I would heartily recommend the four essays at Cato Unbound by White, DeLong, Mulligan and Black. If nothing else, it makes it clear that the brightest economists in the land still have not figured out how we got here. All are well written, without partisan rancor and snark.

Steve

I'm not sure I understand's steve's point that "the brightest economists in the land still have not figured out how we got here." As far as I understand it it's pretty clear that the problem has been cheap credit. This role of cheap credit had four causes:

1) Fed policy

2) foreign investment

3) irresponsible leveraging by banks and other financial institutions, exacerbated by Fannie and Freddie

4) imprudent borrowing by consumers and government

As to 1), the Fed was not necessarily wrong, since there was no serious inflation. As for 2), this was if anything an indication of the relative health of the US economy. As for 3), this seems to have been the result of short-termism in terms of profits (quarter system, which affected the erstwhile investment banks, but not the smaller regional banks, which not coincidentally have been doing fine), and shareholder blindness (or indifference) to such short-termism. As to 4), dumb from the perspective of consumers with negative equity, but not that dumb for others.

Again, I'm just an amateur, but this is what I gather from talking to my friends in the City (who have their own jobs at risk). It strikes me as more of a tragedy rather than as malpractice.

I wonder what people think of this. Also, I wonder whether with hindsight, given all the cheap credit, it would have been better to raise certain taxes, paying off the deficit, to take money out of the economy, encouraging more responsible lending and borrowing. Growth would then have to be based on gains in actual productivity (I don't know but wonder what the productivity numbers were during the credit boom), instead of on the froth of credit (which is illusory growth).

Please tell me where I'm wrong.

What did you think of the longish article in the New Republic a few weeks ago entitled "Debt Man Walking"?

Joel: I was thoroughly unimpressed with it. To be fair, you could ask me, "Dan, what did you think of this John B. Judis essay about ______?" and I'd give you the same answer.

Also by Michael Lewis:

http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom

It's not very technical but I found it very fun to read.

Re #2 (amateur)

I'm an "amateur" too, but I think you've got the basics right. Relatively early on, I went to a panel discussion at the MIT Sloan school, and they basically laid it out as you did. The things I read before and have read since (at least by actual economists) have supported this.

The MIT folks focused on points (1) and (3) more than the others, with emphasis on (3). I think you hit at part of the core with the expression "short-termism," but don't think that captures all of it. At the heart of (3) is the use of exotic financial instruments in ways that we now see were very risky. To call this "short-termism" gets at an aspect of the truth, because presumably if investors were very concerned about long-term risk reduction they would have used greater caution in employing financial instruments that they didn't understand -- and would have viewed the extraordinary performance of certain assets with a skeptical eye, instead of using them as collateral for loans or making highly leveraged investments in them. On the other hand, perhaps many of the people most heavily involved in this didn't, at the time, think of their behavior as short-termism -- perhaps many simply got caught up in the thoughtless excitement about new financial tools to engage the real-estate market, or felt compelled to take on risks as they did to compete with peer institutions for private investment. I think for these reasons, economists tend to focus on the details of the use of these financial instruments (which also points more clearly to how we might prevent this from happening again), instead of chalking it up to "short-termism."

On similar note - common aspects of American and Japaneese economic policies.

http://www-ac.northerntrust.com/popups/popup.html?http://www-ac.northerntrust.com/content//media/attachment/data/econ_research/0812/document/dd121908.pdf

Re: Mike

Thanks for the reply.

As to 1) I do not understand how the housing bubble's expansion of the money supply did not lead to inflation at the time of the bubble. After all, inflation is a monetary phenomenon, as Milton Friedman taught us. Perhaps a bubble is localized hidden inflation: it certainly fueled consumption and distorted price mechanisms, thus obscuring inefficiencies in the economy as a whole. Or so my econ friends tell me. Perhaps the illusion of responsible leveraging (i.e. the illusion that credit had actual backing) prevented inflation. But somehow that feels a bit too voodooish to be true.

I also don't understand why the Fed didn't raise interest rates to encourage more responsible borrowing and lending, which would have prevented as many inefficiencies (i.e. misallocations of capital) creeping into the economy. We're paying for these inefficiencies now, because many industries are due for painful restructuring.

As for 2) this helped keep borrowing cheap and is therefore important. My econ friends warned in April that the US was due for a recession due to foreign capital flight, as relative US efficiency had declined due to the indiscipline brought about by cheap credit.

As to 3), I used the word "short-termism" because that was how a City financier friend spoke of it. He blamed the shareholders for not understanding where the quarterly profits came from and for punishing executives who wouldn't play along. My friend firmly believes that there should not be/have been any bailouts. The overleveraged banks should have gone bust. Of course many shareholders have indeed lost money they invested in the crippled banks.

My instincts scream against the bailouts. The bank bailouts were said to be intended to get liquidity going again, but they have failed at that. Now the Fed itself is injecting liquidity into the economy. It seems to me -the amateur- that the bad banks should have just been let to fail, with the Fed standing by from the beginning to guarantee liquidity should it have been needed.