The Flaw

Stumptown, California

Mat 26, 2021

The financial crisis of 2008. Seems so long ago. Do you remember what caused the crisis? Do you remember the bailouts? Do you remember the convictions of those who were held accountable? That last question was a gotcha — there were no prosecutions, no findings of guilt, no jail time. No person had to give back their ill-gotten gains. The big financial players got bigger and the competitive landscape in financial services was decreased.

If you are like me, the memories of the crisis have faded. Just like my memories of mass shootings fade. In both cases, what’s on my mind is when will it happen again. Well, today we got San Jose. Something seems out of kilter in the financial markets — lots of cash running stock prices up. I’m not complaining — I’m just worried.

The Flaw helped me stay awake last night to see the lunar eclipse. ☹️

A review of the film from The Economist:

The Flaw is a documentary about the causes of the 2008 financial crisis, directed by David Sington, which splices the thoughts of economists such as Robert Shiller and Joseph Stiglitz with the testimony of participants in the housing market and some entertaining cartoons and archive clips. It takes its title from the testimony of Alan Greenspan to Congress in which he admitted to a flaw in his reasoning.

Mr Sington's case is that the boom and bust was closely tied up with the growing inequality of the US population that emerged after 1980. As wealth accumulated in the richest 1% of the population, the living standards of the bottom 50% stagnated. To maintain his or her standard of living the average Joe and Josephine had to go into debt. Meanwhile, the rich had a need for high-yielding assets; they thus snapped up the mortgage debt incurred by poorer Americans as they struggled to get on the housing ladder. Central bankers like Alan Greenspan sat back and did nothing because of their ideological belief that markets could not be wrong.

While I am willing to accept much of this analysis, the film's focus on America means that the international dimension is lacking. There were housing booms in Australia, Britain, Iceland, Ireland and Spain as well, and they did not all show the same expansion of inequality as America. What they did experience was credit booms and a credit boom tends to find its way into property quite quickly.

My view is that the root cause for these credit booms lies in the abandonment of the Bretton Woods system in the early 1970s. Under BW, there was a trade constraint on the amount of credit that could be created; a boom led to consumer spending on imports that resulted in a deficit. To defend their currencies, governments were forced to impose credit controls. All that was swept away in the 1970s and 1980s. There was no exchange rate target to defend; better still for governments, creditors proved remarkably tolerant when lending to countries with currencies that tended to depreciate. The resulting asset boom did indeed contribute to the rise of inequality although the finance sector was not the only beneficiary; think of sports and entertainment stars and, of course, CEOs of mainstream companies. An asset boom benefits those who own assets while globalisation allows those with a marketable talent to sell their services to the highest bidder; the Premier League is dominated by foreign footballers who would not have had the same chance in the 1970s.

The film is a polemic (albeit a very entertaining one) but a more balanced view might also have reflected that the drive to lower lending standards was also driven by Democratic politicians who believed that the poor were being sidelined by the mortgage system. It is far from clear that lending people too much to buy houses they can't afford (and an inability to generate a decent-sized deposit is evidence of unaffordability) is a good idea; the flexibility of renting can be underestimated.

Still, if readers have the chance to see this film, I urge them to do so. It contains some excellent explanation of the build-up to the crisis by George Cooper, whose book on the crisis still remains one of the best. And this does seem to be a golden age of documentaries; my colleague in the office next door was attending a screening of Countdown to Zero, a polemic on nuclear weapons, last night.

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