Getting out of our current financial mess requires understanding how we got into it in the first place. The fundamental cause, according to the likes of Republican presidential candidate Senator John McCain, was greed and corruption on Wall Street. Though not one to deny the existence of such base motives, I would insist that the crisis has its roots in key policy decisions stretching back over decades.
In the US, there were two key decisions. The first, in the 1970s, deregulated commissions paid to stockbrokers. The second, in the 1990s, removed the Glass-Steagall Act’s restrictions on mixing commercial and investment banking. In the days of fixed commissions, investment banks could make a comfortable living booking stock trades. Deregulation meant competition and thinner margins. Elimination of Glass-Steagall then allowed commercial banks to encroach on the investment banks’ other traditional preserves.
In response, investment banks branched into new businesses like originating and distributing complex derivative securities. They borrowed money and put it to work to sustain their profitability. This gave rise to the first causes of the crisis: the originate-and-distribute model of securitization and the extensive use of leverage.
It is important to note that these were unintended consequences of basically sensible policy decisions. Other things being equal, deregulation allowed small investors to trade stocks more cheaply, which made them better off. But other things were not equal. In particular, the fact that investment banks, which were propelled into riskier activities by these policy changes, were entirely outside the regulatory net was a recipe for disaster.
Similarly, eliminating Glass-Steagall was fundamentally sensible. Conglomerates allow financial institutions to diversify their business, and combining with commercial banks allows investment banks to fund their operations using relatively stable deposits instead of fickle money markets. This model has proven its viability in Europe over a period of centuries, and its advantages are evident in the US even now with Bank of America’s purchase of Merrill Lynch.
But conglomeratization takes time. In the short run, Merrill, like the other investment banks, was allowed to double up its bets. It remained entirely outside the purview of the regulators. As a stand-alone entity, it was then vulnerable to market swings. A crisis sufficient to threaten the entire financial system was required to precipitate the inevitable conglomeratization.
The other element in the crisis was the set of policies that gave rise to global imbalances. The Bush administration cut taxes. The Fed cut interest rates in response to the 2001 recession. Financial innovation, meanwhile, worked to make credit even cheaper and more widely available. This, of course, is just the story of subprime mortgages in another guise. The result was increased US spending and the descent of measured household savings into negative territory.
Of equal importance were the rise of China and the decline of investment in Asia following the 1997-1998 financial crisis. With China saving nearly 50 percent of its GNP, all that money had to go somewhere. Much of it went into US treasuries and the obligations of Fannie Mae and Freddie Mac. This propped up the dollar and reduced the cost of borrowing for US households, encouraging them to live beyond their means. It also created a more buoyant market for the securities of Freddie and Fannie, feeding the originate-and-distribute machine.
Again, these were not outright policy mistakes. Lifting a billion Chinese out of poverty is arguably the single most important event in our lifetimes. The fact that the Fed responded quickly prevented the 2001 recession from worsening. But there were unintended consequences.
The failure of US regulators to tighten capital and lending standards when abundant capital inflows combined with loose Fed policies ignited a furious credit boom. The failure of China to move more quickly to encourage higher domestic spending commensurate with its higher incomes added fuel to the fire.
Now, a bloated financial sector is being forced to retrench. Some outcomes, like the marriage of Bank of America and Merrill Lynch, are happier than others, like the bankruptcy of Lehman Brothers. But, either way, there will be downsizing. Foreign central banks are suffering capital losses on their unthinking investments. As they absorb their losses on US treasury and agency securities, capital flows toward the US will diminish. The US current-account deficit and the Asian surplus will shrink. US households will have to start saving again.
The one anomaly is that the dollar has strengthened in recent weeks. With the US no longer viewed as a supplier of high-quality financial assets, one would expect the dollar to have weakened. The dollar’s strength reflects the knee-jerk reaction of investors rushing into US treasuries as a safe haven.
It is worth remembering that the same thing happened in August last year when the subprime crisis erupted. But once investors realized the extent of US financial problems, the rush into treasuries subsided, and the dollar resumed its decline. Now, as investors recall the extent of US financial problems, we will again see the dollar resume its decline.
Emphasizing greed and corruption as causes of the crisis leads to a bleak prognosis. We are not going to change human nature. We cannot make investors less greedy. But an emphasis on policy decisions suggests a more optimistic outlook. Unintended consequences cannot always be prevented. Policy mistakes may not always be avoidable. But they at least can be corrected.
That, however, requires first looking more deeply into the root causes of the problem.
Barry Eichengreen is a professor of economics at the University of California, Berkeley.
COPYRIGHT: PROJECT SYNDICATE
I came to Taiwan to pursue my degree thinking that Taiwanese are “friendly,” but I was welcomed by Taiwanese classmates laughing at my friend’s name, Maria (瑪莉亞). At the time, I could not understand why they were mocking the name of Jesus’ mother. Later, I learned that “Maria” had become a stereotype — a shorthand for Filipino migrant workers. That was because many Filipino women in Taiwan, especially those who became house helpers, happen to have that name. With the rapidly increasing number of foreigners coming to Taiwan to work or study, more Taiwanese are interacting, socializing and forming relationships with
Chinese social media influencer “Yaya in Taiwan” (亞亞在台灣), whose real name is Liu Zhenya (劉振亞), made statements advocating for “reunifying Taiwan [with China] through military force.” After verifying that Liu did indeed make such statements, the National Immigration Agency revoked her dependency-based residency permit. She must now either leave the country voluntarily or be deported. Operating your own page and becoming an influencer require a certain amount of support and user traffic. You must successfully gain approval for your views and attract an audience. Although Liu must leave the country, I cannot help but wonder how many more “Yayas” are still
Earlier signs suggest that US President Donald Trump’s policy on Taiwan is set to move in a more resolute direction, as his administration begins to take a tougher approach toward America’s main challenger at the global level, China. Despite its deepening economic woes, China continues to flex its muscles, including conducting provocative military drills off Taiwan, Australia and Vietnam recently. A recent Trump-signed memorandum on America’s investment policy was more about the China threat than about anything else. Singling out the People’s Republic of China (PRC) as a foreign adversary directing investments in American companies to obtain cutting-edge technologies, it said
The recent termination of Tibetan-language broadcasts by Voice of America (VOA) and Radio Free Asia (RFA) is a significant setback for Tibetans both in Tibet and across the global diaspora. The broadcasts have long served as a vital lifeline, providing uncensored news, cultural preservation and a sense of connection for a community often isolated by geopolitical realities. For Tibetans living under Chinese rule, access to independent information is severely restricted. The Chinese government tightly controls media and censors content that challenges its narrative. VOA and RFA broadcasts have been among the few sources of uncensored news available to Tibetans, offering insights
RSS