Who is to Blame? Crisis Management and the Financial Crisis

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What exactly went wrong to cause the economic downfall?  In exploring this question I looked at several different blogs and many of them pointed to the same factors.  Crisis management of large institutions, that are largely affected by politics, is one of the major issues when discussing the financial downturn in the United States.  The first article I looked at was  “Break Up the Banks” found on baseline scenario.  Kling states first that that “There is a free-market case for breaking up large financial institutions: that our big banks are the product, not of economics, but of politics.” These large institutions are often influenced by governmental policies and therefore do not initiate a free market.  His argument is to make banks smaller so that they are less influence by government policies and therefore are less likely to affect the overall economy.  But what are the chances of this type of regulation actually happening?  In the article it is stated that, “My skepticism of Kling’s argument is that, like some principled right-wing arguments that acknowledge climate change, it argues for an ideal solution that lacks any chance of happening, while favoring the status quo over a second-best solution.”  Although the idea of “breaking up the banks” may be good in theory, it does not seem feasible in American society.

Furthermore, the short sightedness of these large institutions caused the problem of politics to get even bigger. From 1996 to 2006 many businessmen believed that the rapid growth of the housing market would continue indefinitely.  Another article found at Freakonomics addresses this.  In Scaling the Heights of Corporate Greed the risk management put into place by these types of institutions is addressed. “And despite all the protections that were available to these captains of industry — analytics that showed large potential losses in the event of a downturn in housing prices, leverage constraints imposed by regulatory capital requirements, and warning signs from the hedge-fund industry in 2005 and 2006 — they charged ahead anyway…”  This failure to keep in mind long term consequences and the power of these institutions contributed greatly to the financial crisis that we are in now.

Overall, risk management of large financial institutions and those who recognized that problems within the market had a large effect on the financial crises.  Chafkin and Lo argue that we must recognize that sometimes losses will be severe but we must be able to learn from this instead of continuing to back away from crisis management.  In this article, they also point out that CEOs are often used a scapegoats for finances gone wrong and greedy businessmen only seeking to make a profit.  But this is not the case.  The system as a whole contributes to these decisions and the government influences are hard to ignore  “The system … was capable of displaying one type of behavior for a long time and then suddenly changing its behavior completely.” With even educated businessmen unsure of what to do in this type of situations, Chait calls for increased regulation within these powerful institutions.  If this were to happen, it is possible that the shortsightedness of the leaders as well as political influence on some large financial institutions would be less likely to affect the economy as a whole.

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2 Responses

  1. I read a little bit about proposed banking reforms for my post this past week. There are a lot of people calling for breaking up the banks into smaller units, but at the same time there are many who believe this is a terrible idea. What are your thoughts on this Macey? Your post makes it seem like you do not support this type of reform. I would probably agree that it is not feasible right now in our economy.

  2. In theory, “breaking up the banks” seems as though it could be beneficial. With smaller agencies there is bound to be less political influence as well as less governmental regulation. Also, it could be argued that these larger banks do not initiate a free market because of these outside influences. On the other hand, as Chait argues maybe regulation within the institution is what is necessary. Our system is unlikely to be altered since, as we discussed in class, many are reluctant to change despite societal pressures. I think this is especially true for systems that have become so established. Since this move toward smaller institutions seems infeasible, regulation may be what we need to keep the power of these institutions in check.

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