The World’s Second Cyber-Crash
September 15th, 2008
The world’s first cyber-crash happened in 2000 with the bursting of the Internet stock bubble. The damage was confined to one sector of the economy, however, and the subsequent reduction in interest rates provided quick stimulus that prevented a prolonged recession. As we now know, the reduction in interest rates created a real estate bubble in the US as well as some European countries, and the bursting of the real estate bubble is leading to a global recession. I call this a cyber-crash as well, because I believe information technology has made a major contribution to our current economic problems. Here are three themes about the current recession.
Interconnectedness
A priori, we wouldn’t expect that weakness in one sector, even in the world’s largest economy, would lead to a global recession, but we’ve discovered that the US housing market is closely connected to the financial sector in the US, which is closely connected to the financial sector in the rest of the world, which is closely connected to the real economy everywhere else. So the contagion is spreading quickly from the US economy to the rest of the world.
Technological Hubris
Technology has contributed to the problem in several ways. The increase in computational power has given financial engineers the ability to create more complex financial instruments in particular linked to dubious mortgages. Information flows faster and market players can react faster. Like the political world, immediacy has increased in the economic world. As a consequence, volatility has also increased. Unlike the political world, however, technology has not increased transparency; indeed, it has reduced it, as market players know less and less about what real assets the financial instruments they are trading actually represent.
The Public Sector: Ideology or Pragmatism
It is now clear that, in part due to its free market ideology, the Bush administration did not worry about how these developments allowed an increasing portion of the financial sector to operate outside traditional regulatory constraints. The need for restructuring to either avert or respond to bankruptcies (Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, Merrill Lynch and who’s next?) has necessitated government involvement on an unanticipated scale.
Bush and Cheney are as clueless about the cyber-crash as they were about Hurricane Katrina. They seem entirely unable to think about society, rather than individuals. Fortunately, the key US economic players - Bernanke, Paulson, and FDIC Chair Sheila Bair - are more pragmatic than ideological. But will that be enough?
