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Book Review Allan S. Blinder, After the Music Stopped –The Financial Crisis, the Response, and the Work Ahead (New York, Penguin Press, 2013)
Raymond Richman, 6/1/2015

Allan Blinder is a Princeton professor of economics and a former vice chairman of the Federal Reserve Board. As he states in his preface, the American people still don’t quite know what caused the Great Recession, how and why it happened, or what the authorities did about it.

He acknowledges that the housing bubble was not the only contributor to the financial crisis that followed. He writes that seven key weaknesses predated the recession:

  1. Inflated asset prices,
  2. Excessive leverage (heavy borrowing) throughout the economy,
  3. Lax financial regulation,
  4. Disgraceful banking practices,
  5. Unregulated securities and derivatives,
  6. Abysmal performance of statistical credit agencies,
  7. Perverse financial incentives inducing financial institutions to “go for broke”.

He does not mention that the Community Investment Act of 1977, which is still the law, which forced  the banks and Fannie Mae and Freddie Mac, government-sponsored private entities, to make millions of subprime loans. Nor does he mention that the Federal Reserve Board was made responsible by the Act for ensuring that mortgage lenders maintained lending standards, but that it failed to do so and thereby itself helped worsen the recession.  He does not mention the explosion of our trade deficits that resulted from foolish trade agreements and were a drag on economic growth.

The inflated asset prices he criticizes were caused by the low long-term interest rates, partly caused by the inflow of foreign government loans which caused the trade deficits. As every economist knows lowering interest rates inflates asset prices, real estate and corporate stock especially. There was lax financial regulation alright, but the Fed and the other bank regulators did not use the powers they had to regulate financial institutions. Yes, there were disgraceful banking practices. As for perverse financial incentives, banks rewarded executives for taking risks and producing profits as long as the bubble continued. When the bubble burst, Treasury Secretary Paulson bailed out all but Lehman Bros. Its failure precipitated a collapse in the securities markets.

He blames lack of regulation. But he ignores the bankruptcies in the regulated and subsidized climate change industry and the bloated subsidies. Every wind and solar firm and electric or fusion automaker is heavily subsidized. Wind and solar energy producers could continue to exist if electric utilities were not forced to pay them inflated prices which are then passed on to consumers of electricity as a hidden tax.

He believes that if financial institutions and derivatives were regulated and leverage reduced, the crisis would have been less severe. Maybe, and economic growth would be sacrificed. Many investors fear that we face another world-wide financial crisis in spite of the thousands of pages of Dodd-Frank regulations.

He describes the measures taken by Presidents G.W. Bush and Obama to prevent a recession, such as Bush’s tax rebates and the bail-out of Bear-Stearns and AIG by the Fed of the Troubled Assets Relief Fund (TARP) which injected capital into the major banks and the FED’s efforts to increase liquidity, and its purchase from Bear Stearns of $30 billion in sub-prime mortgages.

But Secretary Paulson refused to bail out Lehman Bros. which precipitated the Panic of 2008:. “All hell broke loose after Lehman Brothers failed on September 15, 2008.” AIG. Contagion. Run on the money funds. Treasury and Fed came to the rescue. What the Fed was doing was lending money to banks and money market funds, to other lenders and even some foreign institutions. The Fed encouraged big banks to come to the rescue of other banks and investment institutions. Of the $700 billion in TARP, about $430 was disbursed. It bought few troubled assets and cost taxpayers very little in the end.

Blinder asks, “Stimulus wherefore art thou?” He discusses the Economic Stimulus Act of 2009, the tax rebate, and he remarks that the total stimulus was less than it should have been blaming the Republicans. Given the size of the program and the huge annual federal budget deficits, it is obvious that the policies were ineffective to promote an economic recovery.

Blinder argues that the policies worked about as expected. He does not question, being a Keynesian himself and a member of the Federal Reserve Board, whether the Keynesian policies he would prescribe were defective. It is about time he did. It could be argued that government stimulates best when it stimulates least.

Recovery has to come by stimulating the private sector. Instead, the Obama administration’s policies discouraged investment at home and encouraged American firms to re-locate abroad. China prospered as a result of our policies while manufacturing in the U.S. languished.

Who and what does Blinder blame? Why did the stimulus fail? First, he blames the large interest rate spread between the rate the Treasury pays and the rate that the private sector, including consumers pay. It is hard to take this seriously.  He blames the fact that spreads are based on perceived risk and inflation expectations. 

What does he propose? Some banks are “too big to fail.” He favors adoption of the Volcker rule: insured banks should not engage in proprietary trading. Regulate hedge funds, limit executive compensation so as not to encourage excessive risk taking, over-seeing rating agencies, and use benefit-cost criteria in economic decision–making. He proposes to re-instate Glass-Steagall.

He writes: “Dodd-Frank gives America a comprehensively, if imperfectly reformed financial system if we can keep it.” We believe both are unnecessary. Big banks are not too big to fail. They would continue operations after bankruptcy but the shareholders would be wiped out, as they should be for taking excessive risks.

These are all designed to prevent another recession. But nothing to do with stimulating economic growth.

What did he learn from the financial crisis? He suggests that unconventional monetary policy may be the new normal, that we need more regulation, that regulatory neglect got us into this mess. What nonsense! He writes that, as Hegel wrote: “What experience and history teaches us is that people and governments have never learned anything from history.” True but neither has Prof. Blinder learned much from the history of the recession!

What this reviewer has learned from this recession appears in article after article on this blog.

1. The housing bubble originated in an absurd law called the Community Investment Act of 1977, which is still in effect and which in effect ordered banks to make subprime loans. Oh, the law says that mortgage standards were to be maintained and put the Federal Reserve Board in charge of oversight together with the other bank regulatory agencies. They not only did nothing to maintain lending standards; they aggravated it. But that’s another story.

2. Other factors contributed. Our government ignored the exploding the U.S. international trade deficits which grew to over $800 billion in the early 2000s. They cost millions of American jobs and probably precipitated the defaults in mortgage payments that burst the housing bubble.

3. American corporations by the hundreds relocated their factories abroad secure in the knowledge that U.S. trade agreements enabled them to produce their products abroad and sell them in the U.S. without tariffs.

4. Keynesian policies designed to stimulate consumption did not address the problem that it was the lack of manufacturing investment in the U.S. that was a cause of our malaise.  

5. The federal, state, and city governments prevented millions from finding jobs as result of their minimum wage laws.

6. The Fed’s quantitative easing policies caused an artificial rise in security and real estate prices giving the appearance of a recovery of the economy and economic growth but creating few jobs.  

7. As Prof. Blinder noted, there was excessive leverage throughout the economy, foolish Wall Street policies that permitted abuse of unregulated securities and derivatives, and perverse financial incentives that caused banks and other lenders to take excessive risks.

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Comment by Richard Manfredi, 7/2/2015:

 I disagree ."Many investors fear that we face another world-wide financial crisis in spite of the thousands of pages of Dodd-Frank regulations."Yes, Glass-Steagal 33 pages vs deli baloney . "It bought few troubled assets and cost taxpayers very little in the end." Technically , it didn't cost you "interest" if you never received it. In the real world, any one who saved a dime was , is , and continues to be flogged by the 'Zero' interest policy.Three legged stool anyone? " Keynesian policies designed to stimulate consumption did not address the problem that it was the lack of manufacturing investment in the U.S. that was a cause of our malaise." No, it was a lack of dispoable income from the consumer who provides 80% of the gas for the economy. No demand from wholesalors,  retailers , consumers. This 'recovery' is a maintenance or replacement economy. You maintain what you have until it falls apart , then you replace it . If there was demand, there would be investment . Who in there right mind will build a factory when there is no market for the product ?

I have one word on flipping houses ; I can't flip panckes . This bank and that bank were fined billions,  more deli baloney . The stock holders were fined billions , management should have been put behind bars.  

      

 




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