“A giant government-sanctioned Ponzi Scheme”: How Wall Street and bad policy conspired to create the financial crisis

A new Legatum Institute report gets to the heart of the financial crisis, explains why the crash happened, whose fault it was, and why lessons must be learned.

Gambling With Other People’s Money: How Perverted Incentives Caused the Financial Crisis By Russ Roberts Report Overview “Wall Street was (and remains) a giant government-sanctioned Ponzi scheme…Almost everyone made money from this deal except the group left holding the bag – the taxpayers. There is an old saying in poker: If you don’t know who the sucker is at the table, it’s probably you. We are the suckers. And most of us didn’t even know we were sitting at the table.” (p.47 of the report) The Legatum Institute is pleased to publish this important paper which provides answers to some of the most important questions surrounding the financial crisis. Unlike other studies of the crisis, which are more limited in scope, Gambling With Other People’s Money, provides a comprehensive account of how policy choices, regulatory infrastructure, and consumer demand in the United States created conditions ripe for a global financial crisis. Consequently this paper is indispensible reading for anyone who seeks truth about what happened to cause the crisis – and why. Among the many insightful findings of this paper, Roberts places the blame for the financial crisis not at the doorstep of capitalism but rather with “crony capitalism”, the mutual aid society where Washington takes care of Wall Street and Wall Street returns the favour. This, concludes Roberts, helped to distort the natural feedback loops of capitalism which proved to be a major catalyst of the global financial crisis. This is the second major report into the financial crisis from the Legatum Institute. To read the report in full and to view related material, visit www.li.com Key Findings of the Report • The financial crisis of 2008 was a natural result of these perverse incentives. We must return to the natural incentives of profit and loss if we want to prevent future crises. • The most culpable policy has been the systematic encouragement of imprudent borrowing and lending. That encouragement came not from capitalism or markets, but from crony capitalism. • Instead of trying to improve a system we only imperfectly understand, we would have better luck letting the natural restraints of capitalism re-emerge. • Rescuing rich people from the consequences of their decisions with money coming from average Americans is bad for democracy. • Public-policy decisions perverted the incentives that naturally create stability in financial markets and the market for housing. • Over the last three decades, government policy has coddled creditors, reducing the risk they face from financing bad investments. • Not surprisingly, this encouraged risky investments financed by borrowed money. The increasing use of debt mixed with housing policy, monetary policy, and tax policy crippled the housing market and the financial sector. • Wall Street is not blameless in this debacle. It lobbied for the policy decisions that created the mess. • What we do in the United States is make it easy to gamble with other people’s money – particularly borrowed money – by making sure that almost everybody who makes bad loans gets his money back anyway. • Bad regulation and an expectation of creditor rescue worked together to destroy the housing market. • Over the last three decades, public policy has systematically reduced the risk of making bad loans to risky investors. • Many people have placed the current mess at the doorstep of capitalism . . . This isn’t capitalism – it is crony capitalism. The Legatum Institute is a global policy, research, and advisory organization based in London, United Kingdom. The Institute supports original research in political economy, global development, and democratic governance with an eye toward promoting human dignity, economic progress, and political liberty. The Legatum Institute has been a supportive partner of the Mercatus Center’s work to provide an evidence-based account of the economic crisis of 2008 and is gratefully reprinting this report with permission from the Mercatus Center. Consistent with its worldwide mission, the Institute seeks to bring to an international audience an understanding how policy choices in the world’s largest single economy, the United States, led to a crisis that has affected the global economy. It is our hope that the lessons contained in this account will equip policymakers, business leaders, investors, the media, and everyday citizens with the knowledge necessary to avoid similar pitfalls in the future, and to foster healthier, stronger, and more sustainable prosperity over the long term. To access the full version of this paper visit www.li.com/publications.aspx Contact Christian May of Media Intelligence Partners on 02030088147 or 07876708262 Christian.may@media-intelligence-partners.com