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Subprime Triggered But Didn't Cause Economic Meltdown

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http://www.ft.com/cms/s/8362b1d0-4b59-11dd...amp;_i_referer=

Recession is not the worst possible outcome

By Wolfgang Münchau

Published: July 6 2008 17:53 | Last updated: July 6 2008 17:53

If this had been a mere financial crisis, it would be over by now. The fact that we are suffering its fourth wave tells us there might be something at work other than merely financial euphoria and bad regulation. Maybe this is not a Minsky moment after all. Hyman Minsky, the 20th century US economist, formulated the long forgotten, and recently rediscovered, financial instability hypothesis, according to which capitalist economies, after a long period of prosperity, end up in a vicious circle of financial speculation. The Minsky moment is the point when what economists call this “Ponzi game” collapses.

But there might be better explanations. As the Bank of International Settlements said in its latest annual report, subprime might have been the trigger for this crisis, but not the cause. We do not have a full understanding yet of what happened but the BIS suggested that fast expansion of money and credit must have played a role. I would go further and say this is not primarily a crisis of financial speculation, but one of economic policy. Its principal villains are therefore not bankers, but economists – not in their role as teachers and researchers, but as policy advisers and policymakers.

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http://www.ft.com/cms/s/8362b1d0-4b59-11dd...amp;_i_referer=

Recession is not the worst possible outcome

By Wolfgang Münchau

Published: July 6 2008 17:53 | Last updated: July 6 2008 17:53

If this had been a mere financial crisis, it would be over by now. The fact that we are suffering its fourth wave tells us there might be something at work other than merely financial euphoria and bad regulation. Maybe this is not a Minsky moment after all. Hyman Minsky, the 20th century US economist, formulated the long forgotten, and recently rediscovered, financial instability hypothesis, according to which capitalist economies, after a long period of prosperity, end up in a vicious circle of financial speculation. The Minsky moment is the point when what economists call this “Ponzi game” collapses.

But there might be better explanations. As the Bank of International Settlements said in its latest annual report, subprime might have been the trigger for this crisis, but not the cause. We do not have a full understanding yet of what happened but the BIS suggested that fast expansion of money and credit must have played a role. I would go further and say this is not primarily a crisis of financial speculation, but one of economic policy. Its principal villains are therefore not bankers, but economists – not in their role as teachers and researchers, but as policy advisers and policymakers.

I think it's quite right that economists should be blamed. Not just for the credit bubble and subsequent crash, but for the failure to invest in alternative energy sources or to take limits to growth seriously. Their view on oil has all along been that there is plenty - all that has to happen is for the price to rise sufficiently and the market will supply it. It seems not to have occurred to them that there is a geologically limited amount, just like any other resource.

There is a story about two economists who get locked in a cellar one morning. As lunchtime approaches they begin to feel hunger pangs, but one reminds the other not to be worried. "After all," he says, "our demand for sandwiches will create a supply of them." :rolleyes:

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Human Nature - greed, snobbery, one-upmanship, Class, arrogance.

Actually, I don't like thinking of Human Nature in this way because I do not believe hte majority of us are like that - but enough of us are to mess Life up for all the rest.

Don't go looking for b *****ers or politicians or economists or whoever to blame - the blame lies inside... all of us?

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From further on:

Under this setting, the priority might be not to impede the fall in asset prices. Real house prices in the US, the UK and several other economies might end up falling by some 40-50 per cent, peak-to-trough, in the downward phase of this cycle. Let this happen and do not implement policies to prevent this fall – such policies might alleviate some pain in the short run for some people but will make the adjustment last a lot longer.

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In a low house price environment, sub-prime is perfectly okay provided is adequately judges risk and keeps lending ratios a bit lower than prime. After a few years on a sub-prime deal a borrower will often have repaired their credit rating sufficiently to get a prime deal.

However, because people on sub-prime were buying places that cost so much that a lot of their monthly income went on their mortgage repayments, they're very vulnerable to interest rates and their defaults are what kicked the whole thing off. Some loans were just silly, like those to people on benefits, and once you start getting fast-track sub-prime deals there will inevitably be major problems. The fact is that high-house prices, which fuelled excessive borrowing were the cause of all this and don't really benefit anyone over the long-term.

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Under this setting, the priority might be not to impede the fall in asset prices. Real house prices in the US, the UK and several other economies might end up falling by some 40-50 per cent, peak-to-trough, in the downward phase of this cycle. Let this happen and do not implement policies to prevent this fall – such policies might alleviate some pain in the short run for some people but will make the adjustment last a lot longer.

Second, monetary policy should be geared towards price stability first and foremost. When inflation expectations rise, real interest rates should be positive. This would necessitate a large interest rate increase in the US and further interest rate increases in the eurozone as well.

Third, allow some defaulting banks to go bust.

Fourth, implement long-term policies designed to reduce volatility. Among these are: a change in the monetary policy framework to take explicit account of asset price developments; the removal of pro-cyclical incentives in the banking sector; stricter regulation of mortgages, such as the encouragement of fixed-rate loans and the imposition of maximum loan-to-value ratios; more exchange-rate flexibility in countries with fixed or semi-fixed exchange rates and, of course, the development of alternative energies to reduce our reliance on oil.

I wonder if he means (by specifying some) that some should be bailed out?

The impact of free-falling asset prices on banks is the core issue IMO.

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So economics is an academic idealogical experiment like its more obvious cousin, politics. Someone let them escape from the dusty libraries and now they are running the world into the ground.

The scary thing is the point about them not wanting to lose face and academic standing by being seen to be wrong. This is SO true and is a universal factor in academia and its various cliques.

Its a difficult and complex interaction of concepts and ideas, and l struggle to explain its nuances... but basically it boils down to increasing the chances that some academo-struck young Erasmus student will suck on your wizened *****.

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Recession is not the worst possible outcome

By Wolfgang Münchau

Published: July 6 2008 17:53 | Last updated: July 6 2008 17:53

If this had been a mere financial crisis, it would be over by now. The fact that we are suffering its fourth wave tells us there might be something at work other than merely financial euphoria and bad regulation. Maybe this is not a Minsky moment after all. Hyman Minsky, the 20th century US economist, formulated the long forgotten, and recently rediscovered, financial instability hypothesis, according to which capitalist economies, after a long period of prosperity, end up in a vicious circle of financial speculation. The Minsky moment is the point when what economists call this "Ponzi game" collapses.

But there might be better explanations. As the Bank of International Settlements said in its latest annual report, subprime might have been the trigger for this crisis, but not the cause. We do not have a full understanding yet of what happened but the BIS suggested that fast expansion of money and credit must have played a role. I would go further and say this is not primarily a crisis of financial speculation, but one of economic policy. Its principal villains are therefore not bankers, but economists – not in their role as teachers and researchers, but as policy advisers and policymakers.

Incomprehensible misjudgement on his part IMO. Not enough thinking before he started writing.

Does he sometimes wonder who hires those economists? Who pays them? Does he know how many economists work in banks? Why, to continue Greenspan's legacy, the US goverment hired the only economist whose wet dream since teenagehood has been to save the world from a 1930s depression by flooding the world with liquidity?

I really like that point:

We do not have a full understanding yet of what happened but the BIS suggested that fast expansion of money and credit must have played a role.

Oh really? What a revelation! From what I have read from them the BIS have been pretty clear as to what the crisis was about since the start of the crisis IMO. It looks like Wolfgang Münchau's the one whose just started to understand. His past articles sounded like he did, but clearly not.

Edited by williamdb

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  • 399 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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