muddle through. Then a crisis like this breaks out and you realise that things might be broken at a much more fundamental level.

The various groups that call themselves marxist tend to wave the flag and repeat formula, which may be true or partially true but you don't get the feeling they have done their own thinking.

At the moment I've found the Kevin Phillips interview and the Ludwig von Mises Institute website most interesting and valuable because they seem to be analysing the reality of the current crisis (and not from a marxist standpoint).

At any rate I've a received very helpful response to my question: "Who predicted the meltdown?" I guess I have to go and do some study now rather than talking about stuff I don't understand very well.

Anonymous said...

@Bill Kerr:

The stuff at the Ludwig von Mises Institute is interesting. It reminds me of some stuff I read about and studied when I was just out of college 15 years ago. I realized our monetary system was largely based on debt, which makes our country wholly dependent on the health of the banking system, for they are the source of most of the value in our currency. There was a book I started reading then, but didn't finish, called "Debt Virus", by Jacques Jaikaran. I don't think he argued for a return to the Gold Standard, but rather an alternative debt-free monetary policy that was based on a mathematical formula, which would govern how much currency should be flowing in the economy.

I've heard of Hayek, but only in relation to the "The Chicago Boys", a group of Chicago professors who bucked the prevailing Keynesian wisdom after the Great Depression and taught a different theory of economics, which, so the story goes, the U.S. has gradually adopted: liberated international trade, lowering subsidies, and lifting of price controls. Milton Friedman was one of the other "Chicago Boys", who became the most famous and admired here, and who was for supply side economics. I can't remember if Hayek supported that as well.

The criticism I've heard against Marxism is it's seductive in the sense that it presents a "nice and neat" case for why things are the way they are, and how things can be better under a Marxist system, when the reality is quite different. From what I've seen of it, I'd agree with that assessment. What I was saying is I think Marx's criticism of capitalism has some truth to it, but not the whole truth.

As for my comment about how we "privatize profits but socialize losses", I left out some things I remembered later. Several (non-investment) banks have been allowed to fail so far. One reason for this is we have the FDIC (Federal Deposit Insurance Corporation), which is a government entity that insures bank deposits up to a certain large amount. It was brought into existence after the Great Depression. This makes it easier to let banks fail, because even if customers have their deposits in those banks they are assured that their money will not "go down with the ship". They will get all of it back.

There's this idea in our government that's been around for years that some institutions are "too big to fail". In other words if they fail they will take the rest of the economy down with them, or severely damage it. This was the case, so I heard, with AIG. It is the primary insurer for all/nearly all capital intensive projects, and the value of many money market accounts is based on instruments that AIG holds. The reason Freddie and Fannie were bailed out, again so I heard, is they're the main reason mortgages have been as affordable as they have been, in terms of interest rates. I'm not sure why. The story is if it wasn't for them then mortgage rates would be a lot higher and would require more of a down payment, even if the restrictions on mortgages were more reasonable. Secondly, they've been quasi-government agencies for years.

From what I've heard, Bush refused to make government appointments to Freddie and Fannie, because he didn't want anyone in his administration associated with their practices, which he considered suspect early on. What I'm wondering is if he didn't like the way they were run why didn't he do something about it? I think he had some power to do that if he'd tried.

What's usually happened with government/Fed bailouts of banks or other financial institutions is they try to only bail them out enough to reduce the damage to the economy, not necessarily make the owners or investors whole. In fact many times the investors are the ones who feel the most pain, because they only get pennies on the dollar. They get the brunt of the loss. Often, though not always, the owners lose millions of billions of dollars, too, depending on the size of the loss.

I think the criticism has some validity, but it's not applicable in all circumstances. I think many times the people who are bailed out are in fact us. It just looks like the "fatcats" are the ones who benefit because the institution they created is still standing. And maybe another reason it has validity is that while the owners took a loss, it wasn't as complete as it would have been had the government just stepped back and let their institution fail.

The one thing I heard yesterday that is bothersome to me is apparently the executives at AIG played hardball with the public's money. They had opportunities for a few months to get private funding, but they held out for a government bailout instead, which tells me they anticipated that the bailout would benefit them in some way. Maybe it didn't work out the way they expected, because the government now owns some 80% of the company stock, and it'll expect a return on the loan AIG received from it. Further, many of the executives are expected to be replaced by government appointees. This is the reason people are saying we've effectively nationalized the company. Personally I don't like that, but perhaps it was a pragmatic move. It reflects a sense of "no confidence" from the government towards AIG, that it's so important that it can't be trusted in private hands.

John Dougan said...

I'm glad you liked the link to the Mises Institute. They are somewhat controversial, but their track record is good.

AIG wasn't really bailed out. I think it would be better to say that the govt grabbed control and will probably sell them off for parts to repay the loan (at 12% interest....I can do better borrowing from the Mafia). Paulson has appeared to go out of his way to keep AIG from becoming a ward of the state. He bought warrants on the stock instead of a straight purchase, he is charging high interest, and he kept his % control of AIG down to 79.9% probably because if it reaches 80% it has to go on the govt books. I actually feel a little sorry for the AIG execs...they probably thought they were dealing with just another govt bureaucrat who'd give them a nice bridge loan. Instead Paulson hoisted the Jolly Roger and reamed them out.

I'm not sure if Paulson intended this, but he appears to have set up a situation where the banks are not going to want to go rushing to the govt if there is the slightest chance that they can fix themselves. Paulson has, by turns, bailed out, let fall, and reamed out banks in trouble putting a great deal of uncertainty into the banker's little green hearts. If I was a bank exec I would think very hard before going to Paulson or Bernanke for help.

As near as I can tell, the Bush administration and McCain both separately at different times tried to do something about the lack of oversight with Freddie and Fannie. The attempts appear to have been torpedoed in committee. In these cases the names Chris Dodds and Barney Frank prominently appear. A listing of the FNMA etc. campaign contributions
is also informative. It also appears there was recent behind the scenes concern at the situation, though that was almost certainly too little too late.

John Dougan said...

A highly abbreviated thumbnail Austrian description of the situation:

Anonymous said...

More information is coming out about what caused the mess. I found this blog post today that links to an editorial and an old news article. It corrects somewhat what I said earlier. A law was created in the late 1970s in the Carter Admin. that was designed to help poor people get home loans. It also allowed lawyers to sue banks for "discriminating" against poor folks who wanted loans.

This law was put on steroids in 1995, during the Clinton Admin. (apparently with the help of a Republican congress), lowering the standards that banks had to meet to make these loans. Most of the rest has already been explained. An additional detail I learned on CNBC is that in 2004 the SEC gave waivers to several of the investment banks that recently failed, allowing them to increase the leverage (debt) they could have against their assets.

The post reveals that Pres. Bush tried in 2003 to take measures to stop this problem before it became a crisis, but they were blocked by the Democrats in congress, in the name of poor people.

This is the worst case of good intentions paving the road to hell. Poor people are being forced out of their homes in droves via. foreclosure, and now they're not only poor, they've destroyed whatever credit ratings they had to boot. Hope is a nice thing, but it's best not to give people false hope. It only sets them back.

The blog post contrasts these facts with what Obama has been saying, that the whole thing is the Bush Admin.'s fault, with its "failed policies". From what I've been hearing, the Bush Admin. contributed to the problem, but they were not part of really pushing it to its extreme.

The only thing I'd blame Bush for is while he tried to put a stop to this before it became a crisis, he didn't press hard enough. When he ran into resistance from the Democrats he folded. That's not good leadership. At the same time I can kind of sympathize. If he had tried harder, Bush would've been tarred and feathered the same way he's been with the Iraq war. Since he would've averted a non-obvious crisis before it happened, the Democrats would've found a big opening to demonize him as someone who was doing it for no other reason than he was racist and against the poor. He had bad timing, and maybe a bad "political ear". He tried to put a stop to the abuse a year before the presidential election. He probably figured pressing for it with Democratic resistance might defeat him.

There's a good video here that tells the same story as the blog post, but with more details. It's pro-McCain, but it goes through a lot of good information pretty quickly (you'll have to pause it to really take it in). What it reveals is that some of the same people who were part of causing this problem are now in charge of trying to fix it. Not very reassuring, but they're part of the mix right now, so they have to be part of the solution.

It also makes a compelling case that Obama is very much "in bed" with the same people who caused the problem, and profited from it.

I can hope that these bastards get voted out of office, but I won't be holding my breath. In fact after the first presidential debate, Obama's poll numbers have gone up.

Anonymous said...

Ron Paul in 2003...

Bill Kerr said...

I read the 2003 ron paul article: fannie and freddie - it does accurately envisage what has now developed - thanks anonymous

Anonymous said...

Very welcome. Many, like Paul, who are students of Austrian Economics have been predicting this disaster. And they are very strong in their opposition to this bailout. Paul explains what happened here...
... and says why he opposes the bailout. Another who opposes this is Harvard's Jeffrey Miron...