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Why do I say this is important? Because policy is often driven by politics, and politics is driven by public
anxiety, and public anxiety is driven by the fears of unemployment, not just from those who are actually
unemployed, but those who prospectively could get unemployed. What we have seen again and again as
far as government policy goes is that policy driven by a crisis is not good policy. We have seen that in the
stimulus post-2001. We saw that in the recent stimulus. But more than the fiscal stimulus I want to point
to is the monetary stimulus, which, to my mind, is even more problematic.

People say Greenspan was asleep on the job. Why didn't he raise interest rates? Why didn't Greenspan
take a more active role in regulation?

I want to argue that no central banker would be brave enough to raise interest rates when unemployment
is where it is. If jobs aren't coming back, nobody is going to raise rates. That was true of Greenspan. It is
true of Bernanke right now. In fact, Greenspan went further and said, "Look, you guys are worried about
investing. I'm assuring you, if there is a double dip, I will come in and pour more money into the
economy." This was a famous Greenspan quote, saying, "I will plug the economy with liquidity if, in fact,
you have a problem."

These kinds of government policies are a response to the political inadequacies of the safety net to some
extent. But they create incentive distortions in the financial sector. As you often say, the road to hell is
paved with good intentions.

These kinds of fault lines, in some sense, create the underlying incentive structures for the financial

Let me focus on two—actually, let me focus on just one, given the time, and then leave some time for

Why were low-quality mortgage-backed securities created? What does all this have to say about it?

The explanation is actually quite a simple one. There was a wall of money which was pouring into
subprime lending to fulfill these congressional mandates. There is documented evidence from former
employees of Fannie and Freddie on how much went into these areas every year. There was an
accompanying wall of money coming from outside from the surplus countries which were trying to sell to
the United States. These guys were looking for high-yield safe securities, the triple-A mortgages that
became infamous during this crisis.

With the tremendous amount of money flowing into the financial sector, for noneconomic reasons, from
outside—much of it was being sent by central banks that wanted to, in a sense, preserve the value of
their currency against the dollar and maintain competitiveness. From inside, it was to fulfill the
congressional mandates, not so much from a profit perspective. Given that all this money was not that
focused on pricing, it distorted prices in the sector. The financial sector, when it knew that you could sell
these mortgage-backed securities to people who didn't ask questions, went out and created a whole lot of
rotten mortgages which then were financed.

We can go into the details—the details are in the book—as to how this happened. But I want to end with
this: What is it in the financial sector that makes it focus only on prices and not on whether you are
getting a grandmother who can't afford the house into the house? I want to argue that the nature of the
financial sector is such that it makes you focus on whether you are making money or not. That, in many
ways, is a good thing, except when the prices get distorted.

A quick example. Most people care about whether their work has value. I think the financial sector is no
exception. So when we say "greedy bankers," why did they suddenly become greedy and without social
conscience? I want to give you my explanation for that in a second.

But the experiment I want to talk about is an experiment which was run by MIT researchers using

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Harvard students. They wanted to set the Harvard students a task that they thought was adequate to
their mental capabilities, which they didn't think highly of, so they asked them—this was the
experiment—to make models out of Lego Bionicle kits. It's a model kit. You put together the Bionicle. The
experiment was to try to see whether you feel like working more when you have a product, when you can
see the value of your work.

So they had these guys come in, sit down, and put together the models. They paid you on a decreasing
scale for every additional model that you built. So at some point you were going to quit. It wasn't worth
even the time you were spending to make a model for five cents. But they altered the experiment for one
group of subjects by doing the following.

One group of subjects made the model. The assistant came, and as you were making the second model,
she dismantled the first model and gave you back the kit. It was as if you were on a wheel going
nowhere. For the second group, she took the model and put it on a shelf. You could see eight, nine, ten
models as you built them.

Most people would know that even when you put them on a shelf, once they left the room, they would be
dismantled. They didn't think those models were being kept for posterity. But just the fact that in one
case they dismantled it right off, while in the other case they were kept for a while, made a difference in
how long you wanted to go on doing this.

The point is that we care about the effects of our work. We want to see these things, and the more we
see it, the more we want to build good things. The problem with the financial sector, to some extent, is
that it has become an arm's-length transaction-oriented financial sector. In many ways, this is a good
thing. It allows risk to be spread. It allows us to do things that enhance value, provided the market prices
are right.

For example, a short seller who is selling Enron because he thinks the accounting is flawed, and makes a
ton of money doing that, is providing a service to society, because he is putting Enron out of business,
and Enron wasted tremendous amounts of resources in this society which could have been better utilized
elsewhere. But if he looked at Enron and saw the people going to work every day, saw the people who
would lose their jobs, he would be a little less motivated to sell the shares short. Compassion would be a
bad thing in this case. The fact that he is at an arm's length is a good thing.

But it depends very much on the prices eventually being right, that Enron would collapse in price and he
would make a ton of money. If every stock that he sold short collapsed in price, there would be an
incentive to distort the economy.

Similarly here, if people were willing to buy any garbage that you sold—think about the broker there who
is talking to a client. You know you are not going to see this client ever again. You know that out there
people are waiting to buy any mortgage that you can put out, because they are packing it and selling it to
German banks that don't ask any questions. When you have that kind of structure, immediately you lose
all sense of anchoring, because the prices are telling you, "Do more of it. Do more of it." And they did
more of it—Countrywide, First Century. The rogues' gallery there is pretty strong.

But you don't have to portray these guys as evil, dastardly rascals. They're like us. They're probably here.
It's the incentive structure which, when distorted—when prices get distorted, the modern, sophisticated
financial system can go a long way.

Bottom line: I started by saying, can we blame the bankers? Can we blame the regulators? Yes, they do
deserve blame. But in many ways, you can well imagine that there is some truth to Lloyd Blankfein's
statement that they thought they were doing God's work. The prices were telling them they were doing
God's work. We need to go back and ask why the prices were distorted. Why did things go haywire?

I think, for that, we have to step back and ask a fundamental question about our society: Are we too

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