The Big Short, the Fed, and the Market

If you want to know what happened in 2008, I mean really want to know, read this excellent (and short) book.
If you want to know what happened in 2008, I mean really want to know, read this excellent (and short) book.

I haven’t seen the movie yet but I might over the weekend. One of the reasons I haven’t seen it yet is because I have heard that it pounds on the same old (false) reasons for the 2008 Crash, that being that somehow the market “failed.” That “greed” was the culprit, etc. etc. It’s what most people believe. It is the easiest narrative to sell. And it is also wrong.

People are greedy. This is part of being a human being. The hedge fund guys and the big banks are greedy, just like almost everyone else. The difference is that these guys had their greed facilitated by a central bank which kept rates too low for too long and which had bailed out financial institutions in the past. (2008 was not the first Fed bailout, just the largest.) The reason 2008 happened – the reason the financial markets imploded – was because of central planning from the Federal Reserve. That’s it at the most fundamental level.

Instead of having real interest rates dictated by the market which naturally adjust, the Federal Reserve politburo set rates which were out of line with what rates should have been. (Pretty much all the time but particularly in the lead up to the Crash.) As such there was malinvestment. Tons of it. And eventually the market corrected for the Fed induced malinvestment.

So long as we avoid this “inconvenient truth” we are going to see crisis after crisis – actually we really are still mid crisis on a global scale 7 years after the Crash.

Markets work. Planners don’t. That should be the lesson we take from the Great Recession. But this flies in the face of many vested interests, from Fed addicted banks, to politicians, to Keynesian economists who sell their religion for big bucks, to the media, to your financial advisor. No one wants to acknowledge the truth. It costs them money and power. Admitting the truth means super powerful interests have acknowledge that they are/were wrong and that their power is illegitimate. That ain’t gonna happen.

But at least you will know why things are the way they are.

(From FEE)

So the pro-regulation crowd is cheering. Viewers are given no understanding of the real causal factors and hence fill in the missing data with a feeling that banks just love ripping people off.

To be sure, if you approach this movie with some knowledge of economics and monetary policy, the rest of the narrative makes sense. Of course Wall Street got it wrong, given Washington’s policies on mortgage lending!

However, if this were your one and only exposure to the history of the crisis, and knew nothing beyond it, it is easy to see how a person could walk away thinking: “Wow, Wall Street and the capitalist system are rackets that desperately need controlling by a powerful government.”

But it’s an odd message to read into the story, since the movie also nicely shows how the large banking firms, investment houses, rating agencies, and regulators all worked together, riding the boom as high as possible and delaying the correction until the last possible moment.

How new regulations would fix this is not entirely clear — who regulates the regulators?

Click here for the article.