The consensus view is that the Great Recession of 2008-2009 was caused by financial instability. I believe that view is wrong, and I have written the following: whole book They argue that monetary tightening caused the Great Recession.Recent Bloomberg article It perfectly illustrates why it’s important to understand what went wrong in 2008.
FSOC on Friday released its first investigation into the threat posed by nonbank mortgage companies. Even though nonbank mortgage companies have replaced traditional banks in the market, they have escaped the strong regulations reserved for traditional banks. In 2022, non-banks originated about two-thirds of mortgage loans and repaid most of them.
The sector’s unique business model makes companies vulnerable to fluctuations in house prices, interest rates and arrears, the report said. According to FSOC, nonbanks rely more on the value of mortgage repayment rights than traditional lenders and may have higher leverage, short-term financing, and operational risk.
“Simply put, vulnerabilities among nonbank mortgage companies could amplify shocks in mortgage markets and undermine financial stability. The Board has made this clear in detail for the first time,” said Treasury Secretary Janet Yellen, who heads the FSOC.
Not surprisingly, this view has led to calls for more federal involvement in the mortgage lending market, which would further exacerbate the mortgage problem. moral hazard. Previous attempts to make our financial system more stable have failed because the underlying problems have been misdiagnosed. There are two root causes of financial instability.
1. Monetary policy that causes unstable NGDP growth.
2. Federal regulations that increase moral hazard by guaranteeing depositors and designating some banks as “too big to fail.”
The failure of a commercial bank has policy implications because it may require the FDIC to bail out depositors, but this argument does not apply to the failure of a nonbank mortgage company: there is no reason for regulators to worry about nonbank failures, since the impact on aggregate demand can and should be offset by monetary policy adjustments.
This is why it’s so important to understand exactly what went wrong in 2008. If policymakers correctly understood the causes of the Great Recession, they would focus less on preventing bank failures and more on stabilizing the trajectory of nominal GDP. .
PS. Same thing happened during the Great Depression. His two main problems in the United States were banking regulation, which had too many small, undiversified banks, and monetary policy, which caused him to reduce NGDP by almost half between 1929 and 1933. Countries with weaker banking regulations and more expansionary monetary policy saw significant improvements. Better than the US. This summary is economic history journal Paper by Richard Grossman:
This article attempts to explain the extraordinary stability exhibited by the banking systems of the United Kingdom, Canada, and 10 other countries during the Great Depression. Using data from 25 countries in Europe and North America, this study considers three possible explanations for stability: the structure of the commercial banking system, macroeconomic policy and performance, and the behavior of lenders of last resort. This result suggests that macroeconomic policies, especially exchange rate policy and banking structure, were systematically responsible for bank stability but were not the lenders of last resort.
The Federal Reserve was established as a “lender of last resort.” But it did not address a fundamental weakness in the U.S. financial system, which wasn’t a lack of liquidity. As a result, the financial system in the first few decades after the Federal Reserve was established was even more unstable than it had been in the two decades before the Federal Reserve was established.
If you do not diagnose the problem correctly, the solution may be ineffective.
PS. Some say that financial instability must definitely play a role in what I called “tight monetary policy” in 2008. Consider a truck driver who falls asleep and causes an accident on a bend in the road. In a sense, the curvature of the road contributed to the accident. However, driver drowsiness was a much bigger problem.
