Business, Politics & Society

How ‘08 Happened

Paul Krugman

Lesson time 14:26 min

Learn about the market patterns and unregulated financial activities that led to our worst financial crisis since the Great Depression, and how to prepare yourself for the uncertain economic future.

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Paul Krugman
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There was a period not that long ago, when people were very complacent about things like financial crises. There's an infamous address to the American Economic Association saying the problem of the business cycle has been solved-- that was in 2003. Well, actually, no. It turns out recession crises still happen. And we haven't found it that easy to deal with them. When did they begin? No one really knows, but there was, in fact, a recognizably modern banking crisis in Scotland, in the 1770s. Scotland had led the way in the introduction of paper money, which was, at that time, issued by private banks, which had gold and silver in reserve. But it could go bad. You could have bank runs. You could have a crisis of confidence. And left to themselves, banks can create risks that can then spread out and disrupt the economy as a whole. [MUSIC PLAYING] Banking is a very clever institutional thing that, like many clever institutional arrangements, is extremely useful. But sometimes goes really wrong. The trick about banking is that the bank takes your money. And from your point of view, your money is sitting at the bank and I can withdraw it whenever I want. But the bank doesn't actually keep your money there. They put it to work. They lend it out. They make it available so it can be used to build businesses. Or finance other people's purchases of homes. And that's good. You want wealth to be put to work, but how can they do that? Because since I'm free to take my money out of the bank, how can they guarantee that when the money isn't actually there? And the answer is there's a lot of customers. And on any given day, only some people will be withdrawing money. But suppose I have reason to suspect that my bank has actually lost a lot of money? Suppose I have a reason to think that they've made a lot of bum loans. Then I might want to pull my money out while it's still there. So will everybody else. And if everybody tries to take their money at the same time, well, the bank doesn't have the money. And if they try and raise it by selling their loans to somebody else, it's going to be fire sale. They're going to be trying to sell it at speed and they're go lose a lot of money. Which means that if people believe that a bank is going to fail, that can be a self-fulfilling prophecy-- that's a bank run. Everybody is trying withdraw their money at the same time. That actually dries the bank out of business, even if it was fundamentally sound. [MUSIC PLAYING] The Great Depression was, pretty much-- it started as a recession, which was bad. It turned into the Great Depression because of a wave of bank runs. As each bank failed, that made people nervous about the next bank. And so over the course of 1930, 1931-- huge numbers of banks failed. There was panic. People wanted to put cash under their mattresses. The banks that survived pulled back from lending and just accumulated big reserves of cash, just in case. And that is re...


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For Nobel Prize-winner Paul Krugman, economics is not a set of answers—it’s a way of understanding the world. In his economics MasterClass, Paul teaches you the principles that shape political and social issues, including access to health care, the tax debate, globalization, and political polarization. Heighten your ability to read between the lines and decipher the underlying economics at play.



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Students give MasterClass an average rating of 4.7 out of 5 stars.

Nice focus on basic concepts for a novice like myself!

This made me more interested in 'boring' economics. Thanks!

Learned a great deal more about the nature of trade and international trade

It reaffirmed the Keynesian beliefs I have held for years as Paul explained concepts in an orderly progression.


Comments

Dev K.

Excellent lessons. It was crystal clear to an Economist with 41 years' experience. My worry is that parts of its were a bit dense for non-economists. But, I am not sure how Paul's explanations could have been further elucidated. He touches upon some real difficult topics such as the 2008 financial crisis. I would perhaps have dwelt on the role of wrong ideology--markets know best. That resulted in the regulatory bodies like the Treasury, the FDIC, OCC, and the Fed caught sleeping at their wheels. After all, why exercise strict oversight when markets know best? Well, as it turned out, they don't! Regulatory agencies have to do their job. We all paid the price when they failed to do so.

Bogdan I.

Paul Krugman says in this class that the crisis of '08 brought down all the shadow banks but how come that big banks have also fallen ?

RJane @.

In my perspective, the process of the 2008 recession begun during Bush, Jr.’s or Clinton’s presidency. Obama and the federal government may have contributed to the recession.

Pisko

Paul, ur work has earned u a great reputation as an economist, please help me understand why don't u tell 2008 the way it was!! People here is paying 2 learn, n u come out with "crimeless victims", what!!! We do live in a strange world, where a nobel prize missinforms people that is investing on their education, on a major subject: Bank boards at wall street are responsible, they created the CDO's, they deliverately dodged regulation n created da bubble, n they have the power 2 force the government 2 rescue them with the taxpayers money, works, savings n even lives. That's one lesson people actually has 2 learn from 2008. This is not my opinion but a fact, anybody can learn more by watching the "Inside job" documental or even "The big short" movie. U r one of the few instructors at Masterclass with zero replies, so PAUL PLEASE ANSWER

Mark B.

I would assume all of the folks at the NY financial firms and government and private economists who were looking at the US economy during this time put together are very, very, very, smart people. So why were the factors listed below so hard to grasp: 1. Mean wages had been stagnate since 1973 2. First, families first coped by having both spouses working in dramatically greater numbers than in the 50's and 60's 3. Second they coped by increasing personal debt mostly in form of credit card debt. 4. Finally they used their house as an ATM by refinancing etc, This of course worked as long as as housing values increased. But has there ever been a period in the history of the country where housing prices never dipped? So it is hard to imagine that the brilliant folks described above could not see the storm clouds gathering as we entered the new millenium. I have thought for awhile that a lot of folks did see the storm clouds but just did not have an answer as to how to avoid them and just hoped they would dissipate before they reached our shores. Can someone smarter than me explain why this scenario is not true? Mark Brown, MD

Jan C.

The true cause of financial bubbles is commercial banks ability to create money "out of thin air" when lending to households and businesses. I have Masters in Economics but for some reason, our professors never taught us the truth about how MONEY IS CREATED EVERY TIME COMMERCIAL BANKS ISSUE A LOAN and destroyed when loans are repaid. I'd love to hear Paul explain money creation process and bust the myth of "money multiplier" still taught at universities! Here's how the money system really works POSITIVE MONEY ORG London, U.K. www.positivemoney.org If you want to get involved, find money reform organization in your country https://internationalmoneyreform.org/members/ Thanks.

Norm C.

I love it. This is a very kind, no fingers pointed, generous to the guilty explanation of what happened. It is an explanation people can kind of grasp. I would love to hear Paul explain why the US went off the gold standard and why mortgage interest rates in Canada went to 20% in the late 70's early 80's. Even more I would love to hear why the Canadian government insisted high interest rates were necessary to "protect the Canadian dollar" even though unemployment was high. My opinion is the interest rates were kept extraordinarily high to protect the Canadian banks who had lost mega bucks on bad domestic and overseas loans and the average Canadian was made to pay for it. Once the bad loans were wrote off, interest rates fell.

kristi K.

Where is the workbook? I see the pdf, but it's simply a print version of the lecture. I'm thinking there's more??????

Gordon

Back in the palmy days of 2006, Jimmy Cayne, the Bear Stearns Chairman and CEO revealed the secret of the firm's success at a senior managing directors' quarterly meeting: "Everyone needs a house" ! that's policy on a postage stamp

Joshua P.

His fundamental premise on the Great Depression is incorrect. Every economy goes through economic cycles, booms and busts if you will, but the Great Depression was ultimately caused by a failure in government, not the market. After the crisis began, the federal reserve over the next several years decreased the money supply by roughly 1/3rd. It was this decrease in the money supply that triggered the Great Depression to the record high levels of unemployment accompanied by nearly every other form of human misery we can name. The scarcity of money inevitably made the bank runs of the early 1930s much worse than they would have been if the federal reserve had expanded the supply of money. If we expand to the crisis of 2008, we find much of the same. It wasn't financial innovations that caused the 2008 Great Recession. In the 1990s, we find that the federal government expanded the subprime mortgage lending program that lent money to individuals that were not financially stable enough to purchase a home. Again, every economy goes through booms and busts as a result of the leverage cycle. After all, economic cycles at the most fundamental level are driven by debt. The question we should be asking is what actions turned the bust into a crisis and what actions prolong the crisis. Sure, financial institutions were engaging in risky mortgage-backed securities, but when you begin to probe on what the driving factors of the housing crisis were, we again see the hands of government intervention gone wrong.