The Global Sociology Blog

[Before jumping into Rodrik's analysis, do yourself a favor and go read Mark Bahnisch's posts over at Larvatus Prodeo on the current crisis and the state of capitalism.]

So, on to Rodrik. So, first, the diagnosis (and Rodrik is actually quite positive on the financial tools that got us into this mess):

Dani Rodrik: A perfect storm combined to capsize the US financial markets | Comment is free | guardian.co.uk via kwout

So, who’s to blame for all this? Well, according to Rodrik, the list of suspects is quite long:

"Was the problem unscrupulous mortgage lenders who devised credit terms - such as "teaser" interest rates and prepayment penalties - that led unsuspecting borrowers into a debt trap?

Perhaps, but these strategies would not have made sense for lenders unless they believed that house prices would continue to rise.

So maybe the culprit is the housing bubble that developed in the late 1990s, and the reluctance of Alan Greenspan’s Federal Reserve to deflate it. Even so, the explosion in the quantity of collateralised debt obligations and similar securities went far beyond what was needed to sustain mortgage lending.

That was also true of credit default swaps, which became an instrument of speculation instead of insurance and reached an astounding $62tn in volume.

So the crisis might not have reached the scale that it did without financial institutions of all types leveraging themselves to the hilt in pursuit of higher returns.

But what, then, were the credit rating agencies doing? Had they done their job properly and issued timely warnings about the risks, these markets would not have sucked in nearly as many investors as they eventually did. Isn’t this the crux of the matter?

Or perhaps the true culprits lie halfway around the world. High-saving Asian households and dollar-hoarding foreign central banks produced a global savings "glut", which pushed real interest rates into negative territory, in turn stoking the US housing bubble while sending financiers on ever-riskier ventures with borrowed money.

Macroeconomic policymakers could have gotten their act together and acted in time to unwind those large and unsustainable current-account imbalances. Then there would not have been so much liquidity sloshing around waiting for an accident to happen.

But perhaps what really got us into the mess is that the US treasury played its hand poorly as the crisis unfolded. As bad as things were, what caused credit markets to seize up was treasury secretary Henry Paulson’s refusal to bail out the investment bank Lehman Brothers .

Immediately after that decision, short-term funding for even the best capitalised firms virtually collapsed and the entire financial system simply became dysfunctional."

As opposed to Wallerstein and Hutton, Rodrik does not a major systemic break in the system but rather a perfect storm where all the "right" conditions came together at the same time, which is why there are so many culprits and so many causes. And whatever these are, as the title of Rodrik’s column states, Wall Street is dead and he’s not optimistic on the wave of regulations that is sure to come.

Dani Rodrik: A perfect storm combined to capsize the US financial markets | Comment is free | guardian.co.uk via kwout