2008 Stock Market Crash Predicted Over 70 Years Ago!
The 2008 stock market crash and financial crisis was predicted - over 70 years ago. Who was this great prophet? An economist named Melchior Palyi. This November 6th Wall Street Journal article reported the details.
The guy was a serious critic of the reforms the government put in place as a result of the 1929 crash and subsequent bank failures that marked the onset of the Great Depression. He sounds like a smart, thoughtful guy who did his best to warn regulators that they were asking for trouble.
If you check out his criticisms, you can see he was right.
For example, he nailed the rating agencies from the get-go. They were proposed as a result of the Depression. But he thought they would present a hazard. Right.
Those are the same agencies that rated all those crappy bonds and bond-based vehicles (CDO's) AAA. Then they failed and helped cause the financial collapse in 2008. Recent investigations showed that the agencies - who are paid to rate securities by the firms that issue them, a clear case of conflict of interest - played games with their numbers and really knew they were giving good ratings to crap. Some of us believe we'd be a lot better off without them.
What's interesting about this guy Palyi - a Hungarian by birth who worked at a German bank, helping to restore order after the great German hyperinflation - is not that he saw that the rating agencies would eventually commit fraud in their rating practices. It's that he saw that the whole idea of regulations that required the use of ratings agencies were wrong-headed. He captured his criticism in the idea of "shiftability."
He saw that by requiring the use of ratings agencies in determining the credit risk of a bond, you were essentially shifting the risk from the buyer to the rating agency. In doing that, the buyer then feels like they don't have to do the work of evaluating what they're buying. They shift that responsibility to the agency.
Now that's not so bad, except that the regulators insisted that bonds held by banks had to be rated, or banks (and eventually other financial services firms like insurance companies) couldn't hold them in their investment portfolios. It's not like the agencies operated like a regular business, where customers would decide to buy their product (the rating) based upon some evaluation by the customer that the product held some value worth some price. The customer was forced to buy the agencies' product.
Palyi saw that by shifting the responsibility this way, ultimately the day would come when the taxpayer would foot the bill for any shenanigans that might occur where rating agencies rated bad bonds highly. He knew that because federal regulations caused the banks to use the rating agencies, that somehow the federal government would have to step in and back up the agencies mistakes - with our (the taxpayer's) money.
There's more that he saw coming. You should read the article if you have a few minutes.
My take is this.
First, we all need to be responsible for our actions. That goes for everything we do, including investment decisions. And it includes not just individuals like you and me, but banks too.
In the case of banks, they made some pretty bad decisions. But in some cases, they were forced by regulators to rely on ratings agencies, so they had an "out" when things turned bad. And they're not shy about taking bail-out money from the government. They probably figure that they played by the rules and so the government - which set the rules and insisted they play by them - should shoulder some responsibility.
Still, if you take responsibility for your actions, you don't shift blame. And that's what banks have done in some cases. Plus they play this "we're too big to fail" routine so that we're all afraid of letting one of the big boys go down.
But what's really disturbing when you read the article is that very little has changed. If Palyi (who died in 1970) were alive today, he'd see the same nonsense going on that he criticized in the 1930's. And that tells me that the crisis we saw in 2008 won't be the last crisis of that scale any of us sees. Kind of unbelievable, isn't it?
The guy was a serious critic of the reforms the government put in place as a result of the 1929 crash and subsequent bank failures that marked the onset of the Great Depression. He sounds like a smart, thoughtful guy who did his best to warn regulators that they were asking for trouble.
If you check out his criticisms, you can see he was right.
For example, he nailed the rating agencies from the get-go. They were proposed as a result of the Depression. But he thought they would present a hazard. Right.
Those are the same agencies that rated all those crappy bonds and bond-based vehicles (CDO's) AAA. Then they failed and helped cause the financial collapse in 2008. Recent investigations showed that the agencies - who are paid to rate securities by the firms that issue them, a clear case of conflict of interest - played games with their numbers and really knew they were giving good ratings to crap. Some of us believe we'd be a lot better off without them.
What's interesting about this guy Palyi - a Hungarian by birth who worked at a German bank, helping to restore order after the great German hyperinflation - is not that he saw that the rating agencies would eventually commit fraud in their rating practices. It's that he saw that the whole idea of regulations that required the use of ratings agencies were wrong-headed. He captured his criticism in the idea of "shiftability."
He saw that by requiring the use of ratings agencies in determining the credit risk of a bond, you were essentially shifting the risk from the buyer to the rating agency. In doing that, the buyer then feels like they don't have to do the work of evaluating what they're buying. They shift that responsibility to the agency.
Now that's not so bad, except that the regulators insisted that bonds held by banks had to be rated, or banks (and eventually other financial services firms like insurance companies) couldn't hold them in their investment portfolios. It's not like the agencies operated like a regular business, where customers would decide to buy their product (the rating) based upon some evaluation by the customer that the product held some value worth some price. The customer was forced to buy the agencies' product.
Palyi saw that by shifting the responsibility this way, ultimately the day would come when the taxpayer would foot the bill for any shenanigans that might occur where rating agencies rated bad bonds highly. He knew that because federal regulations caused the banks to use the rating agencies, that somehow the federal government would have to step in and back up the agencies mistakes - with our (the taxpayer's) money.
There's more that he saw coming. You should read the article if you have a few minutes.
My take is this.
First, we all need to be responsible for our actions. That goes for everything we do, including investment decisions. And it includes not just individuals like you and me, but banks too.
In the case of banks, they made some pretty bad decisions. But in some cases, they were forced by regulators to rely on ratings agencies, so they had an "out" when things turned bad. And they're not shy about taking bail-out money from the government. They probably figure that they played by the rules and so the government - which set the rules and insisted they play by them - should shoulder some responsibility.
Still, if you take responsibility for your actions, you don't shift blame. And that's what banks have done in some cases. Plus they play this "we're too big to fail" routine so that we're all afraid of letting one of the big boys go down.
But what's really disturbing when you read the article is that very little has changed. If Palyi (who died in 1970) were alive today, he'd see the same nonsense going on that he criticized in the 1930's. And that tells me that the crisis we saw in 2008 won't be the last crisis of that scale any of us sees. Kind of unbelievable, isn't it?
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