Arnold Kling  

The Bernanke View

PRINT
Does the U.S. Government Incre... Gridlock at the Worst Time...

Ben Bernanke says,


The notion that financial assets can always be sold at prices close to their fundamental values is built into most economic analysis, and before the crisis, the liquidity of major markets was often taken for granted by financial market participants and regulators alike. The crisis showed, however, that risk aversion, imperfect information, and market dynamics can scare away buyers and badly impair price discovery. Market illiquidity also interacted with financial panic in dangerous ways. Notably, a vicious circle sometimes developed in which investor concerns about the solvency of financial firms led to runs: To obtain critically needed liquidity, firms were forced to sell assets quickly, but these "fire sales" drove down asset prices and reinforced investor concerns about the solvency of the firms. Importantly, this dynamic contributed to the profound blurring of the distinction between illiquidity and insolvency during the crisis.

Read the whole thing. What I take away is that Bernanke still holds to the "insider" view of the financial crisis. It was mostly a big, unnecessary panic.

I wonder what the evidence is on this. Did the prices of mortgage-backed securities that fell in the fall of 2008 subsequently rise substantially? Were buyers of toxic assets subsequently rewarded for their nerves of steel?

An NPR story suggests otherwise.


When we bought Toxie , in January of this year, she seemed like a great deal. We paid $1,000. That was 99 percent less than she cost during the housing boom.

Every month, when homeowners paid their mortgages, we got a check. We thought we'd make back our investment before she died. But in the end, we collected only $449.

The NPR experience was that an asset that was once thought to be worth $100,000 only was worth $449. Perhaps their experience was not representative. However, it raises doubts about Bernanke's view of the crisis.

To me, Ben Bernanke has always looked like a "suit" who did not understand the world of the "geeks." He has never made any reference to the nonlinear option characteristics of the securities that played a central role in the financial crisis. Moreover, he has never expressed any sympathy for the view that the financial sector became too big in recent years.

The conventional view, which is likely to make its way into the history books, is that Bernanke understood the crisis and the economy well and that his actions saved us from a worse disaster. In my view, he has an enormous blind spot concerning the valuation of option-like securities. His main "success" was in transferring wealth from future American taxpayers to large foreign and domestic financial institutions.


Comments and Sharing





COMMENTS (3 to date)
Steve Sailer writes:

It seems like the good news is that a lot of other financial assets, such as corporate bonds, turned out not to be as rotten as mortgage-backed securities.

The bad news is that mortgage-backed securities turned out to be just as rotten as feared in October 2008.

Charles R. Williams writes:

If you construct mortgage backed securities and rate them AAA on the basis of collateral value, as soon as housing prices fall they become impossible to value, casting doubt on the equity of financial firms that own them. Panic ensues.

It is possible that these securities are worth more than they can be sold for. It is possible that they are worth less. The sure thing has become a crap shoot. In retrospect the financial sector experienced both solvency and liquidity problems in an interrelated way. Liquid assets became illiquid assets, losing "fundamental" value in the process, thus creating solvency issues.

After the fact it doesn't matter what these things are worth.

Dr Econ writes:

How does Bernanke propose to discover "fundamental values" independent of markets and financial intermediation? Absent a practical theory for that, what do his musings add to real life? Obviously, "fundamental values", if the phrase is to mean anything, must connote the long term market equilibrium, perhaps with some drift within predictable statistical deviations. We were above "fundamental values" up to 2008, it seems, although we didn't really know it, and now we're probably below, because capital markets typically overreact when really bad things happen, just as they overinflate when hope is up. Does Bernanke and/or all his econ-computer dudes at the Fed know how far off we are right now? If they were wrong about "fundamental values" a few years ago, do they really know where we should be now?

I don't think so. In other words, "fundamental values" is not a practical concept. I'm sure it looks good in a DSGE model, but that's it.

Comments for this entry have been closed
Return to top