If at first you don’t succeed, publish a new narrative about the Great Financial Crisis.  You have to do this when you are Ben Bernanke.  After all, his legacy is riding on continuing to defend the indefensible (ie, the save the bankers’ bonuses response to the GFC he helped lead which made the crisis dramatically worse for the real economy and gave rise to the return of populism).

At the 2018 Nobel Symposium on Money and Banking, Bernanke trotted out his new narrative.  As described by John Cochrane, aka the Grumpy Economist,

Ben showed some very interesting evidence that the crisis was an unpredictable run, rather than the usual story about predictable defaults resulting from too much credit. Things really did get suddenly a lot worse in September and October 2008.

Yes, it’s easy to say this is defense against the charge that he should have done more ahead of time. But evidence is evidence, and I find it quite plausible that the relatively small losses in subprime need not have caused such a massive crisis and recession absent a run.

Ben says the material is part of a paper he will release soon, so look for it.

The Great Financial Crisis was not an unpredictable run.  It occurred in exactly those parts of the financial system the Information Matrix predicted it would occur in.  It happened where it did for exactly the reason the Information Matrix said it would.

The Information Matrix provides the framework for understanding financial crises using behavioral economics.  Behavioral economics recognizes people like a good story.  In fact, people can like a narrative so much they behave in ways that are irrational.

Wall Street understands this.  Behind every investment product Wall Street sells is a narrative designed to make the product sound appealing.  However, every investment product narrative is not necessarily accompanied by the disclosure investors need in order to verify the story Wall Street told.

Information Matrix

Keep in mind, behavioral economics’ observation people like a good story operates in both the Perfect Information and Blind Betting quadrant.  The key difference between the two quadrants is in the Perfect Information quadrant the story can be verified and in the Blind Betting quadrant the absence of the necessary information means the story cannot be verified.

Whether the story can be verified or not results in a vastly different response when Wall Street’s valuation story is called into doubt.  In the Perfect Information quadrant, the story can be verified and the doubt dismissed.  In the Blind Betting quadrant, the story cannot be verified.  Not only is the doubt not dismissed, but the logical follow-up question arises:  is the investment worth anything?  This too cannot be verified.  Investors recognize this and, as behavioral economics suggests, naturally panic.  The result is a “run” to get their money back.

So where did the Great Financial Crisis runs occur?  In all the opaque sectors of the global financial system where investors did not have the necessary information to verify Wall Street’s valuation story.

The Great Financial Crisis was effectively an earthquake along the opacity fault line in the global financial system.  It started with subprime mortgage-backed deals before spreading to special purpose vehicles and then to their sponsoring banks.

What is important to note here is not the path the earthquake took along the opacity fault line.  Rather, it is the existence of large, opaque corners of the global financial system was the necessary condition for a financial crisis to occur.  Just like the Information Matrix predicted.

I look forward to seeing if there is anything else that needs to be debunked in Bernanke’s new narrative when it is published.