Why Nobody Saw It Coming
“ Why did nobody see it coming?” Her Majesty the Queen, Elizabeth II, to economics professor Luis Garicano, November, 2008.
True, none of the mainstream economists, those who influence what we read in the news and what governments do, saw the 2008 crisis coming. Some self-deprecating economist drew a meme showing the time economists realize that a bubble, like 2008 popped, was the same time that Wiley Coyote of the Road Runner cartoons realizes he has run out of road: when he’s treading air after running off a cliff. The economist who identified this recurring economic blind spot was Hyman Minsky, and so it became known as a Minsky Moment.
Long before their complete miss in 2008, economist Ezra Solomon had quipped: “God made economists to make astrologers look good”.
But nobody saw it coming is not accurate. A number of very qualified people definitely saw it coming but as authors Matthew Hancock and Nadhim Zahawi show in their book Masters of Nothing: How the Crash Will Happen Again Unless We Understand Human Nature, the economists of influence ignored, suppressed and ridiculed them with the help of the media. Some were made non-persons with a thoroughness that Stalin would envy.
Bankers realized that to maintain the false narrative about 2008, they must ensure only those economists who failed to understand the banking system pre 2008 remained in positions of influence. Note that none of the economists who advised the government on Dodd Frank had seen the weakness in the banking system beforehand; they had all claimed that it was rock solid- and yet were kept in place to advise on the remedies.
We will have a look at one of the earliest, but now nonperson experts, who understood the danger of the system, cried a warning- but was muzzled, a lawyer.
The Cassandra of the Crisis
As early as 2000, Brooksley Born, the head of a small commission with the mind numbing name of the Commodity Futures Trading Commission (CFTC), became alarmed of what she saw. The derivative market is not regulated like the stock market. In fact, it is completely unregulated. Any unregulated section of the financial system is called ‘shadow’.
At this time, the regulated banks were betting with shadow banks (hedge funds), in the shadow markets (derivative market) with Credit Default Swaps (CDS,) also in the shadow markets, relating to the real estate market that depended on Collateral Debt Obligations (CDO’s) also in the shadow markets containing mortgages issued by shadow banks (private lenders). The opportunity for fraud was limitless.
Now, the derivative market is so large that it defies comprehension by those of us who are used to dealing in hundreds and thousands of dollars. Analysts estimate that derivative trading by 2008 was $596 trillion, give or take. That’s almost 10 times the size of the world economy (which raises the side question of how the value given to derivatives could be accurate as discussed in my previous post). As the frequent use of the term shadow above shows, derivative sales were completely unregulated- like a highway with no speed limits, dividing lines and no traffic cops. Born argued there should be police.
Born circulated a white paper calling attention to this dark area with so much potential for fraud. The retaliation by three economic advisors to the president was swift, complete, and effective. Two of them were among the most influential economists of the day: Alan Greenspan, then head of the Fed; and Larry Summers, assistant Treasury Secretary, and former Harvard president. The third team member was Treasury Secretary Robert Rubin, an ex-Goldman Sachs CEO. A powerhouse. Time Magazine dubbed them, “The Committee to Save the World”.
It is worth noting/remembering at this time that this was done under the Clinton administration.
The Committee acted immediately to get Congress to shut her up and shut her down. I can do no better than repeat Born’s description of what Congress did:
“And as a result of that report, a statute was passed in 2000 called the Commodity Futures Modernization Act [CFMA] that took away all jurisdiction over over-the-counter derivatives from the CFTC. It also took away any potential jurisdiction on the part of the SEC, and in fact, forbids state regulators from interfering with the over-the-counter derivatives markets. In other words, it exempted it [the derivative market] from all government oversight, all oversight on behalf of the public interest. And that’s been the situation since 2000.”[My emphasis]
Actually, it did much worse. That statute also declared that the CDS (Credit Default Swap) was not insurance and therefore not subject to the requirements of insurance law requiring an adequate reserve to pay claims.
How the CDS is actually mortgage default insurance in disguise see: Demystifying High Finance
The Market Can Regulate Itself
Born remembers this chat with Alan Greenspan.
“Well, Brooksley, I guess you and I will never agree about fraud,” Born remembers Greenspan saying.
“What is there not to agree on?” Born says she replied.
“Well, you probably will always believe there should be laws against fraud, and I don’t think there is any need for a law against fraud,” she recalls. Greenspan, Born says, believed the market would take care of itself.
Greenspan says he does not remember this conversation.
Born stands by her version.
Originally published at https://jandweir.substack.com.
