What’s needed: Innovation, properly regulated, says Madrick

April 21, 2009

Jeff Madrick and Alex S. Jones.

Jeff Madrick and Alex S. Jones.

April 21, 2009 — Jeff Madrick, editor of Challenge magazine and contributor to The New York Review of Books, discussed “Who Caused the Crisis and What We Can Do” at the Center’s brown-bag lunch.

The cause of the economic crisis, Madrick summarized, is that “we became prisoners of anti-government ideology” that was “beneficial to the financial community.” “Rapid change has come,” Madrick continued, “and government hasn’t been there to help us cope with change.”

According to Madrick, it was not the runaway housing market, but changes to the securitization process that damaged the economy. As simple mortgages were transformed to global securities, demands grew, and banks sought to package everyday mortgages into corporate bonds purchased by private investors.

As a result, local bankers lost their connection to their lenders. “Originate and distribute” was the new motto, Madrick said. Banks no longer faced the risk of a lender defaulting. Additionally, new computer models often measured risk in ways that were often “oversimplified” and “fooled around with,” said Madrick. Banks were “flagrantly taking on too much risk,” so that by the early 2000s, Madrick said, “money was free.”

Along with securitization, bonuses also contributed to the economic crisis. Instead of motivating businesspeople to take intelligent risks, bonuses were used to reward any risk, to the point that people had to “play the game” and take serious risks to keep their jobs, said Madrick.

While a fellow at the Shorenstein Center, Madrick wrote a paper about media coverage of deregulation in the 1990s. Evaluating the media’s coverage of the current economic situation, Madrick pointed out that there was not adequate coverage “until after the collapse.”

In assessing how the Obama administration is handling the crisis, Madrick said that the stimulus package was a good start. What’s needed, Madrick concluded, is “innovation of our financial systems” that is “properly regulated.”

This article was written by Janell Sims and the photos taken by Leighton Walter Kille, both of the Shorenstein Center.