Causes of the Great Recession Part 1 – How We Got Here
Why has the Great Recession occurred — what happened — and given what happened, what can we do to get ourselves out of it?
First, let us be clear about what this recession is — it is a credit crunch brought about by the bursting of a huge real estate bubble. As was the case in the Great Depression, banks leveraged themselves based on irrational exuberance, aided and abbetted by government officials who were unwilling or unable to perform the regulatory tasks assigned to them by law. The proximate cause of the collapse was the creation of a huge, unregulated market in mortgage-backed securities without checks or balances to ensure that the commoditized debt that they represented was good enough to support the leverage to which the banks subjected them to. The derivatives (mortgage-backed securities) served as the reservoir out of which came a great gout of irrational exuberance. Like the Internet Boom of the later nineties, there was a belief that the market would continue to rise — that unlimited prosperity had somehow finally arrived. That great pool of credit was loaned out — and make no mistake, our economy runs on credit — those folks who believe that we can somehow turn the clock back to the nineteenth century (really the early nineteenth century) and return to the gold standard are completely out of touch with reality. Nobody pays cash on the barrelhead for anything these days — we are all recipients of the promises of net-30, net-60, and net-90. Without credit, there can be no flow of goods and services upon which modern civilization depends. Compounding the irrational exuberance, our nation undertook not one but two wars, both done on credit — for the first time in our nation’s history, we fought a war without actually paying for it — and we did it in such a way that far too much was put on the shoulders of far too few — later on I may cover the huge debt that we owe the people who were sent again and again to Iraq and Afghanistan, and who, to add insult to injury were forced to stay in theater after their tours were over — a promise broken on the level of forcing World War II bomber crews to serve on after they had completed the 25 missions that they had been promised would complete their tour of duty. So — there we were, awash in credit that came from the commoditization of our nation’s housing and commercial debt — mixed in with debt munged in from markets around the world, debt which had not been accurately rated and was completely unregulated thanks to the over-permissiveness of the Fed under Alan Greenspan. Greenspan’s faith in the power of markets to be self-regulating, coupled with his distaste for anything that smacked of thoughtful regulation, or really any kind of regulation. Above all, his and other regulator certainty that they knew how the markets operated, even these new, complicated financial instruments that were the product of advanced mathematics, computers, and highly trained academics using game theory and monte carlo simulations to game scenarios whose consequences that even the creators of the model could not with certainty predict the outcomes (except that they knew that the models allowed the people who commisioned them to make extraordinary amounts of money by taking advantage of doing things more quickly than anybody else could — the opposite of Benjamin Graham’s value investors by moving investments around in search of small incremental changes in value that in the aggregate would lead to huge returns through the sheer number of transactions that could be entered into.
To be clear, it wasn’t just derivatives, it wasn’t just bankers and regulators unwilling to do due diligence, nor was it a nation that didn’t look the gift horse of unlimited credit in the mouth, or even legislators who were unwilling to create and enforce the good laws that would have lessened, or possibly even obviated the present credit crunch, but all of these are contributing factors, all wrapped up in the irrational exuberance that is so addictive in our market-based system.
