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Paul Krugman isn't happy about how economists handled the financial crisis.
Just catching up with this. It's the text of Paul Krugman's speech upon receiving some honorary degrees in Spain. It's well worth a full read. There's some wonky econo-speak, but Krugman's labors as a New York Times op-ed columnist have enabled him to convey some complex ideas with admirable clarity.
Quick summary: the economists failed when the financial crisis hit. When the economy isn't in crisis, economists are basically useless. But when it all goes to hell, they're urgently needed and must to be ready to offer the best possible advice.
Krugman thinks he and his fellow economists blew it, mainly because they descended into ideological and intellectual squabbling after the initial, successful response to the crisis was mustered.
He starts by blaming himself. This small portion of the speech, to me, explains a lot about how even a public intellectual/academic economist like Krugman could be blindsided:
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US Treasury Secretary Timothy Geithner
Treasury Secretary Tim Geithner has an op-ed in the Wall Street Journal today in which he makes the case for financial reform based on a "It's déjà vu all over again" argument. We had "financial crisis amnesia" when the financial crisis struck in 2008 — and in 2012, we the amnesia has returned.
But Geithner has his own form of amnesia. Specifically, he's forgotten his role in bringing the financial crisis about in the first place. Here's an excerpt:
Regulators did not have the authority they needed to oversee and impose prudent limits on overall risk and leverage on large nonbank financial institutions. And they had no authority to put these firms, or bank holding companies, through a managed bankruptcy that wound them down in an orderly way or to otherwise adequately contain the damage caused by their failure. The safeguards on banks were much tougher than those applied to any other part of the financial system, but even those provisions were not conservative enough.A large shadow banking system had developed without meaningful regulation, using trillions of dollars in short-term debt to fund inherently risky financial activity. The derivatives markets grew to more than $600 trillion, with little transparency or oversight. Household debt rose to an alarming 130% of income, with a huge portion of those loans originated with little to no supervision and poor consumer protections.
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NEW YORK, NY - APRIL 21: Pedestrians cross the street by the Morgan Stanley building in Times Square April 21, 2011 in New York City. Morgan Stanley profits fell 48 percent In the first quarter of 2011. (Photo by Ramin Talaie/Getty Images)
How do you think it would feel to be cut not one, not two, but three levels on your credit score? All at once?
If you answered, "Not too good!" then you're in the same boat as Morgan Stanley, one of the last two big independent U.S. investment banks (the other one is Goldman Sachs, and neither are as proud as they once were, after converting themselves to bank holding companies during the financial crisis so that they could get more money from the government). Moody's, one of the three main rating agencies, has said that it may knock Morgan down three notches. It may take other banks, such as Goldman, down two.
The potential downgrades, which may raise borrowing costs and force banks to increase collateral, put the ratings company at odds with bond investors, who are sticking with bets that new capital rules and trading limits will make the financial firms safer in the long run. Funding costs have climbed for banks worldwide as Greece’s debt woes roil markets.
“In the next two years, these big banks will be less robust than they used to be, that’s for sure,” Jim Antos, a Hong Kong-based financial analyst at Mizuho Securities Co., said by telephone. “For any bank that has to raise capital today, it’s already very difficult. This makes it just that much more expensive and difficult.”
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A recent ProPublica/NPR report on Freddie May refusing to refinance mortgages for struggling homeowners shows that the market is still coming to terms with new ways of measuring risk.
There's a battle looming between Congress and the Federal Housing Finance Agency, the entity that's been responsible for mortgage giants Freddie Mac and Fannie Mae since the two were taken over by the government during the financial crisis. California and New York are also in the fray, given that those states' attorneys general have been resisting a mortgage settlement with big banks. But that resistance may be collapsing, now that principal writedowns are on the table. Meanwhile, the FHFA remains opposed to writedowns.
So what would principal writedowns entail? Well, the problem many homeowners are up against is that they owe more than their homes are worth. If they paid $300,000, with a 10 percent downpayment, the principal is $270,000. That's what they financed through the mortgage at whatever interest rate they were able to obtain. The monthly expense is made up of a payment that applies to the principal, the interest, and in may cases, insurance and property taxes. (And my example is boilerplate — in some regions, much higher loans, so-called "jumbo loans," make the situation more difficult.)
Leave it to a designer educated in California to create what might be the best explanation of the Wall Street financial crisis. Jonathan Jarvis graduated from Art Center College of Design in 2009 and got hired by Google. He was recently asked back to the prestigious art and design school — perhaps best known for schooling car designers — to elaborate on his experiences at Art Center and beyond and accept an award, but also to talk about "The Crisis of Credit Visualized."
It's a superb piece of information delivery. If you want to understand why everything went horribly, horribly wrong in 2008, just watch it (the entire animation lasts about 11 minutes — a miracle of concision). What's truly impressive is that Jarvis says that he knew nothing about finance before undertaking the project.