The 2008 Crisis

Rob Johnson, President of the Institute for New Economic Thinking, is not your average economist. He’s got heart and soul, or if you’ll have it, the blues! With his deep connection to the arts and humanities, Rob leads the new economic thinking not just with a sharp mind, but also with sensibility.

This article is part of an ongoing series in which Rob shares his life experiences, and biggest lessons learned. If you’re an aspiring expert in economics or a related field, this is for you. It might mitigate the depth and duration of your mid-life crisisEarlier articles in this series can be found here.


10 – The 2008 Crisis

In 2007, I was no longer working in finance but I could see something was wrong in the mortgage market; I kind of smelled a rat.  

So, I got my own money out of harm’s way, and I started having conversations. I sat on the board of a couple of foundations, so I went to meet with the foundation’s leader, Bob Borosage, who arranged for me to meet with Nancy Pelosi. She was hesitant. “This is an election year, she said; we might not be able to deal with this.” I pointed out that we may have to. I warned her that it could all blow up before the election. And it did. 

It was similar to what happened in 1987. Then, too, rocket scientists had been crunching numbers on Wall St, with the management going home each night, happy to know what two standard deviations look like. Financiers were convinced that they didn’t need to be regulated and could control things themselves. But they had divorced from reality. The same mechanical derivatives that Soros had been skeptical of in the late 80s had reared their head again, except worse. It was a collective feeding frenzy on an even larger scale. 

So, now I was back in the scene. Not to make money, but to help scrutinize things. A lot of my former colleagues from when I worked in the US Senate were getting stormed by lobbyists. It was a crisis. We went to work–all hands on deck. But things did not move in the right direction. The TARP legislation that was supposed to avert the crisis was very unsatisfying. As Joe Stiglitz said, “it was paying the polluters.” It was going to put the necessary money out, but they were not taking over firms, the equity wasn’t wiped out, and the managements weren’t going to be fired.  

The financial sector got 800 billion dollars, and the mortgage holders who were under water got nothing. Usually the financiers are the ones who tell you to be prudent; that you can’t afford things. But now that they screwed up, they snapped their fingers and said “give me eight hundred billion dollars because we’ve gotta get out of this mess, or else you’re all going down with us.” And the government went ahead. They didn’t invest in infrastructure, in health care, or in schooling. But they were ready to buy the toxic mortgage bonds off the balance sheets of these perpetrators.  

As this was unfolding, I went to dinner with George Soros and Rob Dugger. Soros, having spent his formative years in Hungary, told us about the parallels he observed. Because in 1930, Austria and Germany had a financial crisis, too, and that really accelerated the rise of the Nazis. There, too, the financial leaders had  been considered the stewards of society. So when they blew it, there was a vacuum made everyone more anxious and to fill that void the Nazis stepped in. Soros was afraid that the handling of the 2008 crash could create a similar loss of credibility for finance, economics, and government. All of which might be deserved. But such turmoil could give rise to an authoritarian reaction.  

So the three of us discussed how we could make a difference. How could we stop people from defending bag ideas? How could we fill the void with good ideas? 

To start, Soros sent me on tour. I went all over the world to meet leading economists. London, Sydney, Australia, Tokyo, Hong Kong. I just flew around and talked to everybody. Leading government officials, leading investors, many of whom I knew. I was looking to answer what came to be called “the queen’s question”: how did you all miss this? It became clear that it had been the unconstrained financial sector. The financiers had been able to make money on the upside, while the risks on the downside were mitigated by their capture of the the regulatory apparatus. 

The issue was not just in the US. Europe was in trouble too. They had been doing repurchase agreements (”repos”) with the ECB. So you’ve got German bonds? Well, Greek, Spanish, Portuguese, Greek, and Italian bonds all yield about 400 basis points more. You could repo them at the same rate, and gain the difference. What that did was it facilitated a tremendous amount of capital flow to the southern European countries. Then the Lehman crisis hit, and everybody wanted to shrink their balance sheet. It was what economist Guillermo Calvo called “a sudden stop” for Southern Europe. 

At the same time, China had been developing fast. This had consequences for Europe, too. Servaas Storm showed that places like Scandinavia, Germany, and Netherlands, benefited from this. They could sell capital goods to build the infrastructure of China. But the labor-intensive industries in southern Europe got a negative shock. The result was that in much of Europe, the 2008 crisis was greater than the Great Depression of the 30s. Many people do not realize this. 

So the tension was building. There was a schism between what people were supposed to put their trust in, and what they saw happening. Right away it spawned the Tea Party and Occupy Wall Street in the United States. 

Trust was faltering, and we needed to fill the void that Soros saw emerging.  That’s what gave rise to INET


Earlier articles in this series can be found here.

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