Thursday, August 10, 2017

The Financial Crisis Tenth Anniversary

Yesterday, August 9, is being widely proclaimed as the tenth anniversary of the beginning of the financial crisis that fully crashed in September, 2008, with the recession that began at the end of 2007 plunging more profoundly and widely after that.  The specific event on August 9, 2007 was the limiting of withdrawals from US mortgage backed hedge funds by the BNP Paribas bank in Paris.  In a post yesterday, one of the leading analysts and prophets of the crisis, Dean Baker, noted that BBC erroneously claimed that housing prices in the US began falling after that date, when in deed Dean accurately notes that it was the decline in housing prices starting somewhat earlier that led to this action by BNP Paribas ten years ago. 

As one of those who analyzed what was going on better than most and with better timing, I link to my post of July 11, 2008, which analyzed what had been happening and forecast a full-out  crash coming soon, which indeed occurred a bit over two months later.  The title of that post is "Falling from the Period of Financial Distress into the Panic and Crash."  I note that the unpublished paper I cited in that post by me with Mauro Gallegati and Antonio Palestrini, "The Period of Financial Distress in Speculative Markets: Interacting Heterogeneous Agents and Financial Constraints," was finally published in Macroeconomic Dynamics in Feb. 2011, vol. 15, pp. 60-79.  A few comments now.

1)  Regarding the matter of the housing market bubble, everybody, including Dean Baker, always cites the numbers provided by the Case-Shiller index of housing prices in the 10 and 20 largest municipalities.  This is indeed an excellent source, but it is not the only one, and it is arguably biased because of its focus on large metropolitan areas.  A much broader index is that estimated by the Federal Housing Finance Agency.  Whereas the Case-Shiller index peaked around June, 2006, the FHA one peaked in January, 2007, over a half year later.  The FHA index is arguably more representative of the broader market, although it is probably true that the worst of the speculative markets and crashes were in larger metro areas, with declines in some of those already at down 10 to 12 percent by August, 2007, as Dean accurately notes in his post.  But even now I rarely see anybody citing the FHA index, with the occasional exception of Calculated Risk.

2)  Regarding the behavior of the Fed in the crash, Dean is right to pound on them not getting that the housing bubble was a problem and that the decline from its peak was a problem threatening a recession, indeed a major one, although they were clearly getting worried after the beginning of the period of financial distress ten years ago, especially as mortgage financiers began going belly up one after another.  As it is, the one person at the Fed who seems to have seen the danger earlier than any other, although she was overruled and later went along with some of the Pollyanna policies, was Janet Yellen.  Needless to say, I have praised her forecasting abilities on several occasions, and she was calling the housing bubble from 2005 on.

3)  In terms of the behavior of the Fed at the time of the crash, there had been some preparations for it, mostly by people at the New York Fed, and indeed the various alternative entities the Fed rolled out temporarily after the hard crash were cooked up in advance by them.  However, the most important thing the Fed did remains widely unknown and unadvertised, although I have posted on it previously, and it has been publicly reported on, it not on front pages anywhere ever.  That would be the half a trillion dollar save the Fed did for the European Central Bank, taking a bunch of very bad assets onto the Fed balance sheet, which were then gradually and quietly rolled off over the next six  months to be replaced by Mortgage Backed Securities.  The euro was crashing, and the ECB was facing the threat that both BNP Paribas and Deutsche Bank were in danger of failing.  This was the immediate danger that could have led to a full blown global financial crash of a 1931 level or worse.  This save was probably the most important thing the Fed did to keep the crisis from bringing about another Great Depression, although it remains not well known, partly because both the Fed and the ECB did not want it advertised.  A good account of this can be found in Neil Irwin's book, _The Alchemists_. 

There is so much more I have to say about all this, but these are a few items that either were not well known at the time or have been largely forgotten since.

Addendum:  Could link to both other posts and cite a bunch of papers, but will not.  So, a bit more on all this is that according to Minsky and Kindleberger there are three kinds of bubbles: ones that go up and crash suddenly and more or less totally, ones that go up and then go back down again without a hard crash, and ones that go up and reach a peak and then go into a period of financial distress and then later crash.  The vast majority are the latter, which was the pattern for the main financial markets as called by me, peak ten years ago, a year and a month of period of financial distress and then crash.  Oil did the first pattern back then, peaking at $147/barrel in June, 2008, then plunging to the low 30s by November before recovering.  Real estate followed the second pattern, going back down the way it went up.  This is because residential homeowners have emotional investment in their houses and refuse to believe or accept the falling prices after the peak. So they do not sell, and volumes collapse rather than prices.

Barkley Rosser


Jerry Brown said...

Why is it that the Fed had to save foreign banks like BNP Paribas and Deutsche Bank? Why couldn't the ECB save them- they were banks within the Eurozone no? Or is it that these banks were indebted in a foreign currency that the ECB cannot create if necessary? If it was necessary for the US Fed to save Deutsche Bank, isn't that an indication of failure of the ECB to regulate it properly? And what is it to me as an American whether Deutsche Bank fails or not? Why did Deutsche Bank get bailed out from the Fed and I didn't?

Your article obviously is very interesting to me. None of these questions are meant to be critical of your article in any way. In fact I had not realized the Fed had acted to save foreign banks. I am still upset about our own domestic banks let alone that. In any event, had I been working at the Fed, Deutsche Bank would have been in very deep trouble if they needed me to spell their name correctly in order to get the money. Misspelled it three times already in one short comment. said...


The troubled assets of the European banks were in dollars, with the crucial problem high level derivatives they held from AIG that were based on the bad mortgage assets from the US. These went bad with the fall of AIG, although AIG itself was bailed out by the Fed at that time. But in fact, the crisis had the euro collapsing against the dollar, with the ECB indeed unable on its own to issue the dollars to save the European banks. This was the dirty dark secret, and the scale and details of the swap arrangements involved were kept secret at the time they were made, although they became public information later.

Again, probably the best account of this is in Irwin's The Alchemists, especially Chapter 11. He quotes one European central bankers as saying that "In a way we became the thirteenth branch of the Federal Reserve," (Irwin, p. 104).

In effect what was involved was both a foreign exchange and a bank crisis, and both needed to be stopped together, with the half trillion dollar swap effectively doing that, simultaneously halting the slide of the euro as it allowed the ECB to keep the major European banks from failing. It was the most crucial moment of the larger Minsky Moment that was going on at the time.

Jerry Brown said...

Thanks Professor! I sort of remember the swap but never understood its significance before.

ProGrowthLiberal said...

FRED reports a series called “Moody's Seasoned Baa Corporate Bond Yield Relative to Yield on 10-Year Treasury Constant Maturity”

Paul Krugman often cites this series giving credit to Ben Bernanke who noted how the credit spread on these bonds jumped at the start of the Great Depression as well as during the period from late 2007 to early 2009. It is interesting that this spread was rising even before August 7, 2007 but moderated a bit during October 2007. Of course by late 2008, these spreads his historically high rates.

Peter T said...

I believe Adam Tooze gives this swap central place in his forthcoming work on the crisis (see his blog).

AXEC / E.K-H said...

Barkley Rosser, petty scientist
Comment on Barkley Rosser on ‘The Financial Crisis Tenth Anniversary’

Economics is a failed science or what Feynman called a cargo cult science. Needless to emphasize that the general public cannot tell the difference between genuine science and cargo cult science. Feynman defined the latter as follows: “They’re doing everything right. The form is perfect. ... But it doesn’t work. ... So I call these things cargo cult science because they follow all the apparent precepts and forms of scientific investigation, but they’re missing something essential.” What is missing is scientific competence.

There are some typical identifiers for the cargo cultic economist.

(i) Barkley Rosser, as a prime example, maintains that science is about predicting the future: “As one of those who analyzed what was going on better than most and with better timing, …, which analyzed what had been happening and forecast a full-out crash coming soon, which indeed occurred a bit over two months later.” and “Needless to say, I have praised her [Janet Yellen] forecasting abilities on several occasions, and she was calling the housing bubble from 2005 on.”

As a matter of principle — science is NOT AT ALL in the business of prediction because it is long known among scientists: “The future is unpredictable.” (Feynman)#1 Only charlatans predict the future, and only morons take them seriously.

(ii) Barkley Rosser cannot tell the difference between prophecy and a scientific ‘prediction’. The latter is a conditional proposition which presupposes: (i) the exact knowledge of initial conditions, (ii) the knowledge of one or more universal laws, (iii) the absence of disturbances. (Popper)

Scientific ‘prediction’ presupposes the true theory. Economists, though, lack the true theory. The four main approaches ― Walrasianism, Keynesianism, Marxianism, Austrianism ― are mutually contradictory, axiomatically false, and materially/formally inconsistent.

For lack of the true theory, economic prediction is an exercise which is in no way different from the poultry entrails reading of the old Roman haruspex.

(iii) Barkley Rosser does not know how the actual market economy works. He does not even know what profit ― the foundational concept of all of economics ― is.#2

(iv) Barkley Rosser represents the wrong type of economics. There are TWO economixes: political economics and theoretical economics. The main differences are: (a) The goal of political economics is to successfully push an agenda, the goal of theoretical economics is to successfully explain how the actual economy works. (b) In political economics anything goes; in theoretical economics, the scientific standards of material and formal consistency are observed.

As a political economist, Barkley Rosser routinely violates scientific standards. His economic policy assessments and proposals do not follow from a valid theory because there is none.

(v) Political economics degenerates quite naturally to proto-scientific inconclusive blather, pure gossip about colleagues, celebrities or political figures, and sitcom reputation management with vacuous euphemism/slander.

The lack of scientific knowledge is compensated for by the hint to piles of hot and exclusive insider knowledge: “There is so much more I have to say about all this, but these are a few items that either were not well known at the time or have been largely forgotten since.”

Political economics is essentially storytelling of the ‘throng of superfluous economists’ (Joan Robinson).#3

Egmont Kakarot-Handtke

#1 Scientists do not predict

#2 Economists: scientists or political clowns?

#3 Fact of life: your econ prof is scientifically incompetent said...

LOL, Egmont, just LOL. More of the same old, same old, snigger.

Anonymous said...

median real income must keep pace with productivity increases, unless all that extra product is going to remain unsold

demand from loans can substitute for demand from income for a while but these lead to debt driven bubbles and economic collapse, which is I guess what Minsky said

I am one of these wierdos who believe rich people don't spend as much of their income as poor and middle class which is why I say that real median income must keep pace with productivity gains to have a viable economy and to be able to sustain economic growth

Anonymous said...

I found somewhere the top four paid with Fed-aid were Goldman-Sachs (US), Barclays (UK), SocGen(FR) and Deutsche Bank (DE); each for some 11 billion, nowhere near half a trillion mainly for eurosons. I recall that financial crisis spoke English. You will need some marketing to convince.