Financial crisis

I have often wondered about the sequence of events that will unfold when our generation's debt comes due.  Who will pay it?  The answer is the owners of any productive capacity within the jurisdiction required to pay the taxes to service the debt.  And if those taxes are high, as they are on a path to be, we can expect to see attempts at avoidance (and evasion), as the most mobile assets and factors of production try to get out of that jurisdiction.  We'll know it's really bad when U.S. citizens start removing themselves to other countries to try to avoid such tax burdens.

While that particular development is a long way off (I hope), we can see the precursors in other areas. 

If there were ever an opening to a news article on the financial crisis to get my blood boiling, this is it:

ATLANTA -- As law enforcement agencies and regulators investigate the likes of Goldman Sachs and Morgan Stanley, and lawmakers debate legislation to revamp financial regulations, it's become conventional wisdom that big investment and commercial banks caused the crisis and small community banks are paying for the sins of others.

That's not true, however. Georgia leads the nation in bank failures since the crisis began, and all of them have been at small banks, most caused by bad loans to builders.

There are two problems.  First, small community banks could fail left, right, and center and not cause anything like the crisis we have endured.  Second, the right way to distinguish between financial institutions is not by size, but by whether they were insured or not and whether they behaved prudently or not.

Today's marathon Senate Permanent Investigations Subcommittee hearing into Goldman Sachs' role in the financial crisis found Goldman executives and senators talking past each other or driving each other to frustration with non-responses and no responses to loaded questions. Subcommittee Chair Carl Levin (D-IL) quickly expressed frustration that Goldman witnesses wouldn't answer "yes" to his questions on whether Goldman had any obligation to disclose its short positions to clients it was unloading "crap" long positions upon as described in a Goldman email. Similarly, Senator Susan Collins (R-ME) kept asking if Goldman had a duty to act in the best interests of its clients, and she didn't get an answer she was satisfied with either. 

During the fourth quarter of 2008, economists Murillo Campello, John Graham, and Campbell Harvey conducted a survey of CFOs to understand their reactions to the financial crisis.  What they found is presented in their new working paper and summarized in this digest article.  One highlight:

Constrained firms, on average, said they plan to cut employment by 11 percent, technology spending by 22 percent, capital investment by 9 percent, marketing by 33 percent, and dividends by 14 percent in 2009. Also, 13 percent of such firms tapped their lines of credit in order to have cash to meet expected needs, and another 17 percent did the same in case their banks shut off their credit. Few unconstrained firms report plans for significant cuts or concerns about the availability of credit during the period.

This ten point explanation from Barry Ritholtz lays out the contribution of ultra-low interest rates to the financial crisis.  Shorter version: low interest rates plus ratings agencies for sale equals enormous debacle.  To his tenth point on the lax regulatory environment emanating, in his words, from the Fed, I would add the abject failure of the SEC to hold the line on investment bank leverage ratios.  This report should have had a bigger impact than it did.