Claude Joseph
In the fall of 2008, the United States faced the worst economic downturn since the Great Depression of 1929. The crisis was so deep that it soon turned global, with approximately 20 million people in China losing their jobs and tens of millions falling into poverty (Stiglitz, 2010). As it had been for previous economic crises such as the Internet crisis, and the savings and loan crisis,[1] economists and policymakers have been using different frameworks to explain the root of this recent economic meltdown.
On one hand, proponents of free and unfettered markets (e.g., Sowell, 2010; Woods, 2009) argue that the 2008 financial debacle was caused by too much regulation that undermined the natural law of supply and demand of the financial market. To Sowell (2010), the crisis has its roots in many policies and regulations that the federal government has enacted. He observes, “among the impelling factors were growing pressures from government regulatory agencies for mortgage lenders to reduce their lending requirements, so that people with lower incomes and lower credit ratings could become home buyers” (p. 139). Thus, the Community Reinvestment Act, which encourages banks to lend to underserved communities, is what led the world economy into this nightmarish crisis (Sowell, 2010). By the same token, Woods (2009) argues, “we’ve been looking in the wrong place. The current crisis was caused not by the free market but by the government’s intervention in the market” (p. 2). Fannie Mae and Freddie Mac, two government-sponsored enterprises, and the Federal Reserve System are the main culprits of the crisis.
Proponents of government intervention offer alternative approaches. They contend that the root of the crisis must be found in a lack of government involvement in the financial system. People that have lost – and continue to lose – their homes have been victims of information asymmetry because mortgage companies had pushed exotic mortgages onto millions of consumers while many of them had not been mindful of what they were getting into (Stiglitz, 2010). The failing in the mortgage market, Stiglitz adds, “were symptomatic of the broader failings throughout the financial system, including and especially the bank” (Stiglitz, 2010, p. 5).
A third explanation for this crisis comes from Robert Skidelsky, Keynes biographer. To him symmetric ignorance, instead of information asymmetry, is the root cause of the crisis. A good definition of the term symmetric ignorance is provided by Moss (2000) in his book When All Else Fails: “in some cases, a market for risk may function poorly or fail altogether, not because one party has better information than the other, but because neither party can obtain sufficient information about the risk in question”(p. 39). In the case of the 2008 subprime crisis, the symmetric ignorance seems to hold because the innovative financial products invented by banks and credit-rating agencies to entice borrowers not only have adverse impact on borrowers but also on the banking system. The collapse of Lehman Brothers and the implosion of Bear Stearns’s hedge funds seem to support the symmetric ignorance argument.
The instance of the 2008 financial meltdown shows that mutually exclusive explanations of a single event can be offered when lenses that are used to look at the event differ from one another. Allison and Zelikow (1999), in Essence of Decision, show how the Cuban missile crisis is explained using three different lenses: the rational actor model, government behaviour as organizational output, and government as politics. Despite objections raised against Allison and Zelikow’s approach, I believe their eclectic contribution to public policy is very insightful. In philosophy, specifically in hermeneutics, this approach is called reflexive analysis[2]. An analysis is reflexive when the focus is on the lenses that are used to explain the event. For example, a specific question involving reflexive analysis about the missiles crisis is: how the 1962 Cuban missiles crisis could be explained, had we looked at it from a different framework? In other words, what would it look like, if instead of using a RAM, we had used governments as politics model? And the same logic holds in the case of the subprime crisis because the way that an advocate of the free market understands the event is quite different from the way a Keneysian understands it.
[1] For much more about the history of financial crisis, see Charles P. Kindleberger and Robert Aliber, Manias, Panics, and Crashes: A History of Financial Crises (New Jersey: John Wisley & Sons, 2005); and Carmen M. Reinahrdt and Kenneth S. Rogoff, This Time is Different: Eight Centuries of Financial Folly (New Jersey: Princeton University Press, 2009).
[2] See Farmer, 1993, The Language of Public Administration
In the fall of 2008, the United States faced the worst economic downturn since the Great Depression of 1929. The crisis was so deep that it soon turned global, with approximately 20 million people in China losing their jobs and tens of millions falling into poverty (Stiglitz, 2010). As it had been for previous economic crises such as the Internet crisis, and the savings and loan crisis,[1] economists and policymakers have been using different frameworks to explain the root of this recent economic meltdown.
On one hand, proponents of free and unfettered markets (e.g., Sowell, 2010; Woods, 2009) argue that the 2008 financial debacle was caused by too much regulation that undermined the natural law of supply and demand of the financial market. To Sowell (2010), the crisis has its roots in many policies and regulations that the federal government has enacted. He observes, “among the impelling factors were growing pressures from government regulatory agencies for mortgage lenders to reduce their lending requirements, so that people with lower incomes and lower credit ratings could become home buyers” (p. 139). Thus, the Community Reinvestment Act, which encourages banks to lend to underserved communities, is what led the world economy into this nightmarish crisis (Sowell, 2010). By the same token, Woods (2009) argues, “we’ve been looking in the wrong place. The current crisis was caused not by the free market but by the government’s intervention in the market” (p. 2). Fannie Mae and Freddie Mac, two government-sponsored enterprises, and the Federal Reserve System are the main culprits of the crisis.
Proponents of government intervention offer alternative approaches. They contend that the root of the crisis must be found in a lack of government involvement in the financial system. People that have lost – and continue to lose – their homes have been victims of information asymmetry because mortgage companies had pushed exotic mortgages onto millions of consumers while many of them had not been mindful of what they were getting into (Stiglitz, 2010). The failing in the mortgage market, Stiglitz adds, “were symptomatic of the broader failings throughout the financial system, including and especially the bank” (Stiglitz, 2010, p. 5).
A third explanation for this crisis comes from Robert Skidelsky, Keynes biographer. To him symmetric ignorance, instead of information asymmetry, is the root cause of the crisis. A good definition of the term symmetric ignorance is provided by Moss (2000) in his book When All Else Fails: “in some cases, a market for risk may function poorly or fail altogether, not because one party has better information than the other, but because neither party can obtain sufficient information about the risk in question”(p. 39). In the case of the 2008 subprime crisis, the symmetric ignorance seems to hold because the innovative financial products invented by banks and credit-rating agencies to entice borrowers not only have adverse impact on borrowers but also on the banking system. The collapse of Lehman Brothers and the implosion of Bear Stearns’s hedge funds seem to support the symmetric ignorance argument.
The instance of the 2008 financial meltdown shows that mutually exclusive explanations of a single event can be offered when lenses that are used to look at the event differ from one another. Allison and Zelikow (1999), in Essence of Decision, show how the Cuban missile crisis is explained using three different lenses: the rational actor model, government behaviour as organizational output, and government as politics. Despite objections raised against Allison and Zelikow’s approach, I believe their eclectic contribution to public policy is very insightful. In philosophy, specifically in hermeneutics, this approach is called reflexive analysis[2]. An analysis is reflexive when the focus is on the lenses that are used to explain the event. For example, a specific question involving reflexive analysis about the missiles crisis is: how the 1962 Cuban missiles crisis could be explained, had we looked at it from a different framework? In other words, what would it look like, if instead of using a RAM, we had used governments as politics model? And the same logic holds in the case of the subprime crisis because the way that an advocate of the free market understands the event is quite different from the way a Keneysian understands it.
[1] For much more about the history of financial crisis, see Charles P. Kindleberger and Robert Aliber, Manias, Panics, and Crashes: A History of Financial Crises (New Jersey: John Wisley & Sons, 2005); and Carmen M. Reinahrdt and Kenneth S. Rogoff, This Time is Different: Eight Centuries of Financial Folly (New Jersey: Princeton University Press, 2009).
[2] See Farmer, 1993, The Language of Public Administration
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