Andrew Lo Review 21 Books on 2008 Financial Crisis

A professor of finance at MIT, Andrew West. Lo is an editor of the RSF book Rethinking the Financial Crisis. The volume addresses important questions near the complex workings of American finance and shows how the report of economics needs to change to deepen our agreement of the financial sector.

Q: In a recent paper, in which you review more than than twenty books on the financial crisis, yous wrote, "in that location is still pregnant disagreement as to what the underlying causes of the crunch were, and even less agreement as to what to do almost it." What is information technology about the financial crisis that has prevented economists from offering a definitive account of its origins?

A: There are at least three challenges in understanding something every bit complex equally the contempo fiscal crisis: the latitude of knowledge needed to span the various parts of the financial system, the data, and the motivation. The crunch involved regulatory bug, financial innovation, existent manor markets, accounting rules, investment and commercial banking, and budgetary policy. No unmarried private has all the necessary expertise to span all these issues, which means that the individuals with the domain-specific knowledge must collaborate to piece together this incredibly intricate jigsaw puzzle. But even if nosotros had the collective expertise, nosotros would nonetheless need to gather significant amounts of data to test the various hypotheses proposed by the experts. Finally, while some of this forensic assay is being done by economists such as those in Rethinking the Financial Crunch, much greater resources are needed to conduct a larger and more systematic analysis, and those resources aren't forthcoming because there isn't a consensus that we need to get to the bottom of these issues. For instance, the Dodd-Frank Act was passed more half a year prior to the terminal report of the Fiscal Crunch Inquiry Commission, and that report wasn't fifty-fifty able to come to a common conclusion (the bipartisan committee came to three mutually contradictory conclusions!).

Q: Many people believe that the financial crisis revealed major shortcomings in the discipline of economic science, and one of the goals of your book is to consider what economical theory tells us about the links between finance and the rest of the economy. Do y'all feel that economists sympathize enough well-nigh the nature of financial instability or liquidity crises?

A: I think that the financial crunch was an important wake-up call to all economists that nosotros need to change the fashion we arroyo our discipline. While economics has made great strides in modeling liquidity risk, fiscal contagion, and marketplace bubbles and crashes, nosotros haven't done a very skilful job of integrating these models into broader macroeconomic policy tools. That's the focus of a lot of recent activity in macro and financial economics and the hope is that we'll be able to do better in the nearly future.

Q: Let me continue briefly on this thread. One topic that has been particularly controversial concerns the efficient-market hypothesis (EMH). Burton Malkiel discusses the effect in his chapter in Rethinking the Financial Crunch, simply I wanted to inquire your opinion of this idea that EMH fed a hands-off regulatory approach that ignored concerns near faulty nugget pricing.

A: In that location'due south no doubt that EMH and its macroeconomic cousin, Rational Expectations, played a significant role in how regulators approached their responsibilities. Nevertheless, nosotros should continue in mind that market place efficiency isn't wrong; information technology's only incomplete. Market participants do deport rationally under normal economic weather, hence the current regulatory framework does serve a useful purpose during these periods. But during periods of extreme growth and reject, human behavior is non the same, and much of economic theory and regulatory policy does not yet reflect this new perspective of "Adaptive Markets."

Q: The years preceding the financial crash saw the ascension of fairly innovative financial products – ABS'southward, CDOs, credit-default swaps, etc – and a number of chapters in your edited volume investigate their utility. Let me pose a broader question: assuming we could exercise it, should nosotros strive to recreate the "boring" era of finance that lasted between the 1930s until the 1980s? Or do these contempo innovations actually make the economy more efficient and add more than value?

A: Financial innovation is a double-edged sword that supports real economic growth during skillful times merely can also wreak havoc during bad times, and this has always been the case. For example, one of the factors that contributed to the Great Low of 1929 was the excessive leverage available to stock-market investors through margin accounts, but this leverage was also responsible for the prosperity that preceded the Low, now known as the "Roaring 20's". In the aftermath of 1929, we enacted a series of new financial regulations to deal with these excesses, including limits on leverage (Regulation T), and the 33 Act, 34 Act, and twoscore Deed largely determined the financial regulatory framework we've been living under until Dodd-Frank. But information technology's important to continue in mind that the 1930s to 1990s were non that "deadening" -- in that location were a number of actually of import financial innovations during that time including: hedge funds, mutual funds, options, futures, swaps, CDOs, electronic trading, etc. The key difference, though, between the 1930-2000 menstruum and the past decade is, in my opinion, the advances in estimator technology, telecommunications and connectivity, and earth population. These features enabled united states to greatly magnify the impact of fiscal innovation across markets, borders, and nugget classes, so that the speed of financial innovation outstripped the ability of regulators and regulations to keep pace. You tin cut a lot more trees much more quickly with a concatenation saw than a hand saw, merely chain-saw accidents tend to me a lot more than serious than hand-saw accidents.

Q: Given how piddling we apparently know about the financial crisis, how do you rate the performance of regulators and policymakers in the crash'due south aftermath?

A: I remember regulators and policymakers take done a pretty decent job in responding to an extraordinarily challenging set of circumstances since 2008, and while no i is happy with the outcome, I believe things would have been much worse if the response was not as quick or every bit stiff is it was. Withal, it could be argued that these same individuals underperformed significantly prior to the crisis past assuasive information technology to develop into the crisis that information technology became. Simply rather than point fingers and cast blame, I think a more than productive approach is to make up one's mind how to change the regulatory framework so that we might be able to avoid future crises. Ane mode to practise this is by having more conferences like Rethinking Finance and studying previous crises to make up one's mind what the root causes of these events were. Only by developing a deeper understanding of financial crises tin can we begin to develop a more than robust financial organisation.

vollexate1941.blogspot.com

Source: https://www.russellsage.org/news/rethinking-financial-crisis-interview-andrew-lo

Share this post