“Precipitating” the Credit Crisis

On Friday, we noted our disagreement professor Paul Krugman as to the multi-variate causes of the crisis and collapse.

The point of contention was the impact of sub-prime loans on the entire US Housing market (and whether lending standards were enforceable). My argument was that then Fed Chairman Greenspan’s nonfeasance allowed all manner of Zero Lending Standard loans — primarily sub-prime 2/28 ARMs. Had he enforced lending standards, it would have prevented ~3-5 million unqualified buyers from entering the housing market. With significantly lowered demand, the credit bubble/housing boom would have looked very different.

That was Friday; The Sunday NYT brings an interesting phrase to our attention: That Lehman Brothers “precipitated the collapse.”

Frank Rich wrote:

“But in the 16 months since that other calamity in downtown New York — the crash precipitated by the 9/15 failure of Lehman Brothers — most of us are still ignorant about what Warren Buffett called the “financial weapons of mass destruction” that wrecked our economy.”

Rich uses an interesting — and I have to admit, correct term — when he states “precipitated.” It means to throw violently; to bring about especially abruptly. It reflects a factor that speeds or expedites an event. (Bill Safire would no doubt approve).

Too many writers seem to confuse causation with the subtler “precipitate.” Lehman Brothers no more caused the crisis than a trailer park that gets destroyed causes a tornado; The difference, as most will all acknowledge, was that Lehman was a factor in the overall build up of derivatives, securtitized mortgages, and leverage. But they were one of many firms doing these financial actions, and hardly a sole, “but for” cause of the collapse.

If I were to have any quibble with Rich, it is with how most people will misread the verb; Too many will read “precipitate” as “create;” rather than its meaning of an enzyme — one that rapidly accelerates a latent or existing chemical reaction. But that is not how most people will read that sentence — they will assume it means cause or create.

Perhaps its easier to conceptualize a feedback loop: There were many factors that contributed to the credit collapse, and each subsequent failure allowed the storm to pick up more force, enabling it to collapse a bigger and previously believed impervious firm:  As each firm went, the crisis was able to knock over a bigger domino, gaining power at every step.

Visually, I find the idea of a feedback loop gaining strength to be appropriate:First Bear Stearns fell, then Fannie Mae, then Lehman Bros, then AIG, Citi, Merrill Lynch and ultimately Bank of America.


Bubbles & Banks & Zero Lending Standard Loans (January 8th, 2010)

The Other Plot to Wreck America
NYT, January 9, 2010

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