Filippo Cobelli - 68875 – Università degli Studi di Brescia – Economia Internazionale
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A BSTRACT
With this work I provide a deep and wide view on the global
financial crisis. My work starts with an overview on the Austrian school
theories provided by Murray N. Rothbard in his work “American’s
Great Depression”, and its dissertation on the genesis of the Crisis of
1929. Then, after some consideration on the Rothbard’s work, I shift my
attention on causes of the current crisis considering the solutions
proposed by the different Governments. The first chapter is based on the
description of the igniting causes of the current economic downturn. I
focus on the crisis’s triggering factors, starting from the house bubble.
After that, I analyze the crash and the rising illiquidity problems
concerning the banking sector and I describe the anatomy of MBS and
CDO: two financial products at the root of the financial crisis. After the
description of the main causes and triggering factors of the crisis. I
focus my analysis on the way of transmission of the deepest and wider
economic downturn till the days of Great Depression. In particular I
examine in detail the transmission process between the tw o sides of
Atlantic Ocean. Here I make a little preview on the situation in US and
EU (a very accurate explanation follows in the next chapters) and then I
try to discover essential features of the crisis spread from US to the
European countries. In the following chapter I conduct a deeper analysis
on the actions of the US and EU Governments to face the crisis. First of
all, I consider the European intervention in the banking to solve liquidity
and solvency problems of many European banks. Through this
Filippo Cobelli - 68875 – Università degli Studi di Brescia – Economia Internazionale
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evaluation I try to give a sum of its possible costs. After that, I throw my
attention to the European Recovery Plan and, in the end, I express my
point of view on the matter. In the following part of the chapter I analyze
the US responses to the crisis starting from the G.W Bush Economic
Stimulus Act of 2008 till the latest Obama’s ARRA. At the same time I
consider the US intervention in the banking sector, giving an estimated
cost for this action. After this chapter I compare and contrast the current
global crisis and the latest economic downturn in term of global
dimension: the Great Depression. Here I write an introduction to the
most important causes of the Great Depression, showing differences and
analogies between the two global downturns, the world response in the
1929 and nowadays and what we had learned from the past crisis and
who has been implementing in the actual anti -crisis action. In the last
chapter I explain my point of view on the entire work, focusing on the
countries intervention and criticizing some actions, taken into account
by some Governments, and finally offering some different proposals,
which, in my opinion, guarantee a better money allocation. In this last
chapter I also analyze a huge problem that Europe has been showing off
during this crisis, the coordination problem.
Filippo Cobelli - 68875 – Università degli Studi di Brescia – Economia Internazionale
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A USTRIAN
S CHOOL
Today’s economic and financial crisis hit hard what was considered till now
the best economic system: the Capitalism. Free market suffered a lot during the crisis
and now everyone is in searching for the root causes of this economic collapse. To
understand better the framework of the actual financial and economic crisis the
publication of Murray N. Rothbard, “Americas’ Great Depression” could give us a
clearer view on the main causes of the crisis and at the same time suggest us some
exit strategies. Rothbard’s work is based on the strong Austrian economic theory and
has its base on the work produced by Mises years before.
The book describes properly the root causes and the triggering factor of the
1929 crisis but, surprisingly, it also offers a detailed description the developing of the
actual financial and economic crisis. The Rothbard’s view sometimes differ from the
Mises one, Rothbard embrace a more exasperated free-economy view, in fact, it was
considered one of the major exponent of Anarcho-capitalism, theory, where the
laissez-faire and the exclusion of any State paradigms was the base element. The
knowledge of the sub-structure of the Rothbard theory give us the tools to better
understand his work and his analysis of the root causes of the 1929 downturn.
Rothbard, in his work, use all the elements given to him by the Austrian theory of
business cycle to explain all the facts that had develop the crisis of 1929. A key
elemet of Rothbard analysis is to distinguish between business cycle and merely
business fluctuation. Rothbard, would describe how business cycle could create
global boom and depression, he say: “The problem of the business cycle is one of
general boom and depression; it is not a problem of exploring specific industries and
wondering what factors make each one of them relatively prosperous or depressed”
and he reach an important consideration “In considering general movements in
Filippo Cobelli - 68875 – Università degli Studi di Brescia – Economia Internazionale
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business, then, it is immediately evident that such movements must be transmitted
through the general medium of exchange-money.” So by the analysis given by
Rothbard only the changes in demand for, and/or the supply of money could generate
price changes but it also says that this monetary-relation “do not by themselves
provide the clue to the mysterious business cycle”. So for Rothbard the crisis was
really generate by “sudden general cluster of business errors” triggered by the
manipulation of monetary market. Murray N. Rothbard in underline how the
monetary expansions start during 1924 and boosted by the easily banks borrowing
condition has created the bases for the worst and deeper crisis of the last century. In
his work he support the thesis where was described how the manipulation of the
money supply could create huge economy imbalance and develop a succession of
entrepreneurs’s mistakes. He says, “In the purely free and unhampered market, there
will be no cluster of errors, since trained entrepreneurs will not all make errors at the
same time. The “boom-bust” cycle is generated by monetary intervention in the
market, specifically bank credit expansion to business.” That alteration of the money
market, thanks to the inherent bank’s bankruptcy, will cause a banks rush and thanks
to that a contraction of credits and trigger a domino of business failure. The same
scenario seen in the actual economic and financial crisis. Rothbard suppose that
those business mistake hardly hit capital goods industries because the businessmen
were misled by bank credit inflation to invest too much in higher-order capital goods,
which could only be prosperously sustained through lower time preferences, greater
savings and investment. As soon as the inflation permeates to the mass of the people,
the old consumption–investment proportion is reestablished, and business
investments seen to have been wasteful. So for Rothbard “The crisis arrives when the
consumers come to reestablish their desired proportions. The depression is actually
the process by which the economy adjusts to the wastes and errors of the boom, and
reestablishes efficient service of consumer desires … The free market tends to satisfy
voluntarily expressed consumer desires with maximum efficiency … The
inflationary boom hobbles this efficiency, and distorts the structure of production,
which no longer serves consumers properly … the depression is the “recovery”
process, and the end of the depression heralds the return to normal, and to optimum
efficiency. The depression, then, far from being an evil scourge, is the necessary and
Filippo Cobelli - 68875 – Università degli Studi di Brescia – Economia Internazionale
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beneficial return of the economy to normal after the distortions imposed by the
boom.” It’s really amazing how the Rothbard analysis and proposal and the Austrian
school theories could describe in a perfect manner the phenomena that have
characterized the current economic crisis.
After that consideration I’ve to underline that, today, the Rothbard economic
view of a exasperate lassie fare would be overtake. Countries like USA pioneer of a
fully free trade market policy are now ever more closer to a “social” economic
market view. Clearly, the theories at basis of Austrian school, is about 100 years old
and also some Rothbard’s Anarcho-Capitalism positions shows pronounced
contradiction with the today’s economic theories. Rothbard point out the
Government intervention as the main actor of the deepening and long lasting of the
1929 crisis. He says, “The more the Government intervenes to delay the market’s
adjustment, the longer and more grueling the depression will be, and the more
difficult will be the road to complete recovery. Government hampering aggravates
and perpetuates the depression.” Then Rothbard underline six moves that the
Government do (also during the actual crisis) to restore the economy but, for
Rothbard, that works in the opposite way.
1- Prevent or delay liquidation. Lend money to shaky businesses, call on banks
to lend further.
2- Inflate further. Further inflation blocks the necessary fall in prices, thus
delaying adjustment and prolonging depression. Further credit expansion
creates more malinvestments. No Easy money policy.
3- Keep wage rates up. Artificial maintenance of wage rates in a depression
insures permanent mass unemployment.
4- Keep prices up. Keeping prices above their free-market levels will create
unsalable surpluses, and prevent a return to prosperity.
5- More saving and less consumption would speed recovery; more consumption
and less saving aggravate the shortage of saved-capital even further. Any
increase of taxes and Government spending will discourage saving and
investment and stimulate consumption, since Government spending is all
Filippo Cobelli - 68875 – Università degli Studi di Brescia – Economia Internazionale
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consumption, shifts the societal consumption–investment ratio in favor of
consumption, and prolongs the depression.
6- Subsidize unemployment. Any subsidization of unemployment will prolong
unemployment indefinitely, and delay the shift of workers to the fields where
jobs are available.
As we see here all the idea proposed by Rothbard work in the opposite ways as
the one proposed by Government during the 1929 crisis, with the New Deal
proposal, and also during the actual economic crisis whit the EU and US recovery
plan. In my opinion, the above proposal, show off the exasperated laissez-faire of the
Rothbard thinking. Another ways was the Austrian theories of economic cycle and in
particular the monetary theories, they s e e m s stunningly able to describe the
triggering factors of 1929s and the triggering factors of the actual economic
downturn. In “American’s Great Depression” Rothbard, propose also free trade as a
way to restore the economy from its downturn, he propose the elimination of every
barrier, like import duties and quotas, that could spoil the economic recovery. The
importance of enhance free trade and avoid any kind of trade barriers for a fast
restore from economic downturn was underline also during 2007 economic crisis by
EU and WTO. The Rothbard’s work give a solid framework to better analyze the
root causes, the triggering factors and the solutions take into account by the
Governments to overtake ours days financial and economic crisis.
Filippo Cobelli - 68875 – Università degli Studi di Brescia – Economia Internazionale
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GENESIS OF THE CRISIS
ROOT CAUSES AND THE DOMINO EFFECT
Since the early 80s, the global economy has seen a rapid expansion in the
availability of savings due in great part to the rapid economic growth of East Asian
economies. The United States of America has historically been viewed as a financial
“safe haven” – a place for foreign citizens to bank their savings – foreign citizens
have often moved their savings to the USA. After the 1990s financial crisis this
perception was enhanced. An important note to analyze the current crisis was the
movement of savings from abroad into this country that significantly increased the
financial base of the U.S. economy in the ’90 and the early part of this decade.
During the this years, the United States was in a globally dominant economic
position. This led the federal Government and the Fed to act as a global guarantor of
economic stability. This was seen in U.S. backing of Mexican debt
1
in 1995and with
the U.S. Central Bank’s significant injection of money into markets following global
crises. Unfortunately, these tools were blunt; they aided the foreign community but
these actions tended to again increase the financial funds available in the United
States.
Also during the 1990s, and continuing into this decade, the United States ran
very large trade deficits. The consequence is clear: any continuing trade deficit must
be balanced over time by a net inflow of financial capital from abroad and these
1
The 1994 Mexican economic crisis happened when the peso crashed under a floating
regime from four pesos to the dollar to 7.2 to the dollar in the space of a week. The United
States intervened rapidly, first by buying pesos in the open market, and then by granting
assistance in the form of $50 billion in loan guarantees. The dollar stabilized at the rate of 6
pesos per dollar
Filippo Cobelli - 68875 – Università degli Studi di Brescia – Economia Internazionale
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inflows continuously increase the availability of financial assets in the United States.
The way to absorb these financial assets drive the U.S. toward the deregulation
of the U.S. economy, started with the Carter Administration
2
. During the 1980s and
1990s, deregulation moved into the banking industry and allowed for rapid changes
in how banks did business. Two significant changes were the partial revocation of
the Glass-Steagall Act
3
in 1980 and 1999, and the huge decreases in restrictions on
the formation of interstate branch banking operations. These changes increased the
range of activities banks were allowed to engage in and reduced the personal
connections between bankers and borrowers. These innovations weren’t wrong but
the rapidity of their introduction did not allow for a sufficient period of time to
develop tools to manage new risks, so this is the real problem. In a retrospective
point of view, it is clear that downside risks were underestimated (starting from the
.Com crisis to the housing bubble and now the financial derivates). Now it’s clear
that the introduction of these innovative products in combination with the increased
monetary base allowed the circumstance for a poor risk control. Also the Financial
Accounting Standards Board
4
changed asset-pricing standards on November 2007.
This change introduced “mark-to-market”
5
asset valuation that change in accounting
standards served to worsen the credit crisis during 2008.
2
The first step was the deregulation of the commercial airline industry in the US was
initiated by the Carter Administration in 1978.
3
The Banking Act was a reaction to the collapse of a large portion of the American
commercial banking system in early 1933. It introduced the separation of bank types
according to their business commercial and investment bank, it also established the Federal
Deposit Insurance Corporation and introduced banking reforms, some of which were
designed to control speculation.
4
Financial Accounting Standards Board (FASB) has been the designated organization in the
private sector for establishing standards of financial accounting. Those standards govern the
preparation of financial statements. They are officially recognized as authoritative by the
Securities and Exchange Commission (SEC). Such standards are important to the efficient
functioning of the economy because investors, creditors, auditors, and others rely on
credible, transparent, and comparable financial information.
5
Mark-to-market accounting refers to the accounting standards of assigning a value to a
position held in a financial instrument based on the current fair market price for the
instrument or similar instruments. So Mark-to-market is a measure of the fair value of
accounts that can change over time, such as assets and liabilities.
Filippo Cobelli - 68875 – Università degli Studi di Brescia – Economia Internazionale
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This kind of innovations in the financial market has rapidly changed the
banking practice, initially, this was seen in the widespread movement to branch
banking and bank consolidation. The creation of big giant of credit eroded one of the
most important tools that the small neighborhood bankers, which fifty years ago was
the primary source for credit in US, could account: the possibility to personally knew
many of his customers, this offered a casual information channel by which a banker
could assess risk. Also another change hit the banking sector: historically, the issuer
of a mortgage was likely to maintain an equity stake in that mortgage, but now the
financial sector deregulation changed that constraint.
Banks and other financial institutions introduced numerous financial derivatives (for
instance, Collateralized Debt Obligations – CDOs) that allowed mortgages (and
other types of debt) to be packaged and re-sold. This reduced the need for lenders to
practice quality loan, if a loan went bad, it would no longer belong to them. With the
growth in foreign savings in the United States and too much domestic money,
lenders found many ready buyers of this repackaged debt. Mortgage turnover
increased as lending practices became increasingly weak.
The current credit crisis was sustained by the house bubble and the perception
that the house price could go nowhere but up. Over the period 1975 till the third
quarter of 2006 the Office of Federal Housing Enterprise Oversight (OFHEO)
6
index
of house price hardly dropped, only in 1981-1982 the index fall in a significant 5,4%,
and that was the period of the worst recession in the post war history. The OFHEO
U.S. house index showed increases in every single quarter, compared to the same
quarter of the prior year. The graph above shows the OFHEO tendency for the period
1975-2009 for the all US and the Meryland State.
6
The Office of Federal Housing Enterprise Oversight (OFHEO), its mission was to promote
housing and a strong national housing finance system by ensuring the safety and soundness
of Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home
Loan Mortgage Corporation). It’s a part of The Federal Housing Finance Agency (FHFA).
FHFA was created on July 30, 2008, when the President signed into law the Economic
Recovery Act of 2008. The Act created a world-class, empowered regulator with all of the
authorities necessary to oversee vital components of our country’s secondary mortgage
markets – Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.
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