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.To10.1057/9780230118478 - Somebody in Charge, Pierre LemieuxFebruary 7, 201121:1MAC-US/CHARGEPage-1429780230112698_09_ch07The State’s Animal Spirits●143paraphrase Keynes, the individuals who run the state tyrannize over theirfellow citizens instead of tyrannizing over their own bank balances.52Faddish Behavior and State BubblesGeorge Akerlof and Robert Shiller note that, in the 1990s, allegations byMartin Luther King III (the son of the civil rights leader) minorities wereleft out of housing opportunities “led to an almost immediate, and uncriti-cal, government reaction.”53 The government jumped in to fuel the housingbubble.Yet, a few pages later, the same authors propose that government stepin to counteract the destructive animal spirits of the private sector.54 Manyanalysts—including, strangely, sophisticated economists—rely on the com-mon and unexamined assumption that government can counter bad fads andveConnect - 2011-04-01encourage good ones.algraIt is an extraordinary idea.We have seen in Chapter 5 how politicians andh - Pbureaucrats encouraged the housing bubble with easy mortgage policies.Asreported in Chapter 6, the Fed further fuelled house purchases with a loose monetary policy.Not only did government encourage the bubble, but it didnot see it coming even when its bursting was imminent.In 2003, FederalReserve Chairman Alan Greenspan addressed what had “been described bysome analysts as possibly symptomatic of an emerging housing bubble.” Heexpressed some concern but added that “any analogy to stock market pric-ing behavior and bubbles is a rather large stretch.”55 On May 17, 2007, justbefore subprime securities were to wreck havoc in the economy, his successor,Ben Bernanke, flatly declared that the subprime problems were containable:veconnect.com - licensed to ETH Zueric.palgraWe know from data.that a significant share of new loans used to purchasehomes in 2005 were nonprime (subprime or near-prime).[and] the shareof securitized mortgages that are subprimes climbed in 2005 and the firstom wwwhalf or 2006.we believe the effect of the troubles in the subprime sectoron the broader market will likely be limited, and we do not expect signifi-cant spillovers from the subprime market to the rest of the economy or to thefinancial system.56yright material frCopThe GSEs were at the vanguard of those who, in the public sector, dis-missed any cause for concern.In 2002, recent Nobel prizewinner JosephStiglitz and two coauthors—one of which, Peter Orszag, was to become direc-tor of President Barack Obama’s OMB (office of management and budget)—were commissioned to write an article for the Fannie Mae Papers.They arguedthat Fannie Mae’s and Freddie Mac’s risk-based capital standard made it veryunlikely that the two GSEs would ever require a government bailout.The10.1057/9780230118478 - Somebody in Charge, Pierre LemieuxFebruary 7, 201121:1MAC-US/CHARGEPage-1439780230112698_09_ch07144●Somebody in Chargeresults of their econometric model, they wrote, “suggest that on the basisof historical evidence, the risk to the government from a potential defaulton GSE debt is effectively zero.”57 The authors underestimated the possiblecredit losses from a deep recession, besides ignoring the possibility that thequasi-nationalized housing market and the GSEs could themselves generateor precipitate a recession.Serious economists writing for a quasi-governmentpublication just followed the herd.The Wall Street Journal uses this grossmistake to argue against a “systemic risk regulator”:Why should anyone think that regulators—or economists—will predict thenext systemic debacle any better?.When the next problem erupts, as in2002, smart people will be on both sides of the argument.And when large,systemically important companies are threatened with curbs on their business,veConnect - 2011-04-01they will pay Nobel laureates to write studies and explain away the dangers,and hire lobbyists to block any reform.58algrah - PFannie Mae and presumably the authors are understandably not proud of thispaper, which has disappeared from the GSE’s site.59The situation of Fannie Mae and Freddy Mac was not quite as bad in2002 as it would become during the following five years.But even as timepassed, the official enthusiasm did not abate.As late as July 13, 2008,a few months before the two GSEs went bankrupt, Senator ChristopherDodd, one of their big boosters and political beneficiaries, declared: “What’simportant are facts—and the facts are that Fannie and Freddie are in soundsituation.They have more than adequate capital.The’re in good shape.”60veconnect.com - licensed to ETH ZuericPublic confidence has an impact on a recession.The more people fear therecession, the more prudent businesses will be in producing and investing,.palgraand the least likely the banks will want to lend.In the autumn of 2008, themost frightful time in the recent recession, the government was not reallyom wwwreassuring people in a way to boost confidence and counter the cascade ofpessimism.On the contrary, it fuelled the ambient pessimism, acted in a verydisorderly fashion, and adopted public policies that had the potential of mak-ing everything worse.The protectionist clauses in the Bush stimulus packageyright material frfuelled protectionism in the world—although the worst was avoided on thisCopfront.When George Bush said, on September 24, 2008, “We’re in the midstof a serious financial crisis, and the federal government is responding withdecisive action,”61 he probably intensified fears, except to the extent that thefederal government is perceived as omnipotent.Another example of how gov-ernments worsened the confidence during the economic crisis was the Britishgovernment’s political coup in the Icelandic banking crisis.In response tothe demise of Landsbanki, an Icelandic bank in which many British residents10
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