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Boys in the 'hood learn very bad habits
June 12, 2009, Friday
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EDITOR'S note: This is the first of three articles about the causes of the global financial crisis. Stuart P.M. Mackintosh is executive director of the Group of Thirty. Allan H. Meltzer is a professor of political economy at Carnegie Mellon University. They addressed a global video conference hosted by the US Consulate General on May 14.
Q: What's the cause of the crisis?
MACKINTOSH: I think that one way of imagining that is we live in a global neighborhood.
Let's say we live in a street, and it's called Global Lane, and the largest house on that street is a McMansion, and it's owned by an American couple who are mostly concerned with foreign affairs, and so they take a laissez-faire attitude to supervising their many, many children.
They also allow those children to handle their own allowances. Soon enough, the older children start becoming tear-aways - Citi(group), Lehman, Bear, AIG.
They gamble up a storm, they max out their credit cards and invite all the other children in the street around to party.
And meanwhile, little Hedge Fund and his pals Madoff and Sanford are running around the street ripping off the rest of the children in the street.
If we think about looking down the street a little bit further, next door we have a British couple who take a principal's approach to supervising their children.
They are also pretty wealthy, but their children are as thick as thieves with the American kids. So soon, Northern Rock, HBOS and RBS are learning all the wrong lessons from their American friends.
If we look a little bit further afield, we can see a different approach from, let's say Hong Kong, where the parents there take a much more structured approach to the supervision of their children's upbringing, and they have a lot of timeouts and they also require the children to keep their allowances - you never know when you might need them.
Finally we have some Australians who are living in the street and they take a Twin Peaks approach to the supervising of their children. Again, they are a bit more conservative, but they too are influenced by what's happening in the McMansion up the street.
Finally, Barack is brought on board to, in essence, reestablish some rules - some parental supervision rules for the street, for the whole neighborhood - and indeed he then turns to his grandfather figure, Paul Volcker, to step in and actually establish some new rules for the entire global neighborhood.
And that's how I think of it. I think of the drive to re-establish a form of stricter parental supervision, as it were, financial supervision for the global neighborhood.
MELTZER: I've written an epilogue to my book that describes what I think of as the seven principle causes. I'm going to talk about two of them, which are the most important.
The first was that Congress and the administration, several administrations, can't do enough for housing.
So after starting with - in the 1930s, Fannie Mae and later Freddie Mac, they allowed them to expand in terrible ways. I mean, the FHA, the Federal Housing Administration, allowed no-down-payment loans.
And then they allowed no-credit-scoring loans. And so they built up an enormous amount of risk.
And (there's) the second big problem, which is that for 30 years we've had "too big to fail" in the American banking system. And if a bank is too big to fail, in my opinion, it's too big.
It's too big because the benefits that we get from economies of scale and economies of scope don't nearly compensate for the losses that we take now.
So those two things together brought us the bulk of this crisis.
Banks didn't believe they were going to be allowed to fail, and after Bear Stearns, one of the big financial houses, failed, and was bailed out, they, many of the bankers, wrote and talked about how the worst was over, because the Federal Reserve and the Treasury had bailed out the losers.
Then the government did something that it had not done to any degree for 30 years. It allowed - without any warning - Lehman Brothers to fail.
That was a shock to the market, and as I tell my students, if I had been running a big portfolio, I would have run for cash too. Because you didn't know what they were going to do next. They had changed all the rules.
Now, I don't like those rules. I think we have to get rid of "too big to fail." But the way to do it is not suddenly to spring it on people in the midst of a downturn. And that created chaos.
We're just beginning to come out of that chaos now. And in reforming the banking system, we have to get rid of "too big to fail."
Otherwise, we'll have another crisis as bad as this because "too big to fail" encourages banks to believe that they make the profits and the taxpayers take the losses, and that's not a system that's viable or one that we should have.
The other thing that we need to do is get rid of Fannie Mae and Freddie Mac. What they do is subsidize home mortgages. And it's a principle of democratic government that those subsidies should be on the budget, not something hidden away in financial institutions that people don't understand.
And that encourages corruption, as it did; it encourages favoritism.
Q: What's the cause of the crisis?
MACKINTOSH: I think that one way of imagining that is we live in a global neighborhood.
Let's say we live in a street, and it's called Global Lane, and the largest house on that street is a McMansion, and it's owned by an American couple who are mostly concerned with foreign affairs, and so they take a laissez-faire attitude to supervising their many, many children.
They also allow those children to handle their own allowances. Soon enough, the older children start becoming tear-aways - Citi(group), Lehman, Bear, AIG.
They gamble up a storm, they max out their credit cards and invite all the other children in the street around to party.
And meanwhile, little Hedge Fund and his pals Madoff and Sanford are running around the street ripping off the rest of the children in the street.
If we think about looking down the street a little bit further, next door we have a British couple who take a principal's approach to supervising their children.
They are also pretty wealthy, but their children are as thick as thieves with the American kids. So soon, Northern Rock, HBOS and RBS are learning all the wrong lessons from their American friends.
If we look a little bit further afield, we can see a different approach from, let's say Hong Kong, where the parents there take a much more structured approach to the supervision of their children's upbringing, and they have a lot of timeouts and they also require the children to keep their allowances - you never know when you might need them.
Finally we have some Australians who are living in the street and they take a Twin Peaks approach to the supervising of their children. Again, they are a bit more conservative, but they too are influenced by what's happening in the McMansion up the street.
Finally, Barack is brought on board to, in essence, reestablish some rules - some parental supervision rules for the street, for the whole neighborhood - and indeed he then turns to his grandfather figure, Paul Volcker, to step in and actually establish some new rules for the entire global neighborhood.
And that's how I think of it. I think of the drive to re-establish a form of stricter parental supervision, as it were, financial supervision for the global neighborhood.
MELTZER: I've written an epilogue to my book that describes what I think of as the seven principle causes. I'm going to talk about two of them, which are the most important.
The first was that Congress and the administration, several administrations, can't do enough for housing.
So after starting with - in the 1930s, Fannie Mae and later Freddie Mac, they allowed them to expand in terrible ways. I mean, the FHA, the Federal Housing Administration, allowed no-down-payment loans.
And then they allowed no-credit-scoring loans. And so they built up an enormous amount of risk.
And (there's) the second big problem, which is that for 30 years we've had "too big to fail" in the American banking system. And if a bank is too big to fail, in my opinion, it's too big.
It's too big because the benefits that we get from economies of scale and economies of scope don't nearly compensate for the losses that we take now.
So those two things together brought us the bulk of this crisis.
Banks didn't believe they were going to be allowed to fail, and after Bear Stearns, one of the big financial houses, failed, and was bailed out, they, many of the bankers, wrote and talked about how the worst was over, because the Federal Reserve and the Treasury had bailed out the losers.
Then the government did something that it had not done to any degree for 30 years. It allowed - without any warning - Lehman Brothers to fail.
That was a shock to the market, and as I tell my students, if I had been running a big portfolio, I would have run for cash too. Because you didn't know what they were going to do next. They had changed all the rules.
Now, I don't like those rules. I think we have to get rid of "too big to fail." But the way to do it is not suddenly to spring it on people in the midst of a downturn. And that created chaos.
We're just beginning to come out of that chaos now. And in reforming the banking system, we have to get rid of "too big to fail."
Otherwise, we'll have another crisis as bad as this because "too big to fail" encourages banks to believe that they make the profits and the taxpayers take the losses, and that's not a system that's viable or one that we should have.
The other thing that we need to do is get rid of Fannie Mae and Freddie Mac. What they do is subsidize home mortgages. And it's a principle of democratic government that those subsidies should be on the budget, not something hidden away in financial institutions that people don't understand.
And that encourages corruption, as it did; it encourages favoritism.
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