Opinion
The Scandal Is What's Legal
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But what made the U.S. financial system so fragile a decade ago, and what made the crisis so deep, were practices that were completely legal. The scandal is that we still haven't addressed these properly.
By Kim Schoenholtz and Stephen Cecchetti
If you haven't seen The Big Short, you should. The acting is superb and the story enlightening: a few brilliant outcasts each discover just how big the holes are that eventually bury the U.S. financial system in the crisis of 2007-2009. If you're like most people we know, you'll walk away delighted by the movie and disturbed by the reality it captures. [Full disclosure: one of us joined a panel organized by the film's economic consultant to view and discuss it with the director.]
But we're not film critics. The movie--along with some misleading criticism--prompts us to clarify what we view as the prime causes of the financal crisis. The financial corruption depicted in the movie is deeply troubling (we've written about fraud and conflicts of interest in finance here and here). But what made the U.S. financial system so fragile a decade ago, and what made the crisis so deep, were practices that were completely legal. The scandal is that we still haven't addressed these properly.
We can't "cover" the causes of the crisis in a blog post, but we can briefly explain our top three candidates: (1) insufficient capital and liquidity reflecting poor risk management and incentives; (2) the ability of complex, highly interconnected intermediaries to take on and conceal enormous amounts of risk; and (3) an absurdly byzantine regulatory structure that made it virtually impossible for anyone, however inclined, to understand (let alone manage) the system's fragilities. (In 2009, one of us tried to summarize the causes of the crisis, and it took 6,000 words. The other one teaches a semester-long course on financial crises.)
Read full article as published by The Huffington Post.
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Kim Schoenholtz is Professor of Management Practice in the Department of Economics and Director of the Center for Global Economy and Business.
But we're not film critics. The movie--along with some misleading criticism--prompts us to clarify what we view as the prime causes of the financal crisis. The financial corruption depicted in the movie is deeply troubling (we've written about fraud and conflicts of interest in finance here and here). But what made the U.S. financial system so fragile a decade ago, and what made the crisis so deep, were practices that were completely legal. The scandal is that we still haven't addressed these properly.
We can't "cover" the causes of the crisis in a blog post, but we can briefly explain our top three candidates: (1) insufficient capital and liquidity reflecting poor risk management and incentives; (2) the ability of complex, highly interconnected intermediaries to take on and conceal enormous amounts of risk; and (3) an absurdly byzantine regulatory structure that made it virtually impossible for anyone, however inclined, to understand (let alone manage) the system's fragilities. (In 2009, one of us tried to summarize the causes of the crisis, and it took 6,000 words. The other one teaches a semester-long course on financial crises.)
Read full article as published by The Huffington Post.
___
Kim Schoenholtz is Professor of Management Practice in the Department of Economics and Director of the Center for Global Economy and Business.