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It's almost worth this depression to find out how little our big men know. -- Will Rogers quoted in After the Music Stopped by Alan Blinder.
TARP was a smashing success. The Obama administration bit off far more than it could chew. And CNBC commentator Rick Santelli didn't speak for most Americans in his epic rant criticizing government efforts to assist struggling homeowners.
Those are just a few of the provocative opinions expressed in After the Music Stopped by Alan Blinder, a Princeton professor and former member of President Clinton's Council of Economic Advisers. The book is the latest attempt to understand the financial crisis, and I think it's one of the better ones.
Blinder looks at the evidence first before delivering his judgments. And he's very honest in admitting that he had been wrong on particular issues in the past. For example, he mentions that he believed at the time that TARP, or the Troubled Asset Relief Program, should have been focused on buying up troubled assets instead of just injecting capital into the big financial institutions. Despite that belief, Blinder concedes that the evidence suggests TARP might be among the most "successful economic policy innovations in our nation's history."
The great strength of Blinder's discussion of the financial crisis is that he attempts to base his opinions on data rather than dogma. Some of his views are very controversial, however. Here are five compelling conclusions that might surprise you.
1. Fannie Mae and Freddie Mac did not play leading roles in the run-up to the financial crisis.
Blinder, of course, agrees that Fannie and Freddie were deeply flawed institutions, but he feels they were "supporting actors" rather than stars of the show. The majority of the Financial Crisis Inquiry Commission agreed with that assessment, though others do not.
Blinder points out that Fannie and Freddie's balance sheets were actually shrinking slightly from 2003 to 2007 -- a time when other Wall Street firms saw their balance sheets double in size. And he reports that their purchases of mortgage-backed securities actually peaked in 2004 and were in the "safest tranches."
2. The Bear Stearns rescue was not an application of the "too-big-to-fail" doctrine.
Blinder believes that describing Bear Stearns as having been "too big to fail" is inaccurate and misleading, even though that's the description that stuck in the public's mind. At the time of the Fed-engineered sale of Bear Stearns to JPMorgan Chase (NYSE: JPM ) , there were at least 16 other financial firms that were bigger (or as big) as Bear Stearns. For Blinder, the precise characterization of the company should have been "too interconnected to fail."
Regardless of terminology, saving Bear implied, according to Blinder, that Lehman Brothers, Merrill Lynch, Morgan Stanley (NYSE: MS ) , and Goldman Sachs (NYSE: GS ) would also be rescued, if necessary. Ultimately, Blinder thinks the decision to let Lehman fail in September 2008 was a colossal mistake that set in motion the worst events of the crisis.
3. ARRA, or the American Reinvestment and Recovery Act, worked just as it was expected to.
There is a lot of contentious debate about whether the Recovery Act of 2009, which is also known as "the stimulus," actually benefited the economy. Blinder, along with Mark Zandi, published a study in July 2010 arguing that the stimulus was indeed successful.
Many others disagree with Blinder on this issue. The fact that unemployment was rising sharply before the stimulus was even set in motion has made the debate somewhat murky. Blinder concedes that the "it would have been even worse" argument isn't terribly effective in most policy debates.
4. The view that the repeal of Glass-Steagall was a major cause of the financial crisis is an urban myth.
The Glass-Steagall Act of 1933 separated commercial banking from investment banking. That Act was, of course, repealed in 1999, and some have argued that the repeal was a major cause of the financial crisis. Senators Elizabeth Warren and John McCain have just recently introduced a bill that would recreate Glass-Steagall for our big financial institutions.
Blinder admits that the repeal of Glass-Steagall may have made Citigroup (NYSE: C ) even more of a mess than it would have been, but otherwise, it wasn't a major factor in any of the big problems during the crisis.
5. Failure to solve the foreclosure problem is one of the main reasons for the weak recovery.
Blinder provides a very detailed analysis of our failed attempts to deal with the ever-growing foreclosure problem. He notes that there might be 10 million homes that will enter foreclosure proceedings before it's all over. And this has considerably slowed our economy's ability to recover. Overall, he assigns a grade of "D" to our response to the home mortgage foreclosure crisis.
Sadly, it didn't have to be this way. For some reason, the single-mindedness we applied to rescuing the banks didn't apply to assisting troubled homeowners. Our economy and countless individuals have suffered unnecessarily as a result.
The work ahead
I highly recommend this book, though you might not agree with all of its conclusions. Blinder is an unapologetic Keynesian, so despite his very admirable focus on the evidence, he clearly has a bias that is not shared by everyone. All of us have our own biases, of course.
Looking forward, Blinder's views on our budget woes seem very sensible to me. He believes we need a short-term stimulus today along with massive deficit reduction for the future. Some of that future deficit reduction will come from taxes, but most of it should come from lower spending.
In the near term, however, Blinder implies that the "austerians" are on the wrong track. He writes:
The Earth is not flat. The moon is not made of cheese. Evolution really happened. And you don't give your economy a short-run boost by cutting public spending.
Clearly, that's a pugnacious statement from this very provocative book. I think you'll enjoy reading it, however, even though it might stir you up at times.