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Economist Says Current Financial Crisis Is First And Foremost A Crisis Of Confidence

Date:
September 26, 2008
Source:
Rice University
Summary:
The current financial crisis is first and foremost a crisis of confidence. The tip of the iceberg may be the subprime mortgage crisis and its immediate aftermath, but the roots of the crisis have to do with unsustainable dual deficits (fiscal and trade) that have resulted in gargantuan levels of US debt, both private and public.

Mahmoud El-Gamal, chair of Rice University’s economics departmentand Amy Myers Jaffe of Rice University’s Baker Institute are near completion of a forthcoming book, tentatively titled “Oil, Dollars, Debt and Crises.” The book closely examines the world financial marketplace. “It’s a book about the petrodollar and the worldwide financial system,” said El-Gamal.*

El-Gamal said, “The current financial crisis is first and foremost a crisis of confidence. The tip of the iceberg may be the subprime mortgage crisis and its immediate aftermath, but the roots of the crisis have to do with unsustainable dual deficits (fiscal and trade) that have resulted in gargantuan levels of U.S. debt, both private and public.

“Ultimately, we have to recognize that a financial system built on credit cannot survive if the issuer of that credit continues to pile up debt. For years now, we in the U.S. have been consuming beyond our means, relying on Asian and oil-exporting countries to finance our expenditures with their trade surpluses and other savings. A long-term solution to this problem can only come from careful rebalancing of global production and consumption patterns. We need to produce and save more; Asians need to consume more of our goods.

“Unfortunately, our government's approach has been to use duct tape to fix structural problems, promising to introduce proper long-term solutions after the crisis subsides. Once the immediate symptoms of the problem are addressed, however, lobbyists and high-rolling financiers make sure that the rules of the game, which favor them richly, remain the same.

“Congress is correct in putting the brakes on the current $700 billion duct-tape solution. Privatized profits and socialized losses may in the end be inevitable, given the brinksmanship of the current game. If this duct-tape fix works for a while, i.e., if the gravely ill patient becomes temporarily nonsymptomatic, we're likely to forget about the long-term debt crisis and go back to business as usual. If it doesn't, then Congress will likely be asked to provide more duct-tape financing, appealing to the ‘sunk-cost fallacy’ that we've already spent so much on the problem and we just need a bit more.

“Unfortunately, failing to provide the duct tape may in fact be as catastrophic as the Treasury Department and the Fed would have us believe. Conversely, providing the temporary fix and eventually ignoring the problem until it flares up again (with larger magnitude) may be equally disastrous. Congress seems wise to exercise double brinksmanship in trying to force the administration to accept more oversight and restrictions on executive pay, thus reducing the incentive to gamble with other people’s money,” said El-Gamal.

*El-Gamal received his bachelor’s degree in economics from American University in Cairo, his master’s degree in statistics from Stanford and his doctorate in economics from Northwestern. Prior to coming to Rice, he taught economics at the University of Rochester, Cal Tech and the University of Wisconsin-Madison. He has also worked at the International Monetary Fund and the U.S. Department of Treasury.


Story Source:

The above story is based on materials provided by Rice University. Note: Materials may be edited for content and length.


Cite This Page:

Rice University. "Economist Says Current Financial Crisis Is First And Foremost A Crisis Of Confidence." ScienceDaily. ScienceDaily, 26 September 2008. <www.sciencedaily.com/releases/2008/09/080925122353.htm>.
Rice University. (2008, September 26). Economist Says Current Financial Crisis Is First And Foremost A Crisis Of Confidence. ScienceDaily. Retrieved October 22, 2014 from www.sciencedaily.com/releases/2008/09/080925122353.htm
Rice University. "Economist Says Current Financial Crisis Is First And Foremost A Crisis Of Confidence." ScienceDaily. www.sciencedaily.com/releases/2008/09/080925122353.htm (accessed October 22, 2014).

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