The question arises: Why did the Great Recession happen?  My answer is poleconomic i.e., that it was due to an interplay of political and economic factors in which those who were supposed to monitor such things as the rate of saving, the elasticity of the international monetary and financial system and the build-up of credit i.e., the formation of a credit bubble did not do their jobs (Borio & Disyatat 2011).  Alan Greenspan was driven by his Libertarian leanings and those ideological blinders make him the number one culprit in the slide into the Great Recession.

     Greenspan and other far-right-thinking economists, partly because of their traditional upbringing in the field of economies and partly because of their political leanings, failed to notice the relationship between the financial markets and the rest of the economy.  They did not see that, collectively, the financial markets were a runaway train (Dittmer 2011h).  They wrongly assumed that an equilibrium model applied to financial markets.  They thought things were moving along swimmingly.  It wasn’t.  When the crisis leading up the Great Recession began to surface these theorists, rather unsurprisingly, struggled to come up with an explanation that did not include their complicity in its creation. 

     Bernanke and others came up with the “savings glut theory.”  This states that savings by Asian and Middle Eastern countries had washed like a tsunami onto financial markets in the USA, thereby forcing U.S. money managers to make imprudent investments in the course of their attempts to cope.  These “excess savings” were widely thought to have reduced long-term interest rates, thereby making credit cheaper (Dittmer 2011h).  Behind their thinking was a “natural markets” assumption i.e., that the market, even if it gets out of kilter a little bit, will self-correct and return to stability (Borio & Disyatat 2011:23).

     What really caused the crisis?  Short answer: fiddling by banksters.  Here’s what happened: bank executives artificially inflated the earning of their financial institutions in order to jack up their incomes in the short-term.  These activities pushed long-term interest rates down, making credit freely available, which further fed the rapidly expanding bubble.  The FED didn’t see a problem because inflation didn’t seem to be a problem and therefore it kept short-term interest rates low, again feeding the fire with gasoline. 

     I am less interested here in going into the gritty details than explaining the thinking behind the actions or inactions that led to the Great Recession.  Those details can be had in Borio & Disyatat (2011) and Dittmer (2011h), the latter being an interpretation of the former.  The problem on which I want to focus is what could be termed “econo-think” i.e., using economic theories or models to “think” about how the economy should be, when, in fact, it might not be responding to the models empirically or in the real world.  Such “econo-thinking” can easily be influenced by the ideological proclivities of the “econo-thinker.”  This was the case with Alan Greenspan, a self-proclaimed Libertarian, and his cohorts in the world of econometric theorizing.  They thought the waves would be regular and predictable and were, instead, hit with a tsunami sent by the gods of the real economy, one that was being fiddled by greedy men.  They weren’t interested in economic modeling.  They just wanted to inflate their corporate profits by any means in order to inflate their salaries, bonuses and attract more investment in their firms so they could continue their inflationary fiddling.  You see, an economic theory that ignores the potential effects of system manipulation ignores the real world of capitalism, probably not a good thing to do if you want to be predictive of where things are heading. 

     My poleconomic answer to why the Great Recession occurred is that government regulators are not doing their jobs sufficiently to curtail fiddling by crooks within the capitalist system and slowly, since the 1970s, Big Money influence has been eroding Congressional oversight of the financial system making get-me-rich schemes easier for the criminals of Wall Street. 

     Furthermore, right-wing economists in the FED don’t make matters better because they gloss over the real world of interactions between politicians and the Big Money moguls and the corrosive influence of wealth on the political system.  That influence has led to the deregulation of the financial system that began with Reagan and continues today under the watchful eye of Libertarian billionaires who are nudging the system this way and that in order to tie the hands of regulators and free them and their buddies up to ravage the wealth of the working class.  They better watch out they don’t kill the Golden Goose in the process.

 

BIBIOGRAPHY

Borio, Claudio & Piti Disyatat.  2011 (May).  Global imbalances and the financial crisis: Link or no link?  BIS Working Papers No 34.  Bank for International Settlements.

 

Dittmer, Andrew.  2011h (September 20).  The very Important and of course blacklisted BIS Paper about the crisis.  Naked Capitalism

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Comment by John McCreery on February 14, 2012 at 4:48pm

Nice post. The critical factor, as I see it, is the positive feedback loop that appears to confirm current theories during a bubble—until, of course, the bubble collapses. Then we are all like the turkey in Nassim Taleb's fable, the one that has 364 days of perfectly consistent data confirming that the farmer will turn up in the morning with feed for the turkey. Then, it's Thanksgiving, and the farmer turns up with an axe. 

The simple fact of the matter is that during a bubble whatever policymakers decide seems to lead to success. I recall an interview with a senior creative executive at the Japanese advertising agency where I used to work. He noted that during the bubble, strategy didn't matter. We were like air molecules in Brownian motion in a hot air balloon. As long as we just moved faster and faster, the balloon got bigger and bigger. Then, however, the balloon stopped getting bigger. Now, he said, strategy, deciding in which direction to move, had become very important. Then he, paused,  grinned and said, "That's the next generation's problem. I am so happy."

Cynical old bastard, but his thinking was spot on.

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