James Galbraith on the causes of the current economic crisis.
This has to be the clearist short explanation of our current economic crisis that I’ve seen. in an interview with New Deal 2.0 in the US and MMNews in Germany, James K. Galbraith was asked the question, “In July of 2009, you signed an initiative of the Roosevelt Institute that seeks an answer to the question: What Caused the Crisis?(ii) May I ask for your personal answer?”
His answer was this:
“The principal cause of the crisis was the dismantling of the system of regulation and supervision in the financial sector which had for much of the post-war period kept the most dangerous elements of that sector in check. In the absence of an appropriate system of effective supervision and regulation, what happens is that the actors in the system, who are intent upon taking the greatest degree of risk — including actors who are intent upon using fraudulent methods to increase their returns — come to dominate parts of the system. As they do that, the general methods of assessing performance in the market, specifically stock-market valuations, become counter-productive. That is to say, they invariably reward the worst actors, while they force more traditional actors, who are still respecting the old norms of conduct, into a competitively disadvantaged position. Thus the bad actors, the fraudulent actors, and the speculative extremists quickly take over.
That is what happened specifically in the origination of mortgages in the United States in the middle part of the last decade. You had a transition from a traditional method of issuing mortgages to people who could be reasonably expected to service them, to a method of originating mortgages that were sold off immediately, that were rated in a way that permitted them to be bundled and sold to fiduciaries, and where the issuer had no interest in whether the borrowers could pay or not. In fact, in some ways the lenders actively preferred people who did not intend to pay, because they could then inflate the value of the loan and earn a larger fee upfront for doing it. And in this way, not only was there a large segment of the market that was explicitly corrupt, but the equity value of homes all across the country was compromised. When these practices collapsed, so too did the home values not only of people who had bad mortgages, but also those for many people who had good mortgages, good incomes and perfectly good credit.
The result of that was a general slump in activity. The wealth and financial security of much of the American middle class disappeared. So far about a quarter of the measured wealth of the American middle class has disappeared – about $15 trillion of $60 trillion. That’s bound to have a fantastically traumatic effect on people’s consumption behaviour and on their ability to get new good credit. Even if they wish to continue to extend the past pattern of borrowing in order to finance activity, they can’t do it. So, this is a very big problem. It starts with a failure to supervise and regulate the financial system, and flows on to the reaction of the broader population, which is to protect their remaining assets, to become extremely adverse to taking ordinary business and consumer risks.”
In another part of the interview he remarks on recent comments that were made by Senator Ron Paul. Galbraith was asked the question:
“Do you agree with Ron Paul that the “Fed will self destruct when it destroys the dollar”?(xiv) Is the Fed indeed destroying the dollar?(xv) And do you see signs that a run on the dollar might start soon? ”
[…clip…] “So, I think Mr. Paul is really, first of all, wrong, alarmist and to some extent politically motivated. In spite of everything that’s gone wrong in the American economy it’s quite unwarranted to start talking as though there’s an imminent collapse of the dollar. All reserve systems are fragile. All monetary regimes can collapse. It’s not excluded that something very bad could happen. The costs of something like this are however very large, and the most likely thing is that the existing system, the existing role of the dollar, will continue and as I say for the reasons that I’ve just given, the euro is in no position to replace the dollar.”
It is a very illuminating interview if you are interested in the subject, and why wouldn’t you be?
A Link is below:
Dover Beach 