The Insider Narrative
By Arnold Kling
Michiko Kakitani reviews David Wessel’s new book, In Fed We Trust. She likes it more than I do. I think it is too much of an insider’s narrative.
There are two dimensions on which people differ about the financial crisis. There is Left and Right; and there is Insider and Outsider. The Left thinks that deregulation did it. “If only they had not repealed Glass-Steagall. If only they had put credit default swaps on an organized exchange. If only there had been a systemic risk regulator.”
Anyone familiar with my views on the crisis knows that I think that all of these stories are silly. I think that the fundamental reason that we had a crisis in the mortgage market was bad housing policy. And the fundamental reason that we had a flimsy financial structure was regulatory capital arbitrage–structures designed to exploit loopholes in regulatory capital requirements.
The Left wants to resuscitate mortgage securitization with better regulation. I am for a more fundamental rethinking of housing policy, that does not try to push mortgage indebtedness to the limit in order to raise home “ownership” rates. I also believe that if capital requirements were sensibly tied to risk, then we not even see mortgage securitization, much less the layers of CDO’s and SIV’s that were built on top of it.
The difference between insiders and outsiders concerns whether troubled financial institutions needed to be propped up or shut down. The insider view is that the main problem was a loss of confidence, and government assistance is important to solving that problem. The outsider view is that the banks were too big, too highly leveraged, and took on too many bad mortgage assets.
The insider view is that the Lehman bankruptcy was the key event in the crisis. The outsider view is that not enough institutions were put out of their misery.
Although Wessel is generally a straight shooter, his book seems to be (I have only had time to skim it) a pure Left-insider narrative. If so, then it has little to offer other than personality gossip about players like Bernanke and Paulson.
The Left-outsider view is represented by Simon Johnson, James Kwak, and The Quiet Coup.
The Right-insider view is represented by Gary Gorton and Perry Mehrling. They think all that securitization needs is for the government to hold the super-senior risk.
The Right-outsider view is represented by yours truly. UPDATE: I also received the other book reviewed in the Times, called A Colossal Failure of Common Sense, a diatribe about Lehman. I opened to a random page, and read
The goddamned cat was out of the bag, and we were staring at an ugly, sneering face engraved on a very hot potato
Not the style of writing that appeals to me.
On the other hand, I can recommend this short paper on credit default swaps. Although they recommend a clearing house for some swaps, they point out that a clearing house would have been no panacea and in particular would not have taken care of the AIG problem.