Surprise, the Only Constant
Published in the Federalist Society.
A review of Alex Pollock & Howard Adler, Surprised Again! The COVID Crisis and the New Market Bubble (2022)
I approach phenomena that I don’t understand with good cheer and don’t give in to them. I’m above them. Man should be aware that he is above lions, tigers, stars, above everything in nature, even above what is incomprehensible and seems miraculous, otherwise he’s not a man but a mouse afraid of everything.
The House with the Mezzanine: An Artist’s Story, Anton Chekhov
In the late 1980s, the United States experienced what was called the “Savings and Loan Crisis.” Savings and loan associations (S&Ls), firms much like banks, had committed the financial sin of borrowing short and lending long: they borrowed by taking deposits repayable in the near term to finance their making of longer-term thirty-year residential and other real estate loans at fixed interest rates. As interest rates eventually rose, the S&Ls and investment firms found themselves having to pay higher and higher amounts of interest to cover the low fixed amounts of interest they were receiving from their borrowers. That is a financial practice in which one can engage, albeit not indefinitely. Regulators and investors nonetheless were surprised when many S&Ls failed, costing the federal government billions of dollars.
Even after that, in the late 1990s and early 2000s, the government and financial markets incented banks and investment firms to lend to higher-risk low-income borrowers to purchase homes. Policymakers thought sincerely that relaxed lending standards would enable lower-income persons to more quickly and easily realize the American dream of home ownership, which would in turn enable them to build up equity in their newly purchased homes as home values rose. That equity could be used to start a small business or send children to college. Unfortunately, home prices did not continue to rise relentlessly and eventually dropped, leaving lenders with inadequate collateral. As these borrowers eventually were unable to repay their loans, the lenders found themselves holding loans of dubious and uncertain value, and investors were surprised. This all came to a head in 2008 with what is now called the “Great Financial Crisis.” Regulators charged with protecting our financial system were surprised again.