In the paper titled ‘Crisis’, the author Alan Greenspan had made an earnest effort to figure out the new emerging economic factors which came to existence as an after effect of the “Cold War” leading to a decline in the long term interest rates on a global basis. The subprime mortgage has been the visible reason for the crisis but it had its roots deep-seated in the Cold War.
It is indicated that the bankruptcy of the Lehman Brothers was the most astonishing global economic crisis ever. He says the global finance was functioning with inadequate capital and was not able to anticipate the risk involved in it. He has also stressed the necessity of the thorough Government reviewing of the global regulatory system as the private system had failed badly.
After the Cold War, some third-world countries like China switched to an export-oriented economic model based on developed world technologies and employed a huge low-cost workforce resulting in the real GDP growing more than two times of developed countries. As a result global real long-term interest and nominal long-term interest declined to indicate the global saving intentions surpassing the global investing intentions. Inflation and long-term interest rates converged to a single digit and asset prices, especially houses, became extremely high. Then the sub-prime crisis unfolded. Apparently unlimited sub-prime mortgage securities were sold to receptive buyers. Leverages swelled up like a balloon. The underlying risk in a condition like this is generally taken care of by the existing efficient global system of financial risk management in case of a market breakdown. But the crisis was not even anticipated by them and they actually broke down. Along with them the Regulatory System also failed and the only chance of crisis aversion was also gone.
The author opines that it is necessary to understand whether the increased financial regulation is appropriate for the enhancement of the economy or whether it hampers its growth. As per his opinion, no intermediary can work without risk. Short-term risk-less government papers can contain credit loss but also account for negative income spread. The ‘evaporation’ of short-term credits which occurred globally in 2008 was previously noticed also but at a miniature level. He says that a ‘hundred-year flood’ (Greenspan 17), which is supposed to come once in a century, actually appears more than once. The crisis in the post-Lehman period is graver than a hundred-year flood.
The author says it is possible to restrict irrational behavior through regulations but that should not be allowed to impose restrains over-competitive market. It is necessary to bring forth rules through examination and supervision that can prevent uncertainties in the future rather than depending on anticipation. The author says it is necessary to address the problem of firms that are ‘too big to fail’, (Greenspan 31) as they tend to absorb the savings needed for investment in the technologies. As a solution, the firms might be split into smaller units that will not be too big to fail.
A breakdown happens due to disruption of income flow because of market sentiment showing fear instead of euphoria. The author thinks the breakdown could not possibly be averted anyway as these are necessary conditions for asset-producing bubbles to emerge. We failed to anticipate their advent and unknowingly supported them. It is necessary for society to avoid leverages so that no bubble emerges and nobody suffers the crisis after deflation. Also, some effective way to deflate the bubbles without causing crisis has to be formulated.
Work Cited
Greenspan, Alan. The Crisis. Brookings. 2010. brookings.edu. Web.