Banks and regulation

Banks and regulation

We are going to debate the role of banks in the economy, why the State regulates their activity and how that regulation can prevent or not the occurrence of crisis, using the 2008 financial crisis as our historical example.

On 23 October 2008, a few weeks after the collapse of the US investment bank Lehman Brothers, former US Federal Reserve chairman Alan Greenspan admitted that the accelerating financial crisis had shown him ‘a flaw’ in his belief that free, competitive markets would ensure financial stability. In a hearing of the US House of Representatives Committee on Oversight and Government Reform

Greenspan was questioned by the chair of the House Committee, Congressman Henry Waxman:

Chairman Waxman: Well, where did you make a mistake then?

Mr. Greenspan: I made a mistake in presuming that the self-interest of organizations, specifically banks and others, were such that they were best capable of protecting their

own shareholders and their equity in the firms. And it's been my experience, having

worked both as a regulator for 18 years and similar quantities, in the private sector,

especially, 10 years at a major international bank, that the loan officers of those

institutions knew far more about the risks involved and the people to whom they lent

money, than I saw even our best regulators at the Fed capable of doing. So the problem

here is something which looked to be a very solid edifice, and, indeed, a critical pillar to

market competition and free markets, did break down. And I think that, as I said,

shocked me. I still do not fully understand why it happened and, obviously, to the extent

that I figure out where it happened and why, I will change my views. If the facts change,

I will change.

Chairman Waxman: Dr. Greenspan, Paul Krugman, the Princeton Professor of Economics who just won a Nobel Prize, wrote a column in 2006 as the subprime

mortgage crisis started to emerge. He said, "If anyone is to blame for the current

situation, it's Mr. Greenspan, who pooh-poohed warnings about an emerging bubble

and did nothing to crack down on irresponsible lending.'' He obviously believes you

deserve some of the blame for our current conditions.

Mr. Greenspan: I found a flaw in the model that I perceived is the critical functioning structure that defines how the world works, so to speak.

Chairman Waxman: In other words, you found that your view of the world, your ideology, was not right, it was not working.

Mr. Greenspan: Precisely. That's precisely the reason I was shocked, because I had been going for 40 years or more with very considerable evidence that it was working

exceptionally well.

In this video, Nobel laurate economist Joseph Stiglitz talks about the impacts of that "flaw in the model", which caused a lack of regulation by the Federal Reserve. Which model do you believe that Mr. Greenspan was talking about (relate with the neoclassical, intermediate and Keynesian models of previous discussions)? Why does professor Stiglitz argues that a lack of regulation incentivizes banks to "behave badly"? In the video, Stiglitz talks about the major macroeconomic effects that such "bad behavior" causes; what are some of these effects?

Important

● Read the prompt above carefully. ● Your post should be at least 7 sentences long ● You are expected to make your own post and comment on at least one other

student’s post.

In your communication with other students, please:

● Expand on or clarify an important point. ● Offer an additional argument to support a position taken in an answer. ● Suggest ways in which an idea could be more clearly expressed. ● Identify passages where you think the writer misunderstood a concept or

applied it incorrectly. ● Disagree with a point or position made in an answer.

If you disagree with the views of another student, please:

● Be constructive and respectful. ● Politely critique a position on an issue, but not the person. ● Avoid sarcasm, swearing, or language that would be considered rude or

argumentative. ● State precisely the point you disagree with. ● Offer reasons why you think their view is incorrect and support your position

by citing the text or other sources.