The New Economics of Debt and Financial Fragility: Unmasking Post-2008 Financial Instability

This podcast episode, featuring Mark Schuler and Rob Johnson from the Institute for New Economic Thinking (INET), delves into the core arguments of the book \"Leveraged,\" which emerged from a conference of a new generation of macro-financial economists. The central thesis challenges the orthodox view that financial liberalization and deeper markets lead to greater stability and growth. Instead, the discussion highlights how the expansion of finance since the 1970s and 80s has paradoxically resulted in endemic financial instability, requiring constant government and central bank backstops, as dramatically demonstrated during the COVID-19 crisis. This reliance on public support for a system that is \"too big to fail\" creates a profound moral hazard, where aggressive risk-taking is effectively subsidized by taxpayers.\n\nThe conversation explores several key distinctions and nuances. It questions whether financial crises are primarily driven by wrong incentives or wrong beliefs, suggesting that a combination of both is likely. The episode also challenges the common perception that financial executives lack \"skin in the game,\" presenting research from the book indicating that many executives suffered significant personal losses during crises, implying that the problem runs deeper than individual cynicism. A critical dilemma discussed is the trade-off between restraining credit allocation to prevent busts and allowing sufficient dynamism to foster innovation and long-term economic growth, acknowledging that a tightly constrained system might sacrifice vitality.\n\nWhile the book primarily offers a diagnosis rather than prescriptive solutions, it implicitly points to areas for deeper understanding and potential reform. The political economy of finance is highlighted as a major impediment to fundamental change, with powerful lobbying efforts often preventing effective regulation after bailouts. The discussion suggests that central banks, while acting with good intentions to protect the economy, inadvertently perpetuate risk-taking by consistently stepping in as the \"reinsurer of last resort.\" The need for a more nuanced regulatory approach, potentially focusing on the asset side of banks rather than just liabilities, is also implied, alongside addressing the challenges of opaque derivatives markets and the global competition among financial centers that can lead to a race to the bottom in regulatory standards.\n\nBroader implications connect financial instability to societal trends, such as income inequality, arguing that shifts in wealth distribution influence financial flows and the creation of new, potentially destabilizing instruments. The episode emphasizes the concept of \"radical uncertainty,\" drawing on thinkers like Frank Knight and George Soros, to argue that traditional economic models fail to account for unknowable future events, like climate change, rendering current debt structures inherently fragile. The optimism of the \"end of history\" era has given way to a highly leveraged world where the future is less predictable, yet high debt levels persist, creating a precarious balance for central banks caught between maintaining stability and exacerbating moral hazard." "concepts": [ "Financial fragility

this looks like with hindsight just looks so it looks like Joseph taken out of Kendall Burger's Brook such a predictable um at the end

market deepening in the area of Finance has not produced what aerody bro would call sort of more complete markets that are self-stabilizing but an endemic Financial stability problem

Financial liberalization the deepening and expansion of financial markets has not made the world a safe place it has not led to more stability and has not LED necessarily led to more growth

we've built this very large and enormously big financial sector that seems to be you know only able to survive with a government Central Bank backstop

it's not so much about the interactions between different things in the private sector it's about that creature which I might call the mother of all moral hazards

how is it possible that more complete markets that we you know growing up as economists you think that more complete markets are great... how did that fail so spectacularly in the case of Finance where more complete markets have presumingly brought us more instability

if you sort of boil it down to the question do Crisis happen because people have bad incentives or people have bad beliefs... it's probably a combination of both

we've created this enormous enormous financial sector we what we know is that our premises our priors that we had 30 40 years ago were wrong but there's a big void in saying like so what is it actually what how do we think about this Leverage well that we've created

fundamental radical uncertainty which George Soros wrote about in alchemia finance is the context in which all of this is embedded

when people get optimistic and they think past his prologue is when they're putting their neck in a noose