Wall Street leverage, liar loans, myopic rating agencies, undercapitalized lenders, out-of-control derivatives, overly aggressive government-sponsored enterprises, misincentivized CEOs, captured regulators and foolish Federal Reserve policy have been blamed to some degree for causing the Great Recession that started at the end of 2007.
Laurence Kotlikoff thinks they’re all wrong.
The Boston University professor, to be clear, isn’t arguing against the existence of all those ills.
“There were plenty of bad actors — enough to fill up hundreds of books and movie scripts. But the story of these bad actors is not the real story of the Great Recession,” he said.
He just doesn’t see them as causes.
“Sheer panic, facilitated by opacity, false rumors, misinformation, exaggeration and a strong assist from interested parties, flipped the economy to a very bad equilibrium,” he says in a new paper circulated by the National Bureau of Economic Research.
For instance, he says, there was no fundamental news in Bear Stearns’ last week that drove its stock value from $70 a share to $2. He quotes Bear Stearns’ former CEO, Jimmy Cayne, as saying, “the market’s loss of confidence, even though it was unjustified and irrational, became a self-fulfilling prophecy.”
And while Cayne’s comments can be construed as self-serving, the former chairman of the Securities and Exchange Commission, Christopher Cox, said similarly.
He points out that models of bank runs find that “a bank run can rise as naturally as not.” More troubling, he says, is that the banking system is inherently built to fail.
The Financial Crisis Inquiry Commission, he says, ignored theories of bank runs, which he compared to the “Federal Aviation Administration investigating a plane crash due to structural failure without referencing the plane’s blueprints.”
His solution is pretty drastic. “Banks that have zero leverage — don’t owe anything to anyone — can’t go bankrupt. Hence, the obvious way to prevent future banking crises is to preclude all financial corporations from borrowing,” he said. Kotlikoff also says the government should oversee disclosure to attack the problem of opacity.
Steve Goldstein is MarketWatch’s Washington bureau chief. Follow him on Twitter @MKTWgoldstein.
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