Diamond and Kashyap on the Recent Financial Upheavals

As an economist, I am supposed to have something intelligent to say about the current financial crisis. To be honest, however, I haven’t got the foggiest idea what this all means. So I did what I always do when something related to banking arises: I knocked on the doors of my colleagues Doug Diamond and Anil Kashyap, and asked them for the answers. What they told me was so interesting and insightful that I begged them to write their explanations down for a broader audience. They were kind enough to take the time to do so. In what follows, they discuss what has happened in the financial sector in the last few days, why it happened, and what it means for everyday people.

The F.A.Q.’s of Lehman and A.I.G.
By Douglas W. Diamond and Anil K. Kashyap
A Guest Post

For most of the last 20 years we have been studying banks, monetary policy, and financial crises. So for us the events of the last year have been especially fascinating.

The last 10 days have been the most remarkable period of government intervention into the financial system since the Great Depression. In talking with reporters and our noneconomist friends, we have been besieged with questions about several aspects of these events. Here are a few of the most frequently asked questions with our best answers.

1) What has happened that is so remarkable?

This episode started when the Treasury nationalized Fannie Mae and Freddie Mac on September 8. Their combined assets are over $5 trillion. These firms help guarantee most of the mortgages in the United States. The Treasury only got authority from Congress to take this action in July, and in seeking the authority had insisted that no intervention would be needed.

The Treasury has replaced the management of both companies and will presumably oversee their operation. This decision marked an acknowledgment by the government that the mortgage market and the institutions to make it operate in the U.S. are broken.

On Monday, the largest bankruptcy filing in U.S. history was made by Lehman Brothers. Lehman had over $600 billion in assets and 25,000 employees. (The largest previous filing was WorldCom, whose assets just prior to bankruptcy were just over $100 billion.)

On Tuesday, the Federal Reserve made a bridge loan to A.I.G., the largest insurance company in the world; perhaps best known to most of the world as the shirt sponsor of Manchester United soccer club, A.I.G. has assets of over $1 trillion and over 100,000 employees worldwide. The Fed has the option to purchase up to 80 percent of the shares of A.I.G., is replacing A.I.G.’s management, and is nearly wiping out A.I.G.’s existing shareholders. A.I.G. is to be wound down by selling its assets over the next two years. (Don’t worry, Man U will be fine.) The Fed has never asserted its authority to intervene on this scale, in this form, or in a firm so far removed from its own supervisory authority.

2) Why did these things happen?

The common denominator in all three cases was the inability of the firms to retain financing. The reasons, though, differed in each case.

The Fannie and Freddie situation was a result of their unique roles in the economy. They had been set up to support the housing market. They helped guarantee mortgages (provided they met certain standards), and were able to fund these guarantees by issuing their own debt, which was in turn tacitly backed by the government. The government guarantees allowed Fannie and Freddie to take on far more debt than a normal company. In principle, they were also supposed to use the government guarantee to reduce the mortgage cost to the homeowners, but the Fed and others have argued that this hardly occurred. Instead, they appear to have used the funding advantage to rack up huge profits and squeeze the private sector out of the “conforming” mortgage market. Regardless, many firms and foreign governments considered the debt of Fannie and Freddie as a substitute for U.S. Treasury securities and snapped it up eagerly.

Fannie and Freddie were weakly supervised and strayed from the core mission. They began using their subsidized financing to buy mortgage-backed securities which were backed by pools of mortgages that did not meet their usual standards. Over the last year, it became clear that their thin capital was not enough to cover the losses on these subprime mortgages. The massive amount of diffusely held debt would have caused collapses everywhere if it was defaulted upon; so the Treasury announced that it would explicitly guarantee the debt.

But once the debt was guaranteed to be secure (and the government would wipe out shareholders if it carried through with the guarantee), no self-interested investor was willing to supply more equity to help buffer the losses. Hence, the Treasury ended up taking them over.

Lehman’s demise came when it could not even keep borrowing. Lehman was rolling over at least $100 billion a month to finance its investments in real estate, bonds, stocks, and financial assets. When it is hard for lenders to monitor their investments and borrowers can rapidly change the risk on their balance sheets, lenders opt for short-term lending. Compared to legal or other channels, their threat to refuse to roll over funding is the most effective option to keep the borrower in line.

This was especially relevant for Lehman, because as an investment bank, it could transform its risk characteristics very easily by using derivatives and by churning its trading portfolio. So for Lehman (and all investment banks), the short-term financing is not an accident; it is inevitable.

Why did the financing dry up? For months, short-sellers were convinced that Lehman’s real-estate losses were bigger than it had acknowledged. As more bad news about the real estate market emerged, including the losses at Freddie Mac and Fannie Mae, this view spread.

Lehman’s costs of borrowing rose and its share price fell. With an impending downgrade to its credit rating looming, legal restrictions were going to prevent certain firms from continuing to lend to Lehman. Other counterparties that might have been able to lend, even if Lehman’s credit rating was impaired, simply decided that the chance of default in the near future was too high, partly because they feared that future credit conditions would get even tighter and force Lehman and others to default at that time.

A.I.G. had to raise money because it had written $57 billion of insurance contracts whose payouts depended on the losses incurred on subprime real-estate related investments. While its core insurance businesses and other subsidiaries (such as its large aircraft-leasing operation) were doing fine, these contracts, called credit default swaps (C.D.S.’s), were hemorrhaging.

Furthermore, the possibility of further losses loomed if the housing market continued to deteriorate. The credit-rating agencies looking at the potential losses downgraded A.I.G.’s debt on Monday. With its lower credit ratings, A.I.G.’s insurance contracts required A.I.G. to demonstrate that it had collateral to service the contracts; estimates suggested that it needed roughly $15 billion in immediate collateral.

A second problem A.I.G. faced is that if it failed to post the collateral, it would be considered to have defaulted on the C.D.S.’s. Were A.I.G. to default on C.D.S.’s, some other A.I.G. contracts (tied to losses on other financial securities) contain clauses saying that its other contractual partners could insist on prepayment of their claims. These cross-default clauses are present so that resources from one part of the business do not get diverted to plug a hole in another part. A.I.G. had another $380 billion of these other insurance contracts outstanding. No private investors were willing to step into this situation and loan A.I.G. the money it needed to post the collateral.

In the scramble to make good on the C.D.S.’s, A.I.G.’s ability to service its own debt would come into question. A.I.G. had $160 billion in bonds that were held all over the world: nowhere near as widely as the Fannie and Freddie bonds, but still dispersed widely.

In addition, other large financial firms — including Pacific Investment Management Company (Pimco), the largest bond-investment fund in the world — had guaranteed A.I.G.’s bonds by writing C.D.S. contracts.

Given the huge size of the contracts and the number of parties intertwined, the Federal Reserve decided that a default by A.I.G. would wreak havoc on the financial system and cause contagious failures. There was an immediate need to get A.I.G. the collateral to honor its contracts, so the Fed loaned A.I.G. $85 billion.

3) Why did the Treasury and Fed let Lehman fail but rescue Bear Stearns, Fannie Mae, Freddie Mac, and A.I.G.?

We have already explained why Fannie, Freddie, and A.I.G. were supported. In March, Bear Stearns lost its access to credit in almost the same fashion as Lehman; yet Bear was rescued and Lehman was not.

Bear Stearns was bailed out for two reasons. One was that the Fed had very imperfect information about what was going on at Bear. The Fed was not Bear’s regulator, the amount of publicly available information was limited, and its staff was not versed in all of the ways in which Bear might have been connected to other parts of the financial system.

The second problem was that Bear’s counterparties in many transactions were not prepared for the sudden demise of Bear. A Bear bankruptcy might have triggered a wave of forced selling of collateral that Bear would have given its counterparties. Given the potential chaos that would have resulted from Bear Stearns filing for bankruptcy, the Fed had little choice but to engineer a rescue. In doing so, the Fed argued that the rescue was a rare, perhaps once-in-a-generation, event.

When Bear was rescued, the Fed created a new lending facility to help provide bridge financing to other investment banks. The new lending arrangement was proposed precisely because there were concerns that Lehman and other banks were at risk for a Bear-like run. Since March, the Fed had also studied what to do if this were to happen again; it concluded that if it modified its lending facility slightly, it could withstand a bankruptcy; it made these changes to the lending facility on Sunday night.

Once the Fed had made these changes and determined that it and the others in the market had an understanding of the indirect or “collateral damage” effects of a bankruptcy, it could rely on the protections of the bankruptcy code to stop the run on Lehman, and to sell its operating assets separately from its toxic mortgage-backed assets.

Against this backdrop, if the government had rescued Lehman, it would have repudiated the claim that the Bear rescue was extraordinary; it would have also conceded that in the six months since Bear failed, neither the new facility that it set up nor the other steps to make markets more robust were reliable. Essentially, the Fed and the Treasury would have been admitting that they had lied or were incompetent in stabilizing the financial system — or both.

It was not surprising that they drew the line at helping Lehman. Based on all the publicly available information, this was clearly the right thing to do.

4) I do not work at Lehman or A.I.G. and do not own much stock; why should I care?

The concern for the man on Main Street is not the bankruptcy of Lehman, per se. Rather, it is the collective inability of major financial institutions to find funding.

As their own funding dries up, the remaining financial firms will be much more cautious in extending credit to normal firms and individuals. So even for people whose own circumstances have not much changed, the cost of the credit is going to rise. For an individual or business that falls behind on payments or needs an increase in short-term credit because of the slowing economy, credit will be much harder to obtain than in recent years.

This is going to slow growth. We have not seen this much stress in the financial system since the Great Depression, so we do not have any recent history to rely upon in quantifying the magnitude of the slowdown. A recent educated guess by Jan Hatzius of Goldman Sachs suggests that G.D.P. growth will be just about 2 percentage points lower in 2008 and 2009. But as he explains, extrapolations of this sort are highly uncertain.

5) What does it mean for the Fed and Treasury going ahead?

A reasonable reading of the recent bailouts suggests a simple rule: if a firm is on the verge of collapse and its ties to the financial system will lead to a cascade of chaos, the firm will be saved. A bankruptcy will be permitted only if the failure can be contained.

Assuming the level of chaos is sufficiently high, this dichotomy is probably consistent with the mandate of the Federal Reserve. The rescue of A.I.G., however, raises some major challenges.

One is where to draw the line. A.I.G. was an insurance company, not a bank or a broker dealer, so the Fed had no special relationship with A.I.G. Presumably, if a very large airline or automaker had been involved in the C.D.S. market, the same reasoning that led to the rescue would apply.

A second challenge comes with defining the acceptable level of chaos. We will never be able to find out what would have happened if A.I.G. had been allowed to fail. Furthermore, there are some reasons to believe that even if A.I.G. continues to operate, the fundamental stress in the financial system will remain. If the rescue does not mark a turning point, the bailout may be viewed quite differently down the road.

Should the government intervene if it merely postpones an inevitable adjustment? Creditor runs can make adjustment too fast; blanket bailouts can make adjustment too slow. Has the Fed found the speed that is just right?

Third, now that A.I.G. has been lent to, how will regulation have to be adjusted? Surely the Fed cannot be called upon to provide backstop financing whenever a large member of the financial system runs into trouble. How does it prevent a replay of this scenario, and can it be done without stifling innovation?

6) What does this mean for the markets going ahead?

Letting Lehman go means that the remaining large financial services firms now must understand that they need to manage their own risks more carefully. This includes both securing adequate funding and being prudent about which counterparties to rely upon. Both of these developments are welcome.

If the remaining investment banks, Goldman Sachs and Morgan Stanley, do not get more secure funding in place, they may be acquired or subject to a run too. In the current environment, relying almost exclusively on short-term debt is hazardous, even if a firm or bank has nothing wrong with it.

7) When will the turmoil end?

The inability to secure short-term funding fundamentally comes from having insufficient capital. There are many indicators that the largest financial institutions are collectively short of capital.

One signal is that there were apparently only two bidders for Lehman, when the ongoing value from operating most of the bank was surely far above the $3.60 share price from Friday. Another is the elevated cost of borrowing that banks are charging each other. A third indicator is the reluctance to take on certain types of risk, such as jumbo mortgages, so that the cost of this type of borrowing is unusually high.

The fear of being the next Lehman ought to convince many of the large institutions that, despite however much they already raised, more is needed. It may be expensive to attract more equity financing, but the choice may be bankruptcy or sale. The decision by the Federal Reserve to not cut interest rates suggests the Fed also recognizes that the short-term interest rate is a very inefficient way to address this problem.

Jean Knox

It appears to me that we lost sight of one detail -- what money is. With low interest rates on bank savings, real estate became a form of money and savings for many. It was such a good investment vehicle that the financial markets made it into a securities business. The banks are under strict rules regarding capitalization, so they could not have done what these other players in the market did. I don't know current markets, but long ago, houses in California were so expensive that they often were not insured by Fannie Mae and Freddie Mac. That didn't matter. Those organizations were for the poor who were buying their first, presumably less expensive house. Now, our young people are working many full time jobs with children just to afford those horrendously expensive houses -- which the markets have driven up because houses are also an investment vehicle. It has often been this ways-- that a house is somewhat expensive above the budget, but the beauty of it has been that people, once they own a house can live there a lifetime, even after they get old. There is a certain cap to that amount, perhaps. We need to seriously re-think housing, food, and economic realities for people. When things get too unfair, society falls apart. Our capitalistic system is good. Government meddling at the last minute to this degree -- my mind is questioning the full necessity. I cannot do the math, but as a gut feeling, it seems that the interest rate should be raised, so that people could put more money into the bank savings accounts and the markets could be re-worked using real economic dollars.


Brian Macker

"Here's a very naive question from someone who has, in fact taken post-graduate economics classes. I hear this is a trillion dollar problem. So where did the money go to start with? Money doesn't just evaporate. A person can lose money, a corporation can lose money, but an accounting system should not."

Money does "just evaporate". Learn about fractional reserve banking. The best and shortest presentation on money is Murray Rothbards, "What has government done to our money". It's available online here for free: http://mises.org/money.asp

You can read over the course of two evenings and it is written for the laymen.

Short explanation: The problem of 'money evaporating' happens because of fractional reserve banking. It would not happen in a non-fractional reserve 100% gold standard economy. It will happen with a fractional reserve system on top of a gold standard.

It's easier to understand with a gold standard so lets start there. The gold is the base money supply, and is true money. The paper currency is claims on this true money.

Start with one million ounces of gold and no banks. People use gold one ounce coin to trade. So there are a million one ounce "dollars".

Banks arise. Lend them your gold ounce dollars. Say everyone saves all their cash in the bank for simplicity. So banks are holding one million dollars in notes. These are short term accounts and you can withdraw at any time. So people collectively think they have a million dollars.

Now the banks discover that not everyone uses their cash at the same time. They discover they can lend out say half the gold money long term. They do so. So $500,000 is lent, and is used to buy goods, and ends up in the producers of those goods pockets. They in turn deposit the money in the banks.

At this point the banks have the full $1,000,000 in gold. However they owe depositors $1,500,000 in cash. Those depositors think they really have $1,500,000 cash, and can access it short term. They treat it as cash.

This continues. 1,000,000 + $500,000 + $250,000 + ..., which is the series 1+1/2+1/4+... which adds up to 2, or twice the currency.

It turns out the multiplier here is the inverse of the reserves. If you hold half reserves then the inverse of 1/2 is 2/1. If you hold one sixteenth reserves the multiplier is 16/1.

When there are bank runs this process reverses itself as people pull their cash and the banks go belly up. If 1/10 of the banks go belly up then 1/10 of the multiplier evaporates. That cash also evaporates.

Rothbard feels that it is fraudulent to lend money long term and borrow short term. He's correct.

One of the big mistakes of this Fanny Mae/Freddy Mac business, plus the Mortgage backed securities, plus many other schemes backed by the government is that they are in essence fractional reserve banking.

The fractional part is the leverage, and everyone was getting into leveraging thus inflating the money supply.

Fanny/Freddy (FF) only had 2% private money at risk, essentially the deposits, against all the currency it had essentially printed up with government sanction. That's a 50 to one ratio.
Worse, the risk was backed by government so they were really lending against taxpayers all along, while sucking up profits privately.

It can't go into all the implications of this in a comment but this monetary inflation hides true prices, distorts investment from short term to long term, reduces savings, causes a trade imbalance, etc. All signals available to Alan Greenspan since early Clinton years.

We are now in a situation where everyone is eyeball deep in debt. The economy is actually doing very badly but it was all concealed, plus the concealing was distorting prices causing people to invest where they should not. This will be uncovered in the long term. How it unfolds depends on government choices.

A free market naturally balances all this stuff. You don't need to do anything. Like your bodies own dynamic homeostasis system, or the govenor on a steam engine.

Instead, the government has choosen a system that is unstable and has pushed that system to the bring of collapse. I continues to push the system to peaks of higher and higher instability.

What we are experiencing is a bank run, where the bank has a printing press in the back room where it can print you all the money you ask for. It also has the arbitary power to decide who it screws, and the power to tax its customers directly.

We US citizens are forced to use this bank. Others are not. Welcome to the forced economy. You do not truly live and work under a free market system. It's gamed.


Brian Macker

"I remember Bush giving a State of the Union address where his stated goal was for every American to own a home thus he made certain regulations more lax. Can tyhis be considered the beginning of (or at least a watershed moment) the Housing Bubble?"

No, the housing bubble has the same roots as the internet bubble. Monetary inflation. If you artifically lower interest rates below market prices you get exactly the effects we have been experencing as predicted by Austrian Economics.

Interest rates are the time cost of money, a price like any other. The government setting prices in any sector is a bad idea and causes either shortages or overproduction.

In this case there was an overproduction of houses and a a shortage of savings. Interest rates are below what people are willing to save at, and thus people don't save. Low interest rates make long term investment look very attractive. Things furthest from consumption. Not may things are more further from consumption than internet companies and housing. Artifically lower interest rates and both look more profitable.

These manias have always followed monetary inflation. The tulip mania, the south sea bubble, the revolutionary French bubble, the roaring twenties, etc. were all the effects (not the cause) of monetary inflation.

Even back during the bubble in revolutionary France there were level heads saying "Don't do that, it ruined many an economy throughout history" yet the government inflated anyway. Same symptoms too, stock jobbing (stock flipping), backing currency with real estate, price bubbles, trade deficit, and so on.

Why shouldn't politicians inflate? It allows them to screw you, the little guy. That's what the FED is all about.


Brian Macker

"Clearly, regulation to end the practice of socializing the risks and privatizing the gains is needed, and "innovation" should not be used as an excuse to avoid it."

That. "socializing the risks and privatizing the gains ", is the regulation. How much time to you have to spend on the boards of the regulating committees, vs. how much benefit you would get by doing so? However, those being regulated have plenty of time and money to sit on those boards, or bribe those who do, plus reap large benefits. Is it surprising those "regulations" end up benefiting them, and rich congressmen.

This isn't free markets. This is a planned monetary economy.

The FED itself was put in place because of the desire of rich private bankers to "regulate" their industry.

Fanny Mae and Freddy Mac are also the results of government intervention in the economy. They are a form of regulation. They were set up specifically by the government in a way that socialized risk and privatized profit.

This whole mess was predicted and predictable by means of Austrian Economics.

It's not done yet either. Massive inflation is in the works. Un-Fn-Believeable inflation.

Due to below market interest rates we have been consuming our capital, our seed corn, for decades. Less capital means the production of less goods. This has been hidden by various schemes by the government to 'keep the economy going'. One scheme has been an increase in the money supply. Well guess what, when you simultaneously increase the money supply and decrease the amount of goods you get, inflation.

This has all been hidden by various factors that main stream economists are two dense to grasp. For instance, the Thatcher/Bush revolution opening up 3rd world markets was highly deflationary, and we should have let prices drop. Instead we tried to keep those prices stable, therefore distorting the markets and causing malinvestment.



Can we trust the government to manage the funds appropriately? Instead is there a way an independent body can be created, supervised by Congress, that can manage the toxic debts bought from the market?
Currently, it seems like the boys at Wall St played fast and loose (with Govt helping them by deregulating everything). Now they are in trouble and want help. That is fine, given how a collapse of markets doesn't help anyone. But can we just give them a blank check with no regulations, questions, transparency or demands for accountability?
Socialism for the rich, capitalism for the poor?


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Thanks for the story. Very informative. It still doesn't change the fact that I feel very sick about the bailout.


The BBC has what appears to be a far more comprehensive answer to what's responsible for the current mess.


Interesting that nobody places blame where it should go, on the lax regulation by Clinton's HUD secretaries who pushed home ownership for everyone including those least able to sustain mortgage payments in over-priced homes that they could not afford and several political appointees (like Raines and Gorelick at Fannie Mae) who cooked the books to reap millions and millions of dollars in bonuses.

For years, I could see the mess coming with all these exotic mortgage derivatives (divided into tranches and resold, stripped IO's and PO's, and inverse floaters), where these things reside by the billions in your "ultra-safe" money market funds.

How many money funds broke a buck last week? How many broke a buck in the prior 38 years of the money fund's existence?

Jonathan J. Horan

Thanks. The first read on 21 Sep is good in Australia. i haven't read your other contributors yet. Prudence is one concept. I think that is the opposite of lustgreed. Pepole got slack. People worked fast. People got slack and tricky and used the language to hide deceit.All those financial engineering labels. Mostly just a barrow full of sloppy swamp. We all seek wealth, growth, security. The swamp sellers just layer their deceit with the common gooals. Sounds like a crime in the mind. who needs a law before the crime?

Peter Sterne,Sr

I haven't read all of this article, not too mention the comments, but doesn't this turn us into, at best, a socialist democracy? Upon what legal authority did the Fed take control of AIG? Not to mention that a free market might prefer a depression to a government takeover of the #! insurer on the globe.

I don;t think the US Constitution supports this government takeover of the financial industry ... I feel like I'm living in Venezuela!

Viva Hugo .., oh, wait, I mean George!


I have a great idea; how about we find out everything we can about the people who actually defaulted on their mortgages instead of all the wild accusations against Wall Street.


Two Thoughts searching explanation still

1. I remember Bush giving a State of the Union address where his stated goal was for every American to own a home thus he made certain regulations more lax. Can tyhis be considered the beginning of (or at least a watershed moment) the Housing Bubble?

2. Just curious about Hank Greenberg. Ex-CEO of Bear Stearns, left there to become CEO of AIG. He was credited with coming up with "innovative and creative new ways to bring money to these firms". Were perhaps these innovative ways actually reckless, endagering the global economy to the point where we find ourselves here now?

Kevin Waspi, CFA

Thank you for the excellent account of THIS chapter of a very interesting book. I could be snide and suggest that anyone wanting to skip to the last chapter of this fascinating book rent the 1981 movie, "Rollover". It Starred: Jane Fonda, Kris Kristofferson, Hume Cronyn, Josef Sommer, Bob Gunton, and was directed by: Alan J. Pakula, who also did "Klute". The acting is enough to make you want to walk out on it, but the plot is fitting, considering that Asia and the Middle East have been financing the growing U.S. appetite for debt for 30+ years. If they loose patience with us, "heaven help us" in the words of Hank Paulson. As a final note, I would love to have you two comment on the Friday, 9-19-08 7:30am (CDT) announcement of the socialization of risk in money market mutual funds. PIMCO should eat their CDS losses they were so brilliant in writing, and money market mutual fund shareholders should be made to understand the part of the prospectus that says the sponsor "will make every effort to maintain a stable $1.00 net asset value, but cannot guarantee that it shall" Should I petition the Fed and Treasury to rescue me from betting my life savings on 17 Black too?



Thank you for this informative article! It is refreshing to read an explanation presented without lots of opinion and emotional bluster.


Thank you for explaining a bit of this crisis.


Give me a break. Missing the forest for the trees.

The explanation is much simpler: We are a debtor nation living beyond our means, a situation that cannot be sustained forever.

You don't need a PhD in economics or a cutesy bestseller to know this.


Here's a very naive question from someone who has, in fact taken post-graduate economics classes. I hear this is a trillion dollar problem. So where did the money go to start with? Money doesn't just evaporate. A person can lose money, a corporation can lose money, but an accounting system should not. Did it go to executive bonuses (in which case, shouldn't we ask for it back?)? Did it go for goods and services (in which case the GNP has been grossly inflated, but the people of the country have reaped a benefit and without this influx of capital we would clearly already be in recession)? Did it go to profit short sellers (in which case we are clearly under-taxing these folks)? Is it really not missing to begin with, but simply the result of changing accounting standards? How do you "lose" a trillion dollars?

Peter Stone

Now that the American people are being called upon to bail out financial institutions that incurred massive debts through an apparent combination of greed,ignorance and mismanagement, the first thing the federal government must do to take some of this burden off the majority of us who are struggling to make it, is rescind those horrendously irresponsible Bush tax cuts for the very wealthy (many of whom are the same characters who are responsible for this financial nightmare.) The current system is designed to keep the richest among us rich and getting richer, while most of us are getting squeezed to a pulp. Our government has become the handmaiden of the very wealthy who have bought its favors. This transformation has been going on for at least 30 years right under our noses at the same time as our rights as individuals have been gradually stripped away, most recently sacrificed to the gods of the so-called "war on terror." The US defense budget is now larger than all the defense budgets of all the rest of the countries in the world combined! "Country First," the angry candidate bellows. I believe you have to consider the welfare of the people first. "Country First" is a formula for keeping the people subservient to a controlling system that obviously doesn't really care about their welfare. We are blinded by the violently waving flags and made deaf by the thundering drums of war. A healthy, happy, unafraid populace means a strong country. First things first.


Chicago Grad

Thank you to professors Diamond and Kashyap for a wonderful, simple explanation.

I have to say I'm not surprised by the anti-Chicago comments. That being said, I think most of these are very misguided.

Chicago is not responsible for the recent financial problems. Critics of free-market economics fail to understand that free-markets function on the ability to access accurate information for decision making.

The problem is NOT that these banks did not have enough regulation, BUT rather that their regulators did not understand the complexity of the financial instruments involved and were THEREFORE unable to act appropriately. In fact, if a bunch of Chicago grads were running all of these agencies, I'd bet the chances that these practices would have been reigned in earlier would be much higher.

The Cold War is over and Chicago economics won. Chicago economics isn't about being a Democrat or a Republican - it's about believing that restrictions create inefficiencies.

One GLARING inefficiency: Why do we favor debt in our tax code? We should treat debt and equity equally. If interest payments are tax deductible, then dividends should be as well or vice versa. Why do we promote mortgages instead of giving renters the same tax credit? Now THAT is the underlying issue that no one seems to talk about.