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A Different Kind of Revisiting the 2008 Financial Crisis

Summary:
During the past few months, John Cochrane and I organized a series of workshops on the 2008 financial crisis. Monika Piazzesi, George Shultz, Niall Ferguson, Caroline Hoxby, and Darrell Duffie joined us in making presentations and, along with other colleagues who attended, turned the series into a vigorous and informative discussion. We defined each workshop by topic: Causes, Panic, Recession, and Lessons, and posted papers or summaries by each presenter as well as full transcripts of each of the four workshops: Causes: Piazzesi, Taylor, Transcript of workshop Panic: Shultz, Ferguson, Transcript of workshop Recession: Hoxby, Taylor, Transcript of workshop Lessons: Duffie, Cochrane, Transcript of workshop An enormous amount of research on the crisis during the past ten years is found

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During the past few months, John Cochrane and I organized a series of workshops on the 2008 financial crisis. Monika Piazzesi, George Shultz, Niall Ferguson, Caroline Hoxby, and Darrell Duffie joined us in making presentations and, along with other colleagues who attended, turned the series into a vigorous and informative discussion. We defined each workshop by topic: Causes, Panic, Recession, and Lessons, and posted papers or summaries by each presenter as well as full transcripts of each of the four workshops:

An enormous amount of research on the crisis during the past ten years is found in these links, so we also had an overview session where the presenters gave 5-minute summaries and took questions from an audience where 300 showed up.  Here’s a transcript and a video of that overview session. It reveals a revisiting that challenges in many ways conventional wisdom recently emanating from journalist summaries, memoirs of public officials, and even other anniversary events recently held at BrookingsCATO, and AEI. Here is a quick overview of that overview:

I started off by reviewing the empirical evidence on the role of “monetary policy in causing, in bringing about, the financial crisis…because that [interest] rate was so low, with excess risk taking to get a higher rate, excesses that spread to the housing market.” I also noted that Monika Piazzesi, who could not be at the overview session, “explored in great detail the excesses in the housing market, that brought a housing boom on a scale that had never been seen before, and an ultimate collapse.” Of course, that monetary policy explanation is not stressed by Fed officials in recent revisits of the 2008 crisis. I also discussed why the fiscal “stimulus packages…really didn’t do much good. Money just went in people’s pockets, and there really wasn’t much effect on the economy.”

George Shultz then noted, more basically, that the crisis was the result of violating “three fundamental principles that need to be kept in mind. One is accountability. From the ground up, there was no accountability. Number two is the sense of competence. Are the people competent running things? That was violated. Number three: trust. You have to have trust that the people doing things know what they’re doing, and that was violated. So, I think the net of all this was a very bad episode, and we still pay the price for it…” The view is quite different from recent revisits that focus in the clean-up operation rather than on these basic problems.

Niall Ferguson then mentioned other policy problems: “undercapitalization of banks” and “the way that structured financial products like collateralized debt obligations proliferated, and rating agencies insisted that they were AAA rated when they really were nothing of the kind…. Monetary policy…had been loose for most of 2002 to 2004 in a way that really wasn’t defensible. There was funny stuff, as George Shultz has mentioned, going on in the US real estate market….a whole bunch of rather opaque contingent liabilities that hadn’t been there before. And finally, I think you have to include in the explanation China, and what we used to call global imbalances….”

Caroline Hoxby sensibly focused on labor markets as a reason for the very slow recovery from the crisis. She noted that “…labor markets really did not adjust quickly…leading to a much longer recovery, a much slower recovery, and in many ways a recovery that has never completely occurred. Despite the fact that we have low unemployment rates…The labor force participation rate fell very sharply during the Great Recession, immediately following the financial crisis, and it has never really recovered.” Citing government policies relating to disabilities and education, she then concluded that “I’m less optimistic than most of my fellow economists here, because I am very concentrated very much on the labor market, where I see a lot of indications that the Great Recession to some extent still continues.”

Darrell Duffie and John Cochrane concentrated on lessons for financial markets and banks. Duffie discussed the problem of “too-big-to-fail” at the time of the crisis. The “banks correctly assumed at the time, that if one of these banks were to fail, that it would cause a crater on the economy…. And creditors before the financial crisis said to themselves, ‘They’d never let that happen. The government wouldn’t let that happen. The government, if necessary, will bail out these banks, because surely they wouldn’t cause a crater on the economy.’ ” While he argues that more could still be done, including reforming the bankruptcy law, he also notes that “Since then, things have changed. The idea that the government will bail out a large bank has been disposed of, or at least in the minds of the creditors; they no longer give credit to the idea that they will get bailed out if the bank gets in trouble.”

John Cochrane focused on having enough capital and on preventing runs.  “…we’re finally figuring out the one central answer is not: send in a bunch of regulators to make sure the assets are even safer, so you can finance them 30 to 1 with overnight debt. The answer is, risky investments need to be financed like the tech stocks, with investors’ money, where if it’s a risky adventure that loses value, if your statement goes down in price and you can’t run and say, ‘Give me back my money now,’ and you can’t do it instantly, you’re out of business. That’s the mechanics that caused the crisis. So, capital is the salve of all wounds, and I think we’re figuring that out…. So, where are we now? Capital’s a good deal higher. It’s, rough numbers, from five percent, it’s now ten percent. In my view, ten percent is nowhere near enough. Ten percent is good enough for a while,” and he worries that political forces are again moving in the wrong direction.

In sum, while there was by no means full agreement, the series brought attention in different ways to the central unifying fact that many economic policy issues still need to be addressed–from accountable top-level leadership to underlying legislative changes–if we are to prevent crises and keep the economy growing  smoothly in the future.

John Taylor
John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University. He formerly served as the Director of the Stanford Institute for Economic Policy Research where he is currently a Senior Fellow. He is also the George P. Shultz Senior Fellow in Economics at the Hoover Institution.

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