Archive for October 21st, 2008

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 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.