Gambling with Borrowed Chips: The Common Misdiagnosis of the Crisis of 2007–08
by Christopher C. Faille
Abbott Press, Bloomington, IN, 2012.
159 pages, $13.99.
Reviewed by Jane G. Gravelle
crisis of 2007–2008 and a set of prescriptions to remedy it. Most of the book, however, is taken up by
a narrative about the players and events of the crisis as well as some of the history that led up to it. (I particularly
enjoyed the chapter looking back to the Middle Ages and the sin of usury.)
Gambling with Borrowed Chips is not a scholarly work, in that it has no references or footnotes. But
the book is readable and entertaining, although not entirely focused, and Faille explains a lot of concepts and
practices along the way.
I don’t regret the time I spent reading the book. But, ultimately, one presumes that an author cares most about
his analysis and his prescriptions, and I see very little in the book to justify either. Faille has a habit of making a
pronouncement about something and then dropping the train of thought to turn to something else, making
it unclear at times what he really intends. I will interpret as best I can.
Faille’s analysis is that the commonly cited causes of the crisis—speculation combined with leveraging,
deregulation, and other problems—are not, in fact, its causes. He apparently views the cause as
the expansionary monetary policies of the Board of Governors of the Federal Reserve System, a claim that
he appears to make based on the low interest rates set by the Fed. (In other parts of the book, he also seems
to blame the Fed for shoring up the economy when asset prices were falling during the Greenspan years.)
I can agree with Faille’s general proposition that speculation is not a problem in and of itself, even if
the funds with which one speculates are borrowed. Risk-taking, the term I would prefer, is an important part
of economic activity, as is borrowing. The problems arise not from borrowing funds to make risky investments,
but from engaging in this activity with poor information and in ways that cause those other than the risk-taker
and the creditor to suffer the consequences of a negative outcome.
Like most economists, I think that a number of factors contributed to the crisis, including many of those that
Faille rejects, such as lack of oversight, excessive leveraging, and poor risk management by some large financial
institutions. I cannot undertake a full discussion of these issues in a book review, but I suggest that the
reader take a look at what an expert says—namely, what Ben Bernanke, the chairman of the Federal Reserve
says. His accessible testimony on this subject before the Financial Crisis Inquiry Commission on Sept. 2, 2010,
discusses the triggers (such as subprime mortgage loans and increased reliance on short-term funding by
shadow banks) and the existing vulnerabilities in the financial system that resulted in a financial panic that
turned into an economic downturn. 1 Of course, the Fed chairman is vilified in some quarters, as is often the case
with powerful persons, but he is widely respected in the economics community. Bernanke’s arguments are
so clear that a reader without economics training can follow them.
There is little evidence for the causal factor that Faille advances—namely, easy money. It is certainly
hard to make the case that monetary policy was excessively loose: inflation continued to be stable and remained
at the same low levels, more or less, that it had been since the mid-1980s. Accelerating inflation while at full
employment, rather than low interest rates, should be the sign of easy money. Interest rates on long-term
debt, such as mortgages, had been falling (indeed had been falling since the late 1980s) but not at an overly
dramatic rate at the time leading up to the financial crisis. The fall of interest rates on long-term debt and other
borrowing may be partially related to the increasing expectations of low inflation rates and perhaps also to
the inflow of capital from abroad. In his testimony to the Financial Crisis Inquiry Commission, Bernanke also
considered monetary policy, but for several reasons that seem compelling to me, he did not consider monetary
policy closely related to the principal trigger—the housing finance crisis.
If Faille’s analysis of the cause of the crisis is questionable, his prescriptions to remedy it—whether or not
the analysis is correct—can only be described as extreme. Faille presents his solutions at the end of the book,
unaccompanied by any analysis of the benefits and costs of the provisions. As with his take on the cause
of the crisis, Faille simply asserts his prescriptions without making a case for them.
Faille’s first two proposals—to abolish legal tender and to abolish the Federal Reserve—are linked in
some ways. Because Faille does not spell out anything beyond “abolishing legal tender,” I take that phrase,
based on some Internet surfing, as a code to mean a return to commoditylinked money—that is, the gold standard.
(In some places, Faille, hoping that the United States would adopt “sound” money, seems to be talking
about using other countries’ currency, which again would presumably be the gold standard. I have no idea
how we would go about using other countries’ currency.) One hopes that whatever Faille is proposing would
be done with an orderly transition; it took many years and a serious and prolonged economic downturn for
the United States to return to the gold standard after the Civil War.
A return to the gold standard (or some form of commodity-linked money) is espoused by a small but
vocal group, which finds few supporters among economists. In fact, most economics textbooks, for good
reason, devote no more than a page or two to explaining the gold standard and how the U.S. and other
the government). Advocates for the gold standard would argue that tying money to a commodity limits the ability
of government to engage in excessive money creation and inflation. Of course, there is no evidence that
the U.S. government has been guilty of that since at least the mid-1980s; inflation has been low and relatively
constant.
The very advantage cited for a gold standard is also its cost: such a money standard does not allow flexibility
to manage the economy, which has been, since the Great Depression and its aftermath, a central concern
of economic policy. Gold discoveries can spark inflation, and, if the supply of gold does not increase enough to
support economic growth, deflation and economic contraction result. The period when the United States had a
pure gold standard (1879 to 1933) was marked by extensive volatility in output and prices as well as by financial
panics. This volatility is documented, for example, in an encyclopedia entry by Michael Bordo, an economics professor
at Rutgers University.2
Or, if a visual picture is more appealing, then take a look at a graph of percentage changes in output from 1821 to 2007
on page 4 of a Congressional Research Service report that I co-authored. 3
argue that it was a significant contributing factor to the Depression, because it limited the ability of the Federal Reserve
to perform its function of lender of last resort. Even the recent contraction looks mild compared to the swings in
output in the later 19th and early 20th centuries. (Faille seems to believe that the gold standard was restored after
World War II, but that standard only applied to international transactions and even then in a limited fashion. Dollars held
domestically could not be converted into gold. This era cannot be characterized as being on the gold standard.)
The Federal Reserve actually coexisted with the gold standard for 20 years, with the Fed functioning
primarily as a lender of last resort. This function was needed in part to deal with the rigidity of the gold standard
itself, which provided insufficient money, particularly around harvest time. Today, the Fed’s primary function
is to manage the economy and attain the objectives of full employment and price stability. The Fed or
a similar institution with that responsibility is necessary with fiat money, but some sort of institution would
probably also be needed with a gold standard.
On the whole, things have gone reasonably well—so well, in fact, that economists referred to the most recent
period as the Great Moderation. The 2007–2008 financial crisis does not change the fact that, for many years,
the economy enjoyed full employment and low inflation relatively undisturbed by business cycles.
Avoiding business cycles entirely is not possible: the economy is too complex and prediction is too difficult.
Moreover, even if higher interest rates could have deflected the financial panic, would we have traded it for 25
years of chaos and contraction? The best we can do now is not to throw the baby out with the bath water, but
to take what lessons we can from recent events, just as we did after the 1929 crash. Those lessons mostly
point to regulatory changes that have been undertaken, although whether they strike the right balance between
controlling systemic risk and allowing markets to work efficiently is never easy to know.
Faille’s third proposal is to eliminate the idea of “too big to fail.” I won’t dwell on this issue because
Chairman Bernanke did so quite succinctly in the testimony referenced above. As Bernanke pointed out, it is
not enough to assert that the government will let failures fail in the future; that assumption is not credible. In the
midst of a crisis, the government is unlikely to hold to such a standard if it means disaster for the broader economy,
as it well might. Rather, Bernanke suggested regulatory changes.
Faille’s final proposal is to “learn greater respect for the profession of accounting.” Because I’m not sure what
Faille specifically proposes, I have no comments on this prescription.
If you are interested in what happened during the financial crisis of 2007–2008, then you might want to
read Gambling with Borrowed Chips for its descriptions of the players and events. But I would not advise relying on it to
guide your views on economiuc policy.
TFL
Jane Gravelle is senior specialist in economic policy at the Library of Congress’ Congressional Research Service.
This review does not reflect the position of the Congressional Research Service.
In this review, Gravelle’s historical discussions were greatly assisted in by two
Congressional Research Service reports by G. Thomas Woodward:
Brief History of the Gold Standard in the United States,
Report 98-986E (Dec. 5, 1996),
and
Money and the Federal Reserve System: Myth and Reality
Report 96-672E (July 31, 1996).
Endnotes
1
2
3
No comments:
Post a Comment