There is much academic debate over what causes so-called bubbles This is something I will post about at a later date. However there doesn’t need to be one single cause. It can be a blend of causes. One thing we do know from every major financial crises is that looting and fraud are pervasive.
In the wake of the 1929 financial crises the Pecora Commission described wide-spread criminal behavior by National City Bank. These findings resulted in the Glass-Steagall Act.
In April of 1994 George Akerlof and Paul Romer of the National Bureau of Economic Research wrote a study titled “Looting: The Economic Underworld of Banking for Profit”.
They examined 4 events in the 1980s: The collapse of the finance sector in Chile, the S&L crises, The Dallas real estate and construction boom and bust, and the boom and bust of the junk bond market.
From the abstract:
In this paper, we use simple theory and direct evidence to highlight a common thread that runs through these four episodes….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.
“Bankruptcy for Profit” is the best was to describe the business model of Countrywide. It was announced yesterday that the government is putting together a civil case against former Countrywide CEO Angelo Mozilo, conveniently after the statute of limitations for criminal charges has expired.
Today we learn from the NY Times that a Texas based subprime auto lender has agreed to pay a fine for submitting bogus information to credit reporting agencies in order to get customers approved for sub-prime auto loans.
This is fraud – and it should be prosecuted. Instead the government has extracted a fine. All told the Obama administration has extracted over $20 billion in fines for Wall Street’s rampant criminal behavior. Why no indictments? One popular theory is that the banks are “too big to indict”, that is, that the government fears that criminal indictments will wreck the financial system. This of course has it backwards: It is criminal behavior that is wrecking the financial system.
Another popular theory is the “revolving door” theory. This supposes that the various regulators all look the other way in order to secure lucrative jobs on wall street at a later time. There is a lot of merit to both of these arguments. I have written elsewhere that this behavior of looking the other way at criminal behavior and then extracting money from the criminals seems to mimic the behavior of Emperor Vespasian.
When Vespasian became emperor he was still dealing with the horrible fiscal mess left by Nero. One of his solutions was to let the tax collectors run rampant. He looked the other way while the tax collectors robbed the citizenry. Then, when they were wealthy, he would become the champion of the people and arrest the tax collectors and seize their ill-gotten gains, which he would of course deposit in the treasury.
As described by Suetonius in “The Twelve Ceasars”: “They were, at any rate, nicknamed his sponges — he put them in to soak, only to squeeze them dry later. ”
For some time now I have viewed the banks and the government as essentially one and the same, and the two political parties as representing one pro-bank and pro-war party, that then squabbles over meaningless things in order to have us think they are in effect two different parties.
While I still feel the same way about the political parties, the recent fines and criminal inquires against JP Morgan and other banks have me wondering if perhaps I was wrong. Instead of the banks owning the government (or being one and the same) that in fact the banks are simply Vespasian Sponge’s.
Having bankrupted the country in all manners of spending (particularly raining bombs down on people on the other side of the world) the politicians figured that it was easier to let the banks steal from the population, (and then to squeeze the money out of the banks) then it was to just take the money directly from taxpayers (which might affect their re-elections). This way everyone wins. The government get’s it’s money, the bankers get their bonuses.