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.
croaking cassandra 
Met up with a couple of Kiwibank Lending Managers and they indicated that the RBNZ shows a public face of easing the 40% equity to LVR restrictions to 35% but in the background have told the banks to tighten up lending exposure by around 10% to 15% which means that credit is even more unavailable than before the public easing.
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Thanks Michael. I would agree with you about the Euro increasing risks for financial crashes. My brother works in Austria providing IT services for the banking industry and certainly in the Germanic world they do not recognise the systemic risks the euro has created -my impression from talking to him over Christmas was they are still very much in the blame game.
On the NZ housing front what did you think of the latest Reserve Bank report indicating Auckland’s housing shortage is 55,000 and a construction worker shortage of 9,000?
The report also indicates immigration could be hyper expansionary as it looks like immigration contribution to employment supply is not as great as its contribution to housing demand.
https://www.interest.co.nz/property/92379/new-reserve-bank-paper-puts-estimate-auckland-housing-shortage-far-higher-previous
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The authors are both v good. I haven’t read the final version, but I did see a draft quite some time ago and thought it a useful contribution, and quite consistent with my concern – the longstanding NZ economics view in the 50s, 60s and 70s – that large scale immigration typically exacerbates excess demand pressures (incl “skill shortages” in and around construction/housebuilding).
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The problem with your hypothesis is that it points to immigration root cause but given that our top industries are in service, then the root cause is not immigration but the type of industries. Therefore high immigration is actually a byproduct of a service based industry that rely on cheaper people to increase margin rather higher productivity to increase margin. The best service equate to more people not less. That is fundamental to great service.
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The RBNZ brings up the collapse of the Finance sector which provided risk finance to developers. The collapse of the Finance sector was due to the bad mistake that the RBNZ made in increasing the OCR to 9% in rapid succession. A development is usually 100% dependent on debt. Development finance is usually dependent on 70% presales which means that 70% of sales has already locked in their sale price. Any increase in interest rates adds a huge cost and margin decimation on any development project. The end result was a collapse of the building industry which lead to the collapse of the Finance industry funding all these developments.
It is about time the RBNZ took full blame for the current housing crises as they were far too trigger happy with interest rate increases engineering a collapse of a strong NZ economy into a long recession.
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I’d have to strongly disagree on where the blame lies for the housing crisis. Recall that most of the increase in real property prices has been the land price, not the price of the buildings on it.
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Interest rates hovering at Bank Overdraft rates of 10% with an OCR of 8.5% equates to around 15% for Development Finance. Say a $100 million project over 2 years will be progressively financed around eg $50 million at 15% equates to a whopping interest rate bill of $7.5 million which is equal to 7.5% of the total project value which usually equates to a loss. It is not only the cost of materials but also the cost to fund which affects profitability.
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There are a billion different opinions as to the causes – this is mine
Just goes to show how easily it is to intellectualise an issue to the point where the reality is lost
Frankly the components of the GFC are far more complex than can be distilled down to a bunch of academics postulating among themselves and then presenting it as authoritative – goes to show how remote and detached they become and try to relate macro
Would you believe I had been involved in the global financial sphere for 17 years at the time the initial tidal wave of the GFC hit the shores of the USA. At that time I had never heard of CFD’s and TRS’s and some other exotic instruments.
I have watched the film “The Big Short” – it should be compulsory viewing – even they didn’t know – but the evidence was their – and they gambled on it
In my opinion the trigger that tipped it all over was the cost of petrol in the US rising from $2 gallon to $4 gallon. People living in California and commuting 40 miles to work in inefficient gas guzzling giant sized SUV’s (not the SUV’s you see here) suddenly were cash strapped between buying petrol and paying the monthly mortgage. Work and commuting took immediate priority over mortgage payments
Picture what would happen here in NZ if 91 octane petrol went from $2 litre to $4 litre
Anyway that was the trigger – then the Federal Reserve bailed out Bear Stearns – that was good … but the big one was all the back-room midnight wheeling and dealing over Lehman Brothers and the ultimate decision on a Sunday night to let Lehman’s fail
The market reaction to that unleashe3d a tidal wave of worry over $500 trillion of derivatives and interbank lending freezing in the face of not knowing who was exposed to those derivatives
You don’t see any of that in the list of causes above – what came after was consequential to the triggers, and I doubt the principals behind the Lehman’s abandonment had any idea of the consequences of their decision
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“”Just goes to show how easily it is to intellectualise an issue to the point where the reality is lost””. Wish I’d said/written that. (Don’t worry I will).
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I am surprised that tight monetary policy was not listed as a potential cause. The Fed’s decision to do nothing in Sep 2008 and the ECB’s decision to raise rates in July 2008 were catastrophic examples of groupthink. And don’t get me started on the 1930s.
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Fair point. In the end, the survey is probably a bit silly. It tries to cover too much ground – what might have predisposed people to take the risks that went bad, what made them go bad, what exacerbated things once the crisis was upon us, and so on. The authoritative history – perhaps 50 years hence – will have to try to unpick all those (and more).
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I think fractional reserve banking was the biggest culprit. We could easily live in a world without banking crises if we gave up on the idea of the free market controlling the money supply. The free market has shown time and time again that it is hopeless at running infrastructure in a way that benefits society.
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and yet, and yet…..Canada (with fractional reserve banking) has gone 150 years without a financial crisis. Australia and NZ (and Norway and Canada) didn’t have a financial crisis in 1987.
Abolishing fractiional reserve banking would certainly change the form crises took, but (having looked quite closely at various suggested alternatives) I’m sceptical it would eliminate crises.
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