The film is a documentary, narrated by Matt Damon, about the cause of the financial crisis, which it puts squarely at the hands of the financial services industry and its cozy ties with the Federal government. On the question, What happened?, including what temporally preceded the actual meltdown, I think the film is quite good.
of that is a matter of record. I didn't know about some of the
personal indiscretions of players on Wall Street. That was new to me.
As I'm writing this during the week of the Educause national conference
in Philadelphia, I should point out that most of the folks I knew
professionally in Information Technology, though milder than the "type
A" personalities depicted in the film, behave differently when at the
conference, where the vendors want to wine and dine them, than they do
when they are back on their campuses, when everything is paid for with
their own nickel. That dealing-with-vendors environment is omnipresent
for folks who work on Wall Street. So I found that less surprising.
That the behavior is financed by the investments of folks like you and
me, surely that is infuriating, the entire film is meant to stroke our
ire. I used to rationalize some of the wining and dining as a way for
the vendors and us to better understand each other, and there was some
truth to that. I suspect that if you did more investigation of the Wall
Street types and asked them to defend some of these practices, they'd
defend the practices similarly, even if some of the behavior is morally
reprehensible. In any event, that is symptom not cause, so I will push
On the question, Why did this happen?, I think the
film is less good. In a couple of places there were factual errors
presented. The film clearly had an agenda and therefore didn't spend
nearly as much time as it might on presenting alternative views. But
mostly, I believe the problem is that it omitted events and practices
that were relevant, in my view, and so the context for considering what
happened is not set properly. More on all of this below.
(of natural monopoly) actually started under Carter, not Reagan, as it
is stated in the film. The first industry to be deregulated was the
airlines, with the effort led by Alfred Kahn. Had Carter won the
election in 1980, surely telecommunications would have been next. ATT
eventually was split up, in 1984. Given the state of air travel now, it
is hard to offer a definitive conclusion that deregulation was a good
thing. But on telecommunications, that seems to me a no-brainer, in
spite of issues that have emerged.
When Reagan became
President the fervor for deregulation swept across the board. It wasn't
just natural monopoly to be deregulated. Environmental and safety
regulations (regulation of externalties) were also taken to task. Anyone
who remembers Reagan's first Secretary of the Interior, James Watt,
will understand the point implicitly. An unfortunate rhetorical
problem, in my view, is that the word "regulation" applies both to the
natural monopoly case and the externality case. That they might be
different, both in kind and in degree, doesn't get discussed
in typical media or political outlets. So one doesn't usually hear that
you can be for some regulation and against others. That is too subtle
for our discourse. Instead, only the straw man argument is made - for
or against regulation, in toto. This puts the Democrats in the "for"
camp and the Republicans in the "against" camp.
is then the issue of regulation for financial services. Is it a
question of natural monopoly or externalities, or is it neither? I note
that with pollution, for example, you can measure the externality at
the source. With systematic financial risk, however, you can only
measure that by looking at all sources simultaneously. The exact same
behavior can be of no consequence, in one instance, and of dreaded
consequence, in another instance depending on what is going on
elsewhere. This makes it difficult to think of financial regulation as
entirely within the externality family. So I believe it should be its
own separate category, in large part because Government will come to the
rescue when there is a cataclysm. An obvious question to ask then is
whether the industry can be self-regulating, as Alan Greenspan believed
it was before the meltdown. It seems clear the industry was not. Less
clear is why.
The film does go as far as pointing out
that there weren't deductibles, for example with mortgage loan
origination. Were there steep deductibles perhaps many of the excesses
could have been avoided.
To me, much of the answer to
that can be found in the leveraged buyout craze of the 1980s, which gets
no mention in the movie whatsoever. I believe that is a mistake in
setting context. As a defensive strategy against leveraged buyouts,
CEOs and other high level executives got "golden parachutes." The
practice lingers although the problem it was aimed to address may no
longer be an issue. More important, however, is the following. The
film makes the point that outsiders: SEC regulators, the ratings
agencies, and the accounting firms, have a tough time interpreting
information that is on the firm's balance sheet. (Sometimes this is
fraud, but I believe much of this is simply not understanding the
picture from the data they do observe, perhaps because the books are
cooked to mask the problem, but also simply because of complexity.) The
film doesn't point out, however, that corporate boards are in the same
boat. Therefore it is extraordinarily difficult to measure how the firm
is positioned for the long haul, whether its hand is strong or weak.
Consequently, current earnings are king. This makes the firm myopic in
its objectives. That has always been a problem. The corporate
takeovers made it much worse. In case its not obvious, deductibles
might have improved the balance sheet long term. But immediately, they
make earnings worse.
The other thing, I believe, that
the LBOs did was to create a hunger in the financial houses, to get more
of the pie from financial transactions. Why leave the spoils for
Michael Milken and Carl Icahn? So I don't see it as such a great leap
to go from the Junk Bonds of 1980s to the subprime loans and the slicing
and dicing of mortgages of the 2000s.
of history that is omitted in the film is the Asian Debt crisis of the
late 1990s. It is tempting to view the U.S. meltdown as an
it-happened-here-first phenomenon. But it may be more appropriate to
consider it part of an ongoing cycle that started earlier. The
fundamental issue then is that cheap credit leads to high leverage,
which in turn can lead to default if circumstances change for the
worse. Much of this is bubble driven. When asset values appreciate
rapidly, why be cautious? Note that in the U.S. the personal saving
rate declined precipitously in 1999 (and then stayed low). Ours
certainly was a larger scale crisis. But that doesn't mean the root
cause was of our making alone.
Let me turn next to the
issue of creating securities to provide insurance - derivatives if you
will. The word itself is toxic now. But the concept shouldn't be.
This is a straight economies of scale argument. Insurance makes sense
from the provider point of view if there are a large number of
independent risks, so the provider can properly diversify. This makes
natural disaster insurance somewhat problematic, because the risks are
correlated. However, the risk correlation is local. Globally, a bunch
of local risks starts to look independent. Global financial markets are
the proper place to bring such risks. Local insurers, even with
reinsurance markets, don't have enough scale to get the right
diversification. This argument is made in a piece by Michael Lewis,
written a year before the financial crisis, in Nature's Casino.
It makes for an interesting read, one that provides an argument for
securitization. That argument is not in the film.
course, insurance does create moral hazard for the insured regarding
inadequate precaution. Where to site a home, when natural disaster risk
is present, is from this point of view the same issue as how big a home
to buy, in the presence of default risk. The moral hazard issue gets
nary a mention in the film. The predatory lenders get all the blame,
instead of sharing it. This is where I have issues with the Occupy Wall
Street protests. They point the finger at the 1%, but don't talk about
the responsibility of the 99%.
Finally, let me turn to
the last part of the film, where some important economists are depicted
either as clueless (like the regulators, Rick Mishkin is cast in a
terrible light) or as having completely sold their souls to the devil,
getting big-time fees for serving on Bank boards, etc. (so doing the
bidding of the financial services industry). In considering this, let
me set Larry Summers aside for a minute on that and talk about the
I believe the movie has cause and effect
reversed here. Glenn Hubbard, Chairman of the Council of Economic
Advisors under Bush II and current Dean of the Business School at
Columbia, is a good case in point. His views about the relationship
between taxation and economic growth, which I disagree with strongly,
are what came first. He's a supply sider and one of the authors of the
Bush Tax Cuts. This makes him kind of a superstar in some circles. His
reputation followed from his academic beliefs. Here it needs to be
pointed out that Economics at the macro level is not science - no
controlled experiments are possible. Cause is imputed from the
historical record. So economists can disagree about cause. But those
disagreements are based on a prior intellectual orientation. Ditto for
Martin Feldstein, also shown in the film, who chaired the Council in the
Reagan era. I believe questioning their integrity was, hitting below
the belt. It is enough to question their views about policy.
do think Larry Summers is a different animal, in part because some of
his academic writings are Keynesian in spirit and in part because quite
recently he has been pro stimulus, particularly for relief on the
payroll tax. In the 1990s, however, in his various government roles he
was very much a free trader and for deregulation of financial services.
So, how does one square that? Here is one conjecture and one
observation. Not all economists are attracted by political power, but
some are and I believe Summers was. He had conquered the world of
academic publishing and was looking for a different game to play. In
the new world, with Robert Rubin his mentor, both free trade (which most
economists would ascribe to at first pass) and deregulation in
financial services part of the mantra, and the U.S. in high growth mode,
forebodings about the impact on future downturns were absent. These
were policies for the present.
This gets me to the
observation. Human nature being what it is, there is a tendency to want
to regulate when the economy slumps, to rule out that past
indiscretions will repeat, and to deregulate at the start of a boom, to
get rid of impediments that might hamper growth. Alas, having an
entirely time consistent view is difficult, particularly if at heart you
are a pragmatist. Ideologues may have it easier on this score, but
they have the issue that their ideology may seem out of sync with
current reality. The problem is more severe in that there can be
substantial lag between policy implementation and economic consequence.
Further, when living in the present we may not understand the causes of
current events. In the late 1990s there was genuine confusion about
whether the Internet had changed the economy unalterably, or if it was a
bubble. The evidence was provided with many companies that had huge
growth in usage but had negative earnings. Would Summers have argued
the way he did in the 1990s had he known how the 2000s would turn out?
I don't know.
Let me wrap up. The film cast the Wall
Street Insiders as perpetrators of a crime. That is probably a good
thing. It implicitly makes us viewers victims of that crime. That is
not a good thing because, apart from punishing the perpetrators, it
doesn't tell us what we should want next. So it missed an opportunity
for the audience to learn. It is still not too late to be asking that