"During the 1980s, a number of unusual financial crises occurred. In Chile, for example, the financial sector collapsed, leaving the government with responsibility for extensive foreign debts. In the United States, large numbers of government-insured savings and loans became insolvent - and the government picked up the tab. In Dallas, Texas, real estate prices and construction continued to boom even after vacancies had skyrocketed, and the suffered a dramatic collapse. Also in the United States, the junk bond market, which fueled the takeover wave, had a similar boom and bust.
In this paper, we use simple theory and direct evidence to highlight a common thread that runs through these four episodes. The theory suggests that this common thread may be relevant to other cases in which countries took on excessive foreign debt, governments had to bail out insolvent financial institutions, real estate prices increased dramatically and then fell, or new financial markets experienced a boom and bust. We describe the evidence, however, only for the cases of financial crisis in Chile, the thrift crisis in the United States, Dallas real estate and thrifts, and junk bonds.
Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.
""It was proposed that there, regulation or at least disclosure be required and the industry fought it and the Federal Reserve under Alan Greenspan vehemently opposed. And they made the argument which you hear all the time, and I can remember Alan saying, "look, these are sophisticated contracts between knowledgeable buyers and knowledgeable sellers; no regulators can do as well as they'll do, so what do you need a regulator for? The market will regulate these." And he won the day. And so among the list of our friends along with me and others, Alan was clearly, I'd say, the key person responsible for the fact that we didn't even know how many of those contracts there were, And they were up in the trillions.
So, when AIG got in trouble, it turned out that they had one division with 400 people in it, they had 80,000 employees, they had 400 people in one division, they wrote all these contracts. They didn't report any of them. So they were, you'd say, gambling by writing these contracts. and when things started to go bad and they had to pay on these contracts, the whole monster, the largest insurance company in the world went under.
"L. William Seidman at Grand Valley State University in Michigan 9 October 2008 (there are 7 videos on YouTube).
"
I remember when we invented this, Alan Greenspan said, "well, this is a great new innovation, because we are spreading the risk all over the world, which, of course, is what we did. And for which at this point the world is, to say the least, blaming the whole financial crisis we're in on us.
"L. William Seidman at Grand Valley State University in Michigan 9 October 2008 (there are 7 videos on YouTube).
"
We have gone clearly into the worst financial panic that we have had since the Great Depression, some ways it's worse because it's much more complicated. And out financial system and most of the rest of the world now has a non-functioning, frozen financial infrastructure.
"L. William Seidman at Grand Valley State University in Michigan 9 October 2008 (there are 7 videos on YouTube).
"
The subprime mortgage market grew in a way that is almost impossible to believe. There were almost 2 million subprime mortgages written in a year and a half. That means somebody had to finance a couple of million homes, almost, of subprime mortgages. So, why did anybody put their money in this? Why would anybody, knowing that these, subprime means that they are not prime? Well, the genesis of that goes back to something called securitization and something called tranche credit-rated securitization. Now, that was invented by one of the people who were operating in the RTC, and mainly it was invented by me and our group.
"L. William Seidman at Grand Valley State University in Michigan 9 October 2008 (there are 7 videos on YouTube).
"Peter Temin, an economic historian at MIT, told The Wall Street Journal on February 22, 1996 that this historical revisionism is "wrong," according to the consensus of the nation's most respected economists. Paul Krugman, one of the world's top international trade economists, and one who is expected to win a Nobel Prize for his revolutionary theories in favor of free trade, calls the Smoot-Hawley theory "incredible." ...
Imports formed only 6 percent of the GNP. With average tariffs ranging from 40 to 60 percent (sources vary), this represents an effective tax of merely 2.4 to 3.6 percent. Yet the Great Depression resulted in a 31 percent drop in GNP and 25 percent unemployment. The idea that such a small tax could cause so much economic devastation is too far-fetched to be believed. ...
The trade war following Smoot-Hawley did not entirely shut down trade. For the U.S., it fell from 6 to 2 percent of the GNP between 1930 and 1932. This does not mean, of course, that Americans necessarily "lost" that 4 percent. It merely means that they had 4 percent more to spend on their own domestic products.
""The economy grew at a slower rate in the 1980s than it had in the 1960s and 1970s and than it would in the 1990s. The less financially rewarding service sector generated most of the growth. Of the millions of jobs created during the Reagan era, about half were minimum- and low-wage posts.
The nation that emerged from the Reagan era diverged greatly from the more egalitarian United States of the immediate post-World War II decades. From the 1970s onward, prosperity flowed disproportionately to the wealthiest Americans. In 1979, the top 1 percent of the population held 22 percent of the nation's wealth; in 1989 that figure had almost doubled, to 39 percent. The greatest gains went to richest elite. Compensation for corporate CEOs jumped from 25 times the income of hourly production workers in the 1960s to 93 times as much as their hourly employees in the 1980s, and 419 times by the end of the 1990s.
""And by the way, it does appear we're rewarding incompetence. Forget about the legal matter here for a second. These bonuses are going to people who screwed this thing up enormously, who made terrible decisions. So since the federal government now, thanks to the Federal Reserve's use of the power under that 70-year-old statute, now essentially owns that company, maybe it's time to fire some people. We can't keep them getting the bonuses, but we can keep some of them from continuing in their jobs. And I'm very skeptical that these retention bonuses, these people got retention bonuses. Well if they were in high school, they wouldn't have gotten retention, they would have gotten detention. And the, and the time has probably come to now look at it and get rid of some of them."
Congressman Barney Frank.
"If you believe that a society cannot be truly democratic without a strong labor movement, and if you believe that the only way to build a fair economy is by making sure people can belong to unions, then, this is where a line must be drawn: Democratic Senators who block or undercut the Employee Free Choice Act should face well-funded primary challenges.
Today, Tom Harkin (D-IA), a member of the Senate Health, Education, Labor and Pensions Committee, and George Miller (D-CA), the chairman of the House Education and Labor Committee, will announce that they are introducing EFCA. There is no doubt that EFCA will pass the Congress and reach the president's desk. The question, in my mind, is: what will the bill say? Will it bear any resemblance to the version Miller and Harkin are introducing? Or will it be watered down? And that's where the primary threat comes in (by the way, I will be on CNBC today at 11:30 a.m. to discuss EFCA).
"
