Earlier in the week I wrote about a couple of the surveys, of US academic economists, conducted out of the University of Chicago by the IGM economic experts panel.
But another of their 2017 surveys caught my eye. It was about the financial crisis of 2008/09.
Panellists (US ones, and those of the sister European panel) were asked (with detailed wording of each item at the link)
Please rate the importance (0=none; 5= highest) of each item below (presented to panelists in randomized order) in contributing to the 2008 global financial crisis.
And this was how the results came back (using the version where respondents indicated how confident they were of their views).
For the most part, the European and American responses were pretty similar (not that surprising given (a) that they were asked about the same events, and (b) that quite a few of the US panel were academics who’d migrated from Europe). Perhaps the only material differences are on the questions around the role of savings and investment imbalances, and around the role of direct government involvement in the housing finance market. In neither case do the (weighted) average respondents think these issues were top-tier factors but in Europe extremely large current account deficits (savings/investment imbalances) were much more salient (Ireland, Greece, Spain, as well as various eastern European countries) – as were the “reinvestment” pressures on eg German banks. And on other other hand, in the United States, between the role of the agencies (Fannie Mae et al), the FHA, and direct federal pressure on banks to lend to support home ownership, the government has a far larger role in housing finance than in most countries. And US housing finace was the epicentre of the crisis.
In some ways, it is a funny mix of questions/options. Even if all these factors contributed in one sense or another to the 2008 crisis, they must have done so in quite different ways. Take, for example, funding runs, resulting from maturity mismatches (short-term liabilities funding long-term assets). Clearly they were a phenomenon observed in the crisis – whether at Bear Stearns or Northern Rock or…. – but since every banking system in the world, strong or otherwise, operates that way, it isn’t clear that the funding structures (or the runs) were a material cause of the crisis.
And one can criticise the rating agencies all one likes – and I’m sure most of the criticism is well-warranted – but few people were compelled to use credit ratings to guide their asset allocation choices. And, for all their faults, the rating agencies were generally only responding to much the same incentives that drove other active participants in the system.
And what might lament that regulators and supervisors didn’t catch the building risks before the crisis broke, but (a) they rarely do, and (b) generally, prudential regulators did not compel or coerce willing borrowers and willing lenders to undertake the transactions that ended badly.
It is interesting to see that the “too big to fail beliefs” item is ranked a fair way down the scale (the specific question is about the beliefs of bankers that their own bank was too big to fail). That sounds about right. In boom times, most participants are focused on maximising the upside, with little focus on the possibility of things going very badly. And for the management and Boards of banks, even if their own bank does prove “too big to fail” it is probably little solace to the people involved – they will still be ousted (RBS, for example, still trades but Fred Godwin – knighthood and over-generous pension too – is long gone).
I’m not quite sure what two or three factors I would rate most important. But one that would rank fairly highly isn’t even directly on the IGM panel’s list: the creation of the euro and the inclusion of so many peripheral states in it. That choice – giving German interest rates to Ireland, Greece, Spain, and associated flows of capital – greatly accentuated imbalances that might already have been there. Again, it caused no bad loans directly, but fostered an environment in which they became more likely.
And I still find quite persuasive – more so than the panels clearly – the story around the importance in a US context (and the US crisis contributed greatly to crises in the UK, Germany and several other European countries) of government efforts to promote easier access to housing credit. As I summarised the story former US official Peter Wallinson told
It is that without repeated, sustained and frighteningly successful US government efforts – under both Clinton and Bush administrations – to promote easier access to housing credit, particularly through the agencies (Freddie Mac and Fannie Mae), there would most likely have been no serious US financial crisis. Wallinson documents how government mandates compelled the agencies to drive down their lending standards, and how because of the dominant role of the agencies in the market, this contributed to a sustained deterioration in the quality of new housing loans being made across the United States. As late as 2004, new mandates were imposed, forcing the agencies to meet higher low income lending targets with loans for new purchases, excluding any refinancing or equity withdrawal loans.
Finally, it is interesting to note that household debt (specifically “Elevated levels of US household debt as of 2007”) also doesn’t rank that highly as an explanation. That has long seemed right to me – apart from anything else, debt to income ratios at the time were higher in New Zealand and Australia (which had no crisis at all) and in the UK (which had no domestic housing finance crisis) than in the US. But the Reserve Bank has tended to put (in my view) too much weight on the debt stock.
I noticed this week that credit growth in New Zealand (household or total) has now again dropped a little below the rate of growth of nominal GDP. I don’t supppose it portends anything very much, but if our debt levels in 2007 didn’t cause a local crisis, the current debt levels don’t seem likely to either.
(with an estimate of Dec quarter 2017 GDP)
It is striking just how little has changed in aggregate. Debt stocks that, as a per cent of GDP, have barely changed over a decade, are very rarely the stuff of which crises are made. Big increases in those ratios can sometimes be associated with subsequent crises – that was what New Zealand had in the 00s, and thus we were worried in 2007 – but very bad banking seems to be what really matters, and in a well-disciplined market economy, “very bad banking” and “more debt” aren’t synonymous.