Both capitalism and dollar will survive, Richard Thaler had told DNA Money

Economists have put across various theories on the genesis of the current financial crisis. Some blame Alan Greenspan, former chairman of the US Federal Reserve, for running a regime of low interest rate for four years after the dotcom bubble burst. This encouraged Americans to borrow more than what they were in a position to repay, these economists maintain, with the benefit of hindsight, of course. Others aren't as convinced that Greenspan alone was to blame, Richard Thaler, a professor of behavioural science and economics at the Booth School of Business (formerly the Graduate School of Business), University of Chicago, for one. "I don't think the low interest rate regime itself was the cause. Americans lived beyond their means, both households and the government. You can't blame Greenspan for that," Thaler told Vivek Kaul. Excerpts from an email interview:

On the failure of regulators across the world, including Greenspan, to see a crisis of such extraordinary magnitude coming…

I don't think the regulators realised that the heads of the major firms were not able to understand what their traders were doing and the risks they were imposing on their firms. As Greenspan says, he relied on the self interest of these firms to protect us. He overestimated their ability to do that.

("Mr Greenspan had faith that banks were prudent enough to make sure they were not lending money cheaply to people who could not pay it back. Yet that is what happened. As Mr Greenspan says of securities based on subprime mortgages: "To the most sophisticated investors in the world, they were wrongly viewed as a 'steal' "," Thaler wrote in a recent article in the Financial Times.)

On GM's impending bankruptcy…

Personally, I think GM should be allowed to go through bankruptcy. Many airlines have done it and have survived. If GM can't, then perhaps we should let them die. We will still make cars in America, but perhaps they will have Honda or Toyota nameplates.

On President-elect Barack Obama, who he first met in 2004, when the latter was seeking election to the US Senate...

("Back then, Obama was, as he said, "the skinny guy with the funny name" and nobody — including me — had heard of him. But I was just blown away and for the first time in my life wrote a cheque to a politician," Thaler told the Guardian newspaper a few months back.) This is certainly a hard time to be taking over as US President, but I think Obama is up to the job.

On the causes of the ongoing global economic crisis…

There are many causes of the crisis, but there are two behavioural causes that I would stress. First, the world has gotten a lot more complicated, and everyone from the individual who is taking out a mortgage to the chief executive officer of a big investment bank has had to learn how to deal with this new complexity. The second cause is self control. Many could not resist the temptation to borrow.

(Also, a lot of borrowers did not understand the kind of mortgages — as home loans are called in the US — they were getting into. But more than anything, Americans were clearly speculating big time on the homes they were buying, feels Thaler.)

I think that confusion was more important than greed for the owner occupied homes, but it is clear there was also lots of speculation going on, which is more about greed. Certainly, herd mentality was important. When I see my neighbour buy a new car by refinancing his mortgage I get jealous and do the same.

On regulating credit…

Disclosure is the best kind of credit regulation. I would like to make it easier for borrowers to understand the real risks that are inherent in any loan they are taking. I would also like to make it easier for investors to understand the risks that the companies they buy stock in are taking. The trick will be to find a way to increase the disclosure and oversight of financial firms without removing their ability to make money. That is difficult but not impossible.

On the end of the crisis…

I thik that 2009 will be a tough year all around the world but economies will rebound. Both capitalism and the dollar are safe and will survive.

DOWN THE MEMORY LANE

US economist Richard Thaler, one of the founding fathers of behavioural economics, has won this year's Nobel Prize for Economics. On this occasion, we are reproducing his interview to DNA Money in the middle of raging economic crisis 2009 where he predicted that the crisis will pass and capitalism will survive.