View Single Post
Old 04-07-2010, 07:13 PM   #92
Phone Booth
Join Date: Aug 2006
Posts: 3,350
Re: Have the Corporations Won?

Originally Posted by Foks View Post
So the economic collapse was the result of 'inefficiencies' in general, and not the gaping regulatory holes in the financial industry that banking industry lobbyists had laid the groundwork for since the 1980s (ie removing caps on leveraged derivative gambling, dissovling glass-steagal = too big to fail, etc)? An FBI report noted that 80% of the financial crisis was due to predatory structuring and loaning practices atleast. I'd say they have had a rather large hand in ruining the country, whether special interest theory notes this or not.
The particular way in which the economic crisis played out has a lot to do with regulatory holes, lending practices, etc, but I don't think the economic crisis as a whole has much to do with these things. The following a bit off-topic (and I'll keep it quite brief) but a lot of the details you mention are US-specific, but the housing bubble was a worldwide phenomenon. The great arbitrager linking these housing markets of various countries together is the market for long-term investments. Not coincidentally, long-term interest rate and long-term expected rate of return on capital remained low. This is, of course, a situation Bernanke called the global savings glut. Except it wasn't that the world was saving too much relative to the past and the uncertainties of the present. Instead, low long-term interest rates were caused by the lack of demand for savings. This lack of demand for capital is, of course explained by the lack of investment opportunities.

I was working backwards above but the whole crisis makes perfect sense if you start with lack of high ROE investment opportunities in the world as a whole, with local markets struggling to incorporate this information appropriately. To institutional investors, ranging from pension funds to insurance companies, fixed income investments appear disproportionately attractive in this environment, driving long-term interest rates low. Consequently, mortgage rates drop, making equity investment in housing attractive for homeowners. Even in the absence of a well-functional mortgage market (common in other countries that also had a significant housing boom) equity investment in housing appears to have the characteristics of a fixed-income investment, which again appears attractive in the absence of high ROE investments elsewhere. All of this boosts housing prices significantly above cost, which creates apparent arbitrage opportunities for the homebuilding industry and related industries (mortgage, finance, materials, machinery, etc). This temporarily cushions the blow to the economy of not having high ROE investment opportunities, by becoming the high ROE investment opportunity itself. But since the demand for housing is driven by miscalculation to start with (lower long-term interest rates driven by lower expected economic growth should not lead to an increase in real estate prices, except to the extent that the underlying real estate itself represents a bottleneck to growth), those high ROE investment opportunities turn out to have been illusory and cause significant losses for whoever in the supply chain is stuck with the excess inventory. The growth in supply of housing uncovers the illusion and the resulting price volatility causes a credit crisis and a severe economic downturn, as the economy faces both the temporary shock of price volatility and the long term shock of lack of high ROE investment opportunities.

And what explains the lack of high ROE investment opportunities in the first place? There are many places to look, but the biggest is the supply bottleneck in energy. While the growth in information technology has been impressive, as is the consequent potential for increase in productivity, none of this can increase return on capital against the backdrop of energy supply bottleneck. This is hard to explain, though my posts in the following thread effectively discuss the logic behind why energy scarcity will lead to low long term interest rates and low growth, not high energy prices:

I haven't read a whole lot in terms of explanations of the credit crisis in the past year or so, and it's possible many more people have gravitated towards this explanation since I last considered it, but the reason for it not being more prominent is that it's narratively unattractive. It doesn't offer solutions, villains or morals. As the spectacle of the right wing in this country trying to blame the crisis on some obscure regulation like CRA without any understanding of the mortgage market shows, most people, when they are faced with a phenomenon that's too complicated for them to understand, has a profound impact on their lives, yet is something they have little control over, they resort to emotionally comfortable rhetoric that serves to reinforce their existing biases. They face no incentives to understand - whether they are right or wrong doesn't mater. So they will simply blame whatever aspects of reality that they already dislike. This could be the state, big corporations, Republicans, Democrats, Congress, dumb people, white people, black people, foreigners, atheists, immigrants, the neighborhood bully, fathers, rappers, video games, movies, pornography, whatever. The causal complexity of society-wide problems is such that you can plausibly blame anybody for them. Practically everyone engages in this sort of victimhood from time to time.

I'd explain how this victim mentality is related to the basic cognitive mechanisms for learning, but I may have lost all readers by now.

Last edited by Phone Booth; 04-07-2010 at 07:30 PM.
Phone Booth is offline