Chaos Theory is my overblown reference to the idea that a small change in one part of a system can have unpredictably large effects in another. I had that reaction while reading Stuart Vyse’s article in Skeptical Inquirer on an academic analysis on one of the causes of the Great Recession of a few years back:
In the 1990s, personal bankruptcies were rising sharply, and the banking industry began a lobbying campaign to stiffen the bankruptcy requirements—a move that was expected to increase the profits of credit card companies. Attempts to pass a bill failed until President George W. Bush was reelected in 2004. Finally, after big banks spent $40 million in campaign contributions and millions more in lobbying efforts, the bill went into effect in late 2005 (Labaton 2005). It had a number of provisions, but most importantly it increased the up-front costs of filing for bankruptcy and made the process more onerous.
This is known as the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). So what of it?
Sources: U.S. Courts and Mortgage Bankers Association. via Stuart Vyse
Although it took a few years to figure it out, several economic studies now conclude that the BAPCPA was a precipitating factor in the ensuing debacle of 2008 (Albanesi and Nosal 2016; Li et al. 2011; Morgan et al. 2012). According to these investigations, once the new bankruptcy requirements went into effect, many people who were struggling with debt found bankruptcy was no longer an option. Ironically, they could no longer afford to declare bankruptcy. But what remained an option was not paying the bills, and beginning in 2007, a little over a year after BAPCPA went into effect, an increasing number of homeowners chose to stop paying the biggest bill of all—the mortgage. The switch from bankruptcies to foreclosures can be seen in Figure 1.
The rest is history. Many of those mortgages had been bundled together and sold to investors, and when the value of those mortgage-backed securities started to tank, so did the stock market, the employment rate, and the economy in general. Obviously there are many other factors that went into the Great Recession. BAPCPA was not the only cause. But the crash of 2008 started when the real estate bubble finally burst in 2007, and the bursting of the bubble gained steam when thousands of homeowners stopped paying their mortgages. Had bankruptcy still been an option, some of those people might have been in a position to keep paying the mortgage.
The beauty of bankruptcy as a form of financial failure is that most of the effects are restricted to the individual filers and the banks. Foreclosure is a different matter entirely. When your neighbor forecloses, your house loses value, and the real estate market and the economy in general are affected.
It’s a lovely causal link chain. And the illustration of how a relatively minor change to the bankruptcy code causes the jello to squeeze out of the mold in an unexpected area is a reminder of the lessons of chaos theory.
But – skipping the debate about bank greed and how that leads to corruption[1] – I’d like to return to my hobby horse[2] by observing closely the responsibilities we can expect the various entities to assume. The bankers who pushed for BAPCPA feel they have a responsibility to increase their profits, and in this depraved age of chasing the dollar, rather than caring for the community which ultimately generates those profits for you in the first place, they do not have the expertise to make judgments concerning the rules which govern them. Indeed, in this extremely complex world of international banking, it may be asking too much of a company, complex in its own right, with rivals which conceal their own internal states, to make exceedingly wise rules concerning their own conduct; and given the rules of engagement for the private sector, leaving a chink in the armor merely invites competitors to take advantage.
Which leads to the responsibilities of government, primarily that of regulation. In this age of Trumpian-anti-regulation, it may seem jejune or even retro, but the propaganda of the right needs to be beaten back before we risk another Great Recession, because proper regulation enhances business. For the doubter, merely consider, following the repudiation of Glass-Steagall, the final fates of Lehman Brothers, Wachovia, or Merrill Lynch. In this instance, the government failed, under the guidance of the party of business, to properly decide not to pass this bill, and the subsequent fallout was quite damaging to both Main Street and Wall Street.
Government not only has this responsibility as part of our cultural remit, but because it’s the natural assignment – government should not be prone to the same pressures as that of business, it has the resources to take the long view, to conduct the deep research needed to make these decisions properly. To keep society safe.
If I may extend this, business cannot make these decisions because they cannot reliably think beyond their own individual boundaries. A single business conducting its business in an unethical manner may cause little systemic damage, but when all the businesses in a niche – such as banking – are conducting business in the same destructive manner, we begin to see damage at our very foundations. This multi-fold effect, invisible to business, must be visible to some regulatory entity, or the so-called free enterprise system is a failure. Fortunately, it is visible, if with some difficulty, so we are left with only the requirement to have the bravery to pursue the proper regulation.
And not fall victim to the amateur’s claim of the evil of regulation.
1It’s a worthy debate, but without proper framing & understanding it just collapses into insults.
2You’d think it would be dead by now, wouldn’t you?
