My views have been influenced by Gary Gorton, well before his latest paper, but I nonetheless disagree with him on important matters.

I view the financial crisis as having four components:

Bad Bets
Excessive leverage
Domino effects
21st-century bank runs

For explanations of those terms, see Not What They Had in Mind.

Gorton’s contribution has been to describe the mechanism of 21st-century bank runs and point out how widespread they were. By the same token, he downplays the significance of bad bets and excessive leverage. If he is correct, then Ben Bernanke knows what he is doing. Treating the financial crisis primarily as a liquidity crisis, the central bank is preventing otherwise sound institutions from being driven under by a short-term panic.

I disagree on that. I think that the runs are the last stage in the process. The mechanisms that Gorton describes account for the rapidity of the collapse of financial institutions. However, those institutions were, in my view, unsound, due to bad bets and excessive leverage.

This relates to an age-old and possibly false dichotomy between liquidity crises and solvency crises. The Bernanke-Gorton view is that the financial crisis was a mild solvency problem that, because of panic, became a severe liquidity problem. My view is that there was a genuine solvency problem, due to bad bets and excessive leverage. Freddie, Fannie, and some other large financial institutions deserved to go out of business. Keeping them alive does not end the crisis, but instead stretches it out. By treating the crisis as a liquidity problem we are maintaining a system with too many banks, too much government-provided mortgage lending (the combined FHA-Freddie-Fannie share is 95 percent), and the conversion of the Fed from a central bank to a piggy bank. (James Hamilton’s has another new post that raisespiggy bank concerns.)