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Stumbling in the dark

In his Op-Ed column at the NY Times Paul Krugman writes:

A few months ago I found myself at a meeting of economists and finance officials, discussing — what else? — the crisis. There was a lot of soul-searching going on. One senior policy maker asked, “Why didn’t we see this coming?”

There was, of course, only one thing to say in reply, so I said it: “What do you mean ‘we,’ white man?”

Krugman goes on to explain that, while people like to call the current financial crisis “unprecedented”, there were lots of warning signs.  Some were obvious – it seems like everyone was aware that the housing bubble was a bubble.  But, shockingly, the banks and rating agencies didn’t seem to realise that house prices might decline.  And we all know what the collapse of the real estate markets in Japan did to the Japanese economy.  No, most people don’t recall what happened in the early 90s.  But economists and policy makers should.  That’s kinda their job.

While the Japanese example is solidly cemented in my mind (thanks, in a large part, to Krugman’s Op-Eds almost a decade ago), I wasn’t familiar with the implications of the collapse of the hedge fund Long-Term Capital Management in 1998.  I remember it being a big deal at the time, and every time I hear the word “hedge fund” something stirs in my memory.  But I had no idea that it “temporarily paralyzed credit markets around the world”.

Krugman goes on to talk about the triumphalism that characterised the recovery from the 1997-1998 crisis and the collapse of the dot-com bubble, and how the fact that the world managed to step back from the brink made people more complacent.

In fact, both the crisis of 1997-98 and the bursting of the dot-com bubble probably had the perverse effect of making both investors and public officials more, not less, complacent. Because neither crisis quite lived up to our worst fears, because neither brought about another Great Depression, investors came to believe that Mr. Greenspan had the magical power to solve all problems — and so, one suspects, did Mr. Greenspan himself, who opposed all proposals for prudential regulation of the financial system.

People on the brink of disaster are often blissfully unaware.  Point it out to them and their reaction tends to be one worthy of a teenager; as Krugman said, “nobody likes a party pooper”.  Talk about the housing bubble, or the dot-com bubble, or the looking climate crisis, and people accuse you of fearmongering.  Or they simply do nothing because the implications are too disturbing to deal with.

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