Reasons for the Crisis: Message 1/10

On April 20 and 21, I attended a special meeting of the "Growth Commission" which took place at Harvard. 

It was an impressive, closed-door gathering of some of the best minds in the profession. There were four Nobel laureates (Akerlof, Scholes, Solow, Spence);  a line-up of academic luminaries (Acemoglu, Aghion, Banerjee, Calomiris, Cooper, Feldstein, Frankel, Hausmann, Ito, Kenen, Portes, Romer, Rodrik, Sheng);  renown current and former policy-makers (Ahluwalia, Boediono, Blejer, Han, Malan, Venner);  leading market players (El-Arian, O'Neill, Steer);  and international civil servants (Dervis, Watanabe).  Ngozi, Danny, Justin, Lars and Otaviano led the Bank's participation.     

There were more than 30 presentations in two days, over an agenda that focused on the global crisis.  Below are the "Ten Main Messages" I carried from the meeting:   

i) The crisis has many culprits.  A series of interconnected factors combined to produce the crisis, some causative and some amplifying.  First, excess liquidity creation by the US in what appears to be a loss of control by the Fed.  Second, a consequent mega imbalance between savings and consumption across the world (roughly, the US consumed while the rest of the world saved).  Third, failure of regulation, especially over the segment of the financial industry that was left to operate on its own because it did not technically take deposits but grew so large as to carry massive systemic risk (the "shadow banking" of, among others, hedge funds and special investment vehicles).  Fourth, subsidies to housing, from the tax treatment of mortgage interest to the implicit guarantees of Freddie Mac and Fannie Mae.  Fifth, pro-cyclical accounting principles that mechanically marked assets at market prices even when there was no longer a market.  Sixth, myopic underestimation of tail-end risk ("black swans" events).   Seventh, global lack of sound and liquid financial assets, which kept investors pouring money into the US.   Eighth, agency problems between shareholders of financial institutions and their celebrity managers ("fake alpha" traders).  Ninth, unbridled "animal spirits" in the form of greed and herd-like behavior by investors.  And, tenth, securities so complex that only a few traders could tell good from bad ("snake-oil securities").