Explaining the Financial Crisis, Assuming No Prior Knowledge

I was a guest lecturer in a large undergrad lecture class yesterday, for Intro to International Politics. It was the first time I've gotten to speak for 50 minutes to an audience of several hundred, so good practice/preparation for me. I gave a talk on the financial crisis. Before that, I'd done an informal survey of some students to find out what they knew about the crisis, and the consensus was that some of them had some vague idea that a crisis had occurred, and a very small minority of those knew that it had something to do with housing, but that's it. The majority have no economics training at all. So the lecture was very much geared towards explaining to them why this was important, and how and why we can think about it in political terms, in ways they could understand.

I had to cover a lot of ground pretty quickly, but I think I covered my bases fairly well, given the constraints. I would've liked to spend more time on the politics than the brush-clearing, but I just couldn't assume enough prior knowledge to make that happen. Ideally, this would be split into two or three lectures, at minimum. Anyway, the students didn't complain to my face, so it couldn't've been too bad.

No video/audio, unfortunately, but here are the slides. Since I had so much to cover in 50 minutes, I made the slides pretty detailed, and gave them to the students so they'd be able to just listen to me rather than furiously scribble notes.

FinCrisisLecture

Note1: In the pdf version of the slides, there's a time series animation of banking integration embedded in slide 18 that probably won't show up in Scribd. That can be found here. The students seemed to like that part especially.

Note2: The gorgeous Beamer template was created by the excellent Skyler Cranmer. Technically, I think I'm using it without his permission -- I got it from a grad student who got it from a grad student who got it from a grad student who got it from him, or something -- so credit to him, and hopefully he doesn't mind my free-riding. Whenever he gets back from Europe I'll ask him if there's a favor I can trade in exchange.

Who is to Blame?

Who should we blame for our current economic difficulties? I have been thinking about this question for the past week. Not because I wonder who we should blame, but because I am puzzled by the quest to find the person or persons who are responsible. The consensus places primary responsibility on Alan Greenspan. A few, such as Fred Bergsten, blame the IMF as well (for what, exactly, remains unclear). There appears also to be a consensus that Bernanke is to blame for failing to respond correctly to financial weakness (whatever that means) in order to make things better.

I find the search for a culprit puzzling for two reasons. First, the blame game rests on faulty reasoning. Those who assign blame implicitly compare what did happen with a utopian counter-factual of what would have happened had a different policy been followed. Greenspan is to blame because he cut rates too much and fueled the housing bubble. Asserting that these rate cuts were mistaken (and thus G is to blame) requires one to believe that not cutting rates would have produced a much better outcome. Yet, what would have happened had G not cut rates? We might have had a severe rather than a mild recession in the early 2000s. Then we would blame him for not cutting rates (fully unaware, of course, that cutting rates would have produced a housing bubble). So, when we assign blame we assume that the path not taken was a better path without having any good reason to believe this.

Second, when we assign blame we assume that individuals can control highly complex systems. Yet, our understanding of the relationship between monetary policy instruments and economic activity has not yet reached the status of Newtonian mechanics. There is considerable uncertainty about how financial markets work, and how they respond to changes in monetary policy. Whatever imperfect understanding does exist is constantly in flux as financial markets innovate. Is it reasonable to expect the Fed to anticipate the emergence of the new and highly complex financial instruments that drove the sub-prime lending boom? How reasonable is it then to argue that the housing bubble was foreseeable (and foreseen) by Greenspan? This is, of course, the inverse of the first flaw in reasoning; we assume that the future consequences of our current decisions are knowable and we can therefore avoid bad futures.

So why do we insist on assigning blame? I don't know, maybe it reflects our discomfort with the uncertainty that pervades all of the decisions we make and our inability to accept how little direct control we have over the broader forces that shape our lives. Or, perhaps it reflects the exigencies of democratic politics. In a world in which we expect so much from our government, we have lost the capacity to distinguish between those things that a government can be reasonably expected to do and those things we think it should be able to do. As a consequence, we expect unreasonable things from our government, and these expectations create opportunities that those seeking office can exploit to their electoral advantage.