The Good Intentions of the Fathers, Visited on their Sons: Thoughts on the Financial Crisis

Sharon October 21st, 2008

Have you ever noticed how often problems are caused by our failures to figure out what the mistakes of the past actually are?  I remember noticing this first with parenting - noticing that often parents overcompensate not for their own parenting failures, but for the failures of their parents before them - even though their kids are their children, not the children of their grandparents - instead, the kids get parents so busy fixing what their own parents did wrong that they miss the real problems.

Gardeners do this all the time (not excluding me) - we get focused on a problem, and ignore the root soil or ecological conditions that create the problem. We do this in politics as well, focusing on superficial failures that don’t have much to do with the reality - thus everyone learns not to scream like Dean or forget their makeup on tv, but not how to actually address the needs of people.

Fascinatingly, what happens is that what starts with the best of intentions - who doesn’t want to fix prior mistakes? - becomes at best a distraction from reality, and at worst, The best of intentions often cause the very things that we most struggle to deal with. My point is not to single out any generation, or to judge them, just to observe that a lot of times, our worst mistakes come when we can’t see the present reality clearly, but are busy thinking that the past and the present are the same.

I realize this isn’t a particularly original insight, but I’ve been thinking about it a lot lately, as we’ve watched our attempt to deal with the current financial crisis.  Because just as we can look at the problems of overcompensation in individual families or by generation, we’re seeing it right now in the strategies used to address the financial crisis.

Ben Bernanke’s work focused on the Great Depression.  His theory is that the Depression itself was caused by the failure of intervention early on in the Great Depression, in the very early 30s.  He has argued that if banks and government had intervened earlier in the crisis, and more seriously with a great influx of liquidity and other interventions, a Depression could have been averted.  Sound familiar?  Much of what has happened in the last months has depended on the assumption that Bernanke knows how to avert a Depression, any Depression, because he has a theory about the last one.

Now Bernanke may be right about the Great Depression, but it is important to realize that right now, Bernanke is testing his theory about the economy and the past, on the present. (This is assuming you grant him and Paulson good faith, which I don’t, but for the purposes of this article, we’ll assume it anyway ;-).) Many of the major market interventions being taken are motivated by this underlying idea that this is what would have fixed the Great Depression.

 Here are two articles by Karl Denninger and Ambrose Evans-Pritchard that explore precisely the problem of getting the wrong part of the Depression analogy correct.  Consider Denninger here:

As I spend more and more time pondering the actions of our Treasury and Fed, along with the last Depression and the actual steps taken by various administrations (most specifically Hoover and FDR), I come to the conclusion that those who claim to know so much about it, and how to prevent it, are in fact either talking out their ass - or worse.

Yes, this means you Ben.

See, the common rhetoric is that we had a Depression because credit tightened and liquidity dried up - the government took a “you made a mess, you burn in it” attitude.

This, however, is simply not true, and worse, it ignores the fact that The Fed created the bubble in the 1920s that led to the Depression, just as The Fed created this bubble that is now bursting!

In fact, one wonders - if Ben was chosen for his expertise on The Depression, was (and is) his intent to cause the second one?

But I also think that we are getting different results than we would if Bernanke was able to look at the present crisis through eyes not largely shaped by his experience as a scholar of that period.  He’s trying to stop the reproduction of one particular experience - but we’re not having that experience.  For example, we’re not experiencing an economic depression in an era of cheap abundant resources.  Instead, we’re entering a depression without energy and natural capital to get us out.  We are being shaped by world derivatives and hedge fund forces that didn’t exist during the Depression.  And there are a host of other differences.

Is it possible that the market interventions will work/have worked?  It is, although I don’t think it likely.  We still haven’t seen the rest of the problems - and the current rally is no real suprise. Trillions of dollars have been poured in - Ilargi over at www.theautomaticearth.blogspot.com observes that if we had spent a million dollars every day from the birth of Christ to the present, we still wouldn’t have equalled the quantity of money spent last week by the Fed on the feeding the markets - getting an occasional market (sucker?) rally out of it seems pretty reasonable to me. 

 Meanwhile, we’re exacerbating many of the problems that caused the economic crisis in the beginning - we’re increasing inequity, we’re stripping wealth from the people who drive the economy - those who buy food and clothes and housing.  We’re not addressing the foreclosure crisis or crashing home values, we’re not addressing the fact that cheap energy is over.  In fact, we’re making it less likely that our nation, states, cities and individuals will be able to afford to adapt to a lower energy future.  We’re not investing in infrastructure - instead we’re investing in banks, probably doomed banks.  We’re lowering interest rates - when low interest rates are part of the problem.

 My own bet, if I had to place one, is that in 50 years, the economic historians will agree that part of the problem is that the people in charge, besides looting the treasury and enriching their buddies, even when they had good intentions, were trying to fix the wrong problems.  They were seeing the problem through the lens of their past, not the present - and because they couldn’t see the present, they have visited on the next generation the pathological version of their good intentions.  And we’ll be paying a price for it for a long, long time.

Sharon

15 Responses to “The Good Intentions of the Fathers, Visited on their Sons: Thoughts on the Financial Crisis”

  1. Steve in Coloradoon 21 Oct 2008 at 12:29 pm

    Quite agree.

    Another interesting set of comments are the ones by Anna Schwartz, co-author with Milton Friedman of the classic book on the GD, “A Monetary History of the United States” (1963). From Mr. Carney, a member of The Wall Street Journal’s editorial board:

    New York
    On Aug. 9, 2007, central banks around the world first intervened to stamp out what has become a massive credit crunch.

    Since then, the Federal Reserve and the Treasury have taken a series of increasingly drastic emergency actions to get lending flowing again. The central bank has lent out hundreds of billions of dollars, accepted collateral that in the past it would never have touched, and opened direct lending to institutions that have never had that privilege. The Treasury has deployed billions more. And yet, “Nothing,” Anna Schwartz says, “seems to have quieted the fears of either the investors in the securities markets or the lenders and would-be borrowers in the credit market.”
    The credit markets remain frozen, the stock market continues to get hammered, and deep recession now seems a certainty — if not a reality already.

    Most people now living have never seen a credit crunch like the one we are currently enduring. Ms. Schwartz, 92 years old, is one of the exceptions. She’s not only old enough to remember the period from 1929 to 1933, she may know more about monetary history and banking than anyone alive. She co-authored, with Milton Friedman, “A Monetary History of the United States” (1963). It’s the definitive account of how misguided monetary policy turned the stock-market crash of 1929 into the Great Depression.

    Since 1941, Ms. Schwartz has reported for work at the National Bureau of Economic Research in New York, where we met Thursday morning for an interview. She is currently using a wheelchair after a recent fall and laments her “many infirmities,” but those are all physical; her mind is as sharp as ever. She speaks with passion and just a hint of resignation about the current financial situation. And looking at how the authorities have handled it so far, she doesn’t like what she sees.

    Federal Reserve Chairman Ben Bernanke has called the 888-page “Monetary History” “the leading and most persuasive explanation of the worst economic disaster in American history.” Ms. Schwartz thinks that our central bankers and our Treasury Department are getting it wrong again.

    To understand why, one first has to understand the nature of the current “credit market disturbance,” as Ms. Schwartz delicately calls it. We now hear almost every day that banks will not lend to each other, or will do so only at punitive interest rates. Credit spreads — the difference between what it costs the government to borrow and what private-sector borrowers must pay — are at historic highs.
    This is not due to a lack of money available to lend, Ms. Schwartz says, but to a lack of faith in the ability of borrowers to repay their debts. “The Fed,” she argues, “has gone about as if the problem is a shortage of liquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that the balance sheets of financial firms are credible.”

    So even though the Fed has flooded the credit markets with cash, spreads haven’t budged because banks don’t know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is “the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue.”

    In the 1930s, as Ms. Schwartz and Mr. Friedman argued in “A Monetary History,” the country and the Federal Reserve were faced with a liquidity crisis in the banking sector. As banks failed, depositors became alarmed that they’d lose their money if their bank, too, failed. So bank runs began, and these became self-reinforcing: “If the borrowers hadn’t withdrawn cash, they [the banks] would have been in good shape. But the Fed just sat by and did nothing, so bank after bank failed. And that only motivated depositors to withdraw funds from banks that were not in distress,” deepening the crisis and causing still more failures.
    But “that’s not what’s going on in the market now,” Ms. Schwartz says. Today, the banks have a problem on the asset side of their ledgers — “all these exotic securities that the market does not know how to value.”

    “Why are they ‘toxic’?” Ms. Schwartz asks. “They’re toxic because you cannot sell them, you don’t know what they’re worth, your balance sheet is not credible and the whole market freezes up. We don’t know whom to lend to because we don’t know who is sound. So if you could get rid of them, that would be an improvement.” The only way to “get rid of them” is to sell them, which is why Ms. Schwartz thought that Treasury Secretary Hank Paulson’s original proposal to buy these assets from the banks was “a step in the right direction.”
    The problem with that idea was, and is, how to price “toxic” assets that nobody wants. And lurking beneath that problem is another, stickier problem: If they are priced at current market levels, selling them would be a recipe for instant insolvency at many institutions. The fears that are locking up the credit markets would be realized, and a number of banks would probably fail.

    Ms. Schwartz won’t say so, but this is the dirty little secret that led Secretary Paulson to shift from buying bank assets to recapitalizing them directly, as the Treasury did this week. But in doing so, he’s shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. “They should not be recapitalizing firms that should be shut down.”

    Rather, “firms that made wrong decisions should fail,” she says bluntly. “You shouldn’t rescue them. And once that’s established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich.” The trouble is, “that’s not the way the world has been going in recent years.”

    Instead, we’ve been hearing for most of the past year about “systemic risk” — the notion that allowing one firm to fail will cause a cascade that will take down otherwise healthy companies in its wake.

    Ms. Schwartz doesn’t buy it. “It’s very easy when you’re a market participant,” she notes with a smile, “to claim that you shouldn’t shut down a firm that’s in really bad straits because everybody else who has lent to it will be injured. Well, if they lent to a firm that they knew was pretty rocky, that’s their responsibility. And if they have to be denied repayment of their loans, well, they wished it on themselves. The [government] doesn’t have to save them, just as it didn’t save the stockholders and the employees of Bear Stearns. Why should they be worried about the creditors? Creditors are no more worthy of being rescued than ordinary people, who are really innocent of what’s been going on.”

    It takes real guts to let a large, powerful institution go down. But the alternative — the current credit freeze — is worse, Ms. Schwartz argues.

    “I think if you have some principles and know what you’re doing, the market responds. They see that you have some structure to your actions, that it isn’t just ad hoc — you’ll do this today but you’ll do something different tomorrow. And the market respects people in supervisory positions who seem to be on top of what’s going on. So I think if you’re tough about firms that have invested unwisely, the market won’t blame you. They’ll say, ‘Well, yeah, it’s your fault. You did this. Nobody else told you to do it. Why should we be saving you at this point if you’re stuck with assets you can’t sell and liabilities you can’t pay off?’” But when the authorities finally got around to letting Lehman Brothers fail, it had saved so many others already that the markets didn’t know how to react. Instead of looking principled, the authorities looked erratic and inconstant.

    How did we get into this mess in the first place? As in the 1920s, the current “disturbance” started with a “mania.” But manias always have a cause. “If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset.

    “The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it’s so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object. And then of course if monetary policy tightens, the boom collapses.”

    The house-price boom began with the very low interest rates in the early years of this decade under former Fed Chairman Alan Greenspan.

    “Now, Alan Greenspan has issued an epilogue to his memoir, ‘Time of Turbulence,’ and it’s about what’s going on in the credit market,” Ms. Schwartz says. “And he says, ‘Well, it’s true that monetary policy was expansive. But there was nothing that a central bank could do in those circumstances. The market would have been very much displeased, if the Fed had tightened and crushed the boom. They would have felt that it wasn’t just the boom in the assets that was being terminated.’” In other words, Mr. Greenspan “absolves himself. There was no way you could really terminate the boom because you’d be doing collateral damage to areas of the economy that you don’t really want to damage.”

    Ms Schwartz adds, gently, “I don’t think that that’s an adequate kind of response to those who argue that absent accommodative monetary policy, you would not have had this asset-price boom.” Policies based on such thinking only lead to a more damaging bust when the mania ends, as they all do. “In general, it’s easier for a central bank to be accommodative, to be loose, to be promoting conditions that make everybody feel that things are going well.”

    Fed Chairman Ben Bernanke, of all people, should understand this, Ms. Schwartz says. In 2002, Mr. Bernanke, then a Federal Reserve Board governor, said in a speech in honor of Mr. Friedman’s 90th birthday, “I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

    “This was [his] claim to be worthy of running the Fed,” she says. He was “familiar with history. He knew what had been done.” But perhaps this is actually Mr. Bernanke’s biggest problem. Today’s crisis isn’t a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. “I don’t see that they’ve achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job.”

    It is interesting to read het thoughts, which parallel my own: that the lending crisis is not one of liquidity but of trust. That is why adding more credit to the system is not having the desired effect.

  2. WOW Traineeon 21 Oct 2008 at 2:56 pm

    Remember it’s all in the spin. There’s an interesting article on MSNBC reTEOTWAWKI. Might be too dangerous.

  3. […] Casaubon’s Book » Blog Archive » The Good Intentions of the Fathers, Visited on their Sons: Thou… Have you ever noticed how often problems are caused by our failures to figure out what the mistakes of the past actually are? I remember noticing this first with parenting - noticing that often parents overcompensate not for their own parenting failures, but for the failures of their parents before them - even though their kids are their children, not the children of their grandparents - instead, the kids get parents so busy fixing what their own parents did wrong that they miss the real problems. […]

  4. Bruce Fon 21 Oct 2008 at 4:23 pm

    I like the analogy you’re using to explain what’s going on in the financial markets.

    It seems like you’ve made some optimistic assumptions about the Intentions of our Leaders. My thought is that we’re being led by the cumulative “wisdom” of generations of Bad Parents.

    Very little is done to address needs of people. No expense is spared to appease Power. When in doubt, blame your problems on the weak.

    Rinse and repeat.

  5. Verdeon 21 Oct 2008 at 4:44 pm

    How interesting, I was thinking this today as I read about how much is known about the (first) Great Depression and how it won’t happen again. And I thought to myself: well things are so different now that it seems that there surely could be more than one cause of a depression.

    Yes, the article on MSNBC is titled “In hard times some flirt with survivalism”. Um, there’s no slant there.

  6. Josephon 21 Oct 2008 at 5:06 pm

    Sharon, is not the entire banking/monetary system rigged in favor of the financial aristocracy, and hasnt it always been so? Ya know, this ability to create “money” out of thin air and charge interest for it.

    Things went on like this because massive amounts of cheap fossil energy allowed the game to expand and expand but… now that cheap energy is gone on an over-populated planet that is in fact growing poorer and poorer every year by trillions of dollars because of resource depletion and ecological degradation, the “growth” game is ending.

  7. Josephon 21 Oct 2008 at 5:10 pm

    P.S.

    Remember I talked about one of our big problems being the incredible level of spiritual immaturity of the average american? Well, take a good look at the kind of vicious morons coming to Palin rallys - THAT is what I am talking about - how right-wing fundamentalist christianity creates a dumbed-down mob of morons who are truly trying to drag this country down into their stupid reality. I rest my case.

  8. jdelgatoon 21 Oct 2008 at 7:40 pm

    Well presented. Yes, the cause of this coming depression is the same as the last one. The differences will make the effects much worse. Those in charge are either corrupt or morons or, God help us, both.

  9. conchscooteron 22 Oct 2008 at 5:48 am

    I do not attribute good intentions to the people at the top, they are meneuvering to protect themselves- does that seem unnatural? I am surprised no one has mentioned Georges Santayana’s remark that those who forget history are doomed to repeat it it. Americans have an excesss of spirituality and and an abysmal lack of historical references on which to base current decisions. Thus every new twist in an old story of greed and corruption takes them by surprise.

  10. Anion 22 Oct 2008 at 7:03 am

    It has been said that generals train to fight the last war. That it is ineffectual in warfare and the economy as well should perhaps be no suprise. It appears to be the only way most humans have of apraising a situation and deciding how to deal with it. Biology rules???

  11. Green Assassin Brigadeon 22 Oct 2008 at 8:02 am

    The collapsing credit bubble/stock market of the 1929 had to eventually happen and any amount of liquidity added would have just postphoned the inevitable. What should have been a 1-2 year correction/recession was turned into a depression because of the a series of tax increases that made it virtually impossible to justify business investment, and even made keeping existing businesses open. Unemployment increases, less demand, more closures, wash rinse repeat.

    A recession was required to erase Malinvestment, it was a normal short term fix for an exagerated market. It was the government moves to tax heavily and spend heavily as stimulus that killed industry and promoted workfare. In some juristictions the combinations of federal and local taxes were in the mid 90s, giving no incentive to invest in production. Those who had money just bought fire sale assets and waited for the dust to clear, but created no real employment.

    There are so many differences between then and today that are going to make the decimation of the formal ecomomy that much harder than a simple depression

    Resource depletion

    The U.S. being a net creditor rather than a net debtor(and a huge one at that).

    A small minority having some stake in the stock market, compared to virtually everyone today through pension plans, RSPs, etc

    Having modest households to maintain rather than McMansions

    Having a a significant portion of population on the land and able to feed themselves.

    Man power rather than machine power needed in agriculture

    Issolationalist vs empire

    levels of expectation

    experience with deprivation

    The two sets of data are too different to expect the same result or assume a theoretical hindsighted answer to the first problem can answer a new problem that has not totally shown itself.

  12. Greenpaon 22 Oct 2008 at 8:26 am

    Partly, what you’re saying here, is that people do not behave in a fully rational manner.

    You’ve known that for a long time, of course, but it’s very hard for rational people (that would be you, and me I hope) to actually accept, on a daily basis, that it’s a mistake to expect constantly rational behavior (of anyone, including, of course, ourselves).

    Even though I realized this long ago, I am still susceptible to the occasional rant of “How can they not SEE!!??”

    As I have probably said here before;

    “Logic is the opiate of the educated.”

    I think that’s partly what you mean by good intentions- not only are the intentions good, but the perpetrator is telling us “see, I’m thinking very hard about this, so I can do the right thing!” Except that they’re totally locked into a non-rational thought pattern.

    It is, indeed, a huge problem for our species, as we try to cope with a rapidly changing world.

    It’s absolutely fascinating to me that the whole current financial debacle was based on logic- and mathematical models, allegedly the ultimate logical tools- and the logic seduced almost the entire world.

    And one of the key fallacies- was the stated assumption, in the models- that consumers are “rational”. lies, damned lies…

    Astonishing.

    So, my question for you would be- do you think this problem- of the failure of logic to solve human problems- is susceptible to a logical solution?

  13. RCon 22 Oct 2008 at 8:46 pm

    I have to disagree with you Greenpa that the current economic and monetary debacle was a product of logic or assumptions of rationality.
    Without a very long explication, and even then, due to the large number of yet unknowns {real values of CDSs and CDOs, real intentions of most of the humans involved} the debacle remains Gordian.
    In short, so much of the mathematics of the exotic and toxic instruments was overridden by the management arms of the investment and trading operations throughout the world. So much of the actual decisions to engage in the exotic trading was not made by the average investor, but almost entirely by insiders. And the ultimate insiders at the top went for short term returns, very predictable in a corporate atmosphere especially in publicly traded profit driven operations.
    Someone who is no one’s fool, although frequently and historically plain spoken, Warren Buffett, warned about the explosive nature of these instruments long ago.
    Humans do tend to listen only when there are no other alternatives. It’s too late to pay attention now. Enjoy survivalism, Greenpa, I intend to. After all, the time has come to ask the question, — what is the alternative to survivalism? Humans: Attention! are you listening? Pension funds are being seized by governments to manipulate as they see fit as we speak.
    So what does the trajectory look like now? Of course, in the US, the pensions not part of Social Security took a 40% hit this year {it is only October} and the dear Social Security is already held and manipulated by the US government, so let us not be so judgmental of poor commodities ravaged Argentina. We have heard of the Oil Curse, now the Commodities Curse. Well, enough for now, got to go plant some more casava. Survivalism you know. Green was the old catch phrase. Survive if you can is the new theme. Thank you for playing!

  14. Greenpaon 23 Oct 2008 at 10:48 am

    RC, I have to disagree that we disagree. :-)

    No, really, we’re on the same page. What I was trying to say was that they used “logic” to SELL all that crap; and people were cheerfully willing to use “logic” to rationalize buying it. Underneath it all- yep, a Gordian tangle of causes and motivations. Or maybe a kraken. One good sword can handle a Gordian problem- but we’re gonna need nuclear harpoons for this one.

  15. RCon 23 Oct 2008 at 8:37 pm

    I hears ya Greenpa, and I hope the guineas are doing fine.

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