During this financial crisis, at the top levels of all the major banks, where people get paid tens of millions of dollars a year, the most common refrain is "who could have known?" Okay, I don't know that anyone is saying this, but I do know that these people are not being fired en masse. How could people who put their banks at the edge of bankruptcy, or beyond, not get fired. If this doesn't get someone fired what would? Are these people paid tens of millions of dollars to destroy tens of billions of shareholder value and put thousands of workers out of their jobs? The reason that they don't get fired is the "who could have known?" ethic. The collapse of the housing bubble and the related fallout are treated as unpredictable events, as opposed to entirely preventable mistakes. The reason why this is important is because the Wall Street Journal writes that that collapsing bubbles would require raising interest rates, which would in turn slow the economy and throw people out of work. That is certainly unpleasant outcome, but let's try an alternative route. Suppose that in 2002, instead of testifying that there is no housing bubble, Alan Greenspan tells Congress that he is very worried about the unprecedented run-up in house prices. Suppose that he tells Congress that this run-up in prices cannot be explain by any changes in the fundamentals. Suppose further that he says that when this bubble bursts it is likely to lead to serious damage to the banking system because default rates will soar, leading to large losses. Suppose that he repeated these comments again and again with supporting evidence. Suppose that Greenspan had the Fed staff grinding out papers documenting the evidence that there was a housing bubble and projecting the damage to various banks and other financial institutions from its collapse. Will everyone panic and reverse their irrational exuberance? That would be my bet. But suppose that they don't and the housing bubble just keeps expanding. Then we arrive at this same juncture with a collapsed housing bubble and devastated financial system, in spite of the Fed's best efforts. Does anyone think that the execs at Goldman Sachs, Citigroup, Merrill Lynch and the rest could say "who could have known?" to their shareholders, who just saw most of the value of their stock disappear? My guess is that all of these execs would be out of their jobs and facing lawsuits for neglecting their responsibilities to their shareholders. The Fed would have taken a situation where the risks are now entirely one-sided (the Wall Street crew face no risk from going with the flow) and made them more symmetric. The Wall Street executives would then have to analyze the evidence and make their own judgment. In other words, they would have to work for a living. I know that the Wall Street gang would consider this the height of injustice, but hey, we all have to sacrifice.
--Dean Baker
