Further Research: Alan Greenspan’s Take on the Causes of the Recession

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In preparing to write the final paper I have come to the conclusion that I desire to focus on how the actions of economists and large firms like Lehman Brothers led to the current economic recession. My preliminary explorations suggested to me that both economists and Firms like Lehman brothers had a sense that the market was now safe and that they could predict its course of action with ease. As I mentioned in my post last week, the belief that the market had become “inherently stable” led market actors to make decisions that ultimately resulted in financial crisis. Moving forward, I want address the question of why they acted in the manner they did in a little more detail, but more importantly I want to understand how the actions of economists and large firms caused the market to collapse. In addition, I want to see if there was a chance to avoid this recession by looking at the case of Lehman Brothers and exploring their organizational actions prior to the recession; hopefully enabling me to identify points in time where actions could have been taken to avoid the downturn, what those actions were, and who should have undertaken them. However, to do so I still need to look more deeply into the causes of the recession.

To start looking into the causes of the recession with greater depth I first turned to the Financial Crisis Inquiry Commission and the testimony of Mr. Alan Greenspan that can be found on their web page. Greenspan states early that while the “global proliferation of securitized U.S. sub-prime mortgages” was the trigger for the recession, he traces its roots back to the discrediting and displacement of central planning by competitive markets in the late 1980’s and early 1990’s. Stating that the huge economic growth of the decade and the “unsustainably low” risk premiums encouraged huge investment in the sub-prime market, Greenspan goes on to point at the involvement of government sponsored enterprises like, Freddie Mac and Fannie Mae, as committing such a large amount of money in the industry that the deflation of the housing bubble caused significant damage to the economy.

Greenspan’s testimony made clear to me that because there was no central planning in the industry, and because the market was overly focused on competition, the impact of the housing bubble’s deflation was not properly understood or planned for. Coupled with the assumption of the market’s “inherently stable” nature it becomes easy to see how the collapse of the having bubble could have resulted in an economic downturn because there was no preparation for its occurrence. Meaning that when the bubble did collapse, those hurt by it had no way to respond and mitigate its damage. Forcing financial institutions to respond to situation they were wholly unprepared for, and resulting in a chain of events that caused the “Great Recession“. Overall, I found Greenspan’s testimony very helpful in beginning to look at the causes of the economic crisis in greater depth. I plan on reading the book “A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers” by Lawrence McDonald and Patrick Robinson to identify the organizational failure that contributed to the situation.

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4 Responses

  1. Derek, this is similar to my topic. I think it would be a good idea to bounce ideas off each other regarding this.

    • Yeah, I think that could work well for both of us. It might help us build our own ideas by hearing each other’s views of the issue.

  2. How did economists and the financial sector influence each other? In general, economists live in their little worlds of academia- publishing articles, teaching, writing books. Not that many serve on boards of firms and they don’t run the companies?

    I think examining how ideas about economics and economic theory move between academia and the financial system (or the business community generally) would be a useful aspect to look at when looking at how economic ideas contributed to the Great Recession. Your interest in sociology or organization theory can help fill this in. How did economics ideas become part of the environment for financial firms?

    I don’t know what Greenspan means about central planning being displaced by markets. Planning of what?

    There are some good strong opinions out there about Greenspan’s role in advocating for that displacement. Also, there is a very politicized process about trying to blame Freddie Mac and Fannie Mae. If you are going to address that issue, you will want to look at both sides.

    Finally, in terms f being able to anticipate how to respond, Be Bernanke, the current fed chair, specialized in economic history of the Great Depression. So, if anyone had thought about how to respond, it was him.

  3. You might want to check out Jerry Davis’ book about markets called Managed by Markets. It may be that kind of broad analysis you want.

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