“We had the worst financial crisis, the Great Recession, the worst since the 1930s. That was in large part because of tax policies that slashed taxes on the wealthy, failed to invest in the middle class, took their eyes off of Wall Street, and created a perfect storm.”
— Hillary Clinton, remarks in the first presidential debate, Sept. 26, 2016
Several readers have asked us about this comment, especially Clinton’s assertion that the George W. Bush tax cuts played a significant role in creating “a perfect storm” that led to the 2008 Great Recession. Clinton also cited a lack of regulation (“took their eyes off of Wall Street”) and a failure to invest in the middle class.
It’s difficult to summarize vast economic changes in a single sentence — and economists will forever argue on root causes of the crash. But Clinton’s effort to pin much of the blame on Bush’s tax cuts is rhetorical poppycock.
People may have legitimate disagreements on the combination of factors that led to the crisis. But there was a U.S. government commission, the Financial Crisis Inquiry Commission, that in 2011 issued a 663-page report that carefully dissected the reasons for the crisis. The commission was chaired by former California state treasurer Phil Angelides, a big fundraiser for the Clinton campaign.
The findings were not without controversy – four Republican members dissented – but nowhere in the report is there any mention of or blame assigned to the Bush tax cuts. The key summary said:
“While the vulnerabilities that created the potential for crisis were years in the making, it was the collapse of the housing bubble — fueled by low interest rates, easy and available credit, scant regulation, and toxic mortgages — that was the spark that ignited a string of events, which led to a full-blown crisis in the fall of 2008. Trillions of dollars in risky mortgages had become embedded throughout the financial system, as mortgage-related securities were packaged, repackaged, and sold to investors around the world. When the bubble burst, hundreds of billions of dollars in losses in mortgages and mortgage-related securities shook markets as well as financial institutions that had significant exposures to those mortgages and had borrowed heavily against them. This happened not just in the United States but around the world. The losses were magnified by derivatives such as synthetic securities.”
The report went on to assign blame to failures in financial regulation and oversight, failures of corporate governance and risk management and a combination of excessive borrowing and risky investments. That comes close to Clinton’s reference to regulators taking an eye off Wall Street, but again, it has nothing to with Bush’s tax cuts.
A campaign official said Clinton “sees their [the Bush administration’s] failure to properly regulate Wall Street as an immediate trigger of the financial crisis.” (Note: the commission report specifically cited “the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards.” The Fed is an independent agency, although the report also criticized various Bush administration financial-services regulators.)
The official then offered a defense for also assigning blame to the tax cuts. He said that “the Bush tax cuts significantly aggravated the trends of rising income inequality and stagnating wages for the middle class.” He added that “by turning the surpluses we saw under President Clinton into significant deficits, the Bush tax cuts (and other fiscal policies of the Bush administration) put us in a much weaker fiscal position to combat the crisis.”
But there are several problems with this explanation. Income inequality started surging in the mid-1980s and, except for a brief pause, continued through the Bill Clinton and Bush administrations. Moreover, President Obama largely accepted the Bush tax cuts, with the exception in 2012 of an increase on taxpayers earning more than $400,000.
Democratic dogma holds that the budget surpluses projected at the end of President Clinton’s term were wiped out by Bush’s tax cuts, but that’s wrong. The surpluses disappeared mainly because of increased spending (36.5 percent) and forecasting errors by the Congressional Budget Office (28 percent); the tax cuts accounted for just 24 percent of the missing surplus.
The Clinton campaign offered two academic papers in support of Clinton’s argument, but they were off point. One article claims increased inequality contributed to the slow recovery, but that’s not the same as causing the crisis. The other article described a theoretical model of a closed economy in which increased income inequality would lead to a credit bubble. But that does not apply to the 2008 financial crisis, which was exacerbated by global capital flows.
We asked Angelides and other members of the commission’s majority to comment on Clinton’s analysis but did not get a response.
[Update: Angelides provided a statement saying the Commission’s “investigation was focused on matters related to financial markets and regulation, the collapse of major financial institutions, and potential violations of law related to the financial crisis. Accordingly, our findings were focused on those matters, not on matters of broad tax policy. …I concur with Secretary Clinton that the Bush Administration policies of slashing tax cuts for the wealthy, failing to stabilize and strengthen the middle class, and turning a blind eye to recklessness on Wall Street severely weakened our economy, making it particularly vulnerable to financial shock and resulting in the deepest economic downturn since the Great Depression. I believe her statement was accurate and on point."]
Alan B. Kreuger, a Princeton economist who called The Fact Checker on behalf of the Clinton campaign, acknowledged that “my ears perked up also” when he heard the reference to the Bush tax cuts. But he said he interpreted her statement as a reference to how income inequality led to the stagnation of the middle class and spurred excess borrowing and leverage — key components of the crash along with lax regulation. The Bush tax cuts, he said, contributed to income inequality, although, he added: “I don’t want to say the Bush tax cuts were the only factor.”
Simon Johnson, a professor of global economics at the Massachusetts Institute of Technology and former chief economist for the International Monetary Fund, also contacted The Fact Checker on behalf of the campaign. He said he read Clinton’s comments to mean that the Bush tax cuts weakened the ability of the U.S. government to respond to the financial shocks. “The financial crisis led to a deeper recession because the federal government could not respond effectively/as much as was needed – there was less fiscal space because of the Bush tax cuts,” he wrote in an email, because of higher deficits. “This meant a deeper recession, i.e., more loss of output and a slower recovery.”
(Historical note: The transition memo written for President Obama by economic advisor Lawrence Summers did not mention the level of possible debt as a key concern. Obama was given four stimulus options, with largest at $890 billion. “We do not believe it is feasible to design sensible proposals along these lines that go much beyond this total size,” Summers wrote.)
Keith Hennessey, a dissenting member of the commission who now lectures at Stanford Business School, pointed to a 2009 paper written by Douglas J. Elliott and Martin Neil Baily of the Brookings Institution. (Baily chaired the Council of Economic Advisers under Bill Clinton.) The paper outlined three competing narratives for the fundamental causes of the crash:
Narrative 1: It was the fault of the government, which encouraged a massive housing bubble and mishandled the ensuing crisis. (Basically a conservative position.)
Narrative 2: It was Wall Street’s fault, stemming from greed, arrogance, stupidity, and misaligned incentives, especially in compensation structures. (Basically a liberal position.)
Narrative 3: “Everyone” was at fault: Wall Street, the government, and our wider society. People in all types of institutions and as individuals became blasé about risk‐taking and leverage, creating a bubble across a wide range of investments and countries. (The position taken by many former policymakers, including Hennessey.)
Hennessey, who was director of the National Economic Council under Bush, said he was struck by Clinton’s comments in the debate, believing they broke new ground.
“To my knowledge, this is the first time someone with her prominence has advanced the argument that fiscal policy caused the crisis. Think of it as a new narrative 4,” Hennessey said. “That many of those who typically agree with narrative 2 might also oppose the Bush tax cuts does not mean that narrative 2 and narrative 4 are the same, or that narrative 4 has the intellectual heft of narrative 2. They are not, they are quite different arguments. And the support her people have given so far for this new argument is, in my view, incredible. The new intellectual ground she broke Monday night is intellectual quicksand.”
Two other Republican members of the commission, former CBO director Douglas Holtz-Eakin and Peter J. Wallison of the American Enterprise Institute, agreed that the Bush tax cuts did not play a role in the crisis.
It is interesting that Clinton made no reference to the role that the home mortgage market played in the crash. But that might have been a sensitive issue, given that many analysts cite a 1995 Clinton administration policy to encourage home ownership by pushing for less-stringent credit requirements for middle-class families. Bush expanded on the push by introducing a zero-down-payment initiative for first-time home buyers.
The Pinocchio Test
Clinton is a disciplined debater, but it’s pretty clear she flubbed this. No credible analyst would cite the Bush tax cuts as playing a key role in spurring the crash. If she had meant to pin the blame on rising income inequality, she should have said so clearly, without putting a political spin on the policies of a Republican president. (If, as Johnson said, she meant that the tax cuts made it more difficult to respond to the crisis, she certainly could have been clearer.)
Her statement is mitigated, slightly, by the reference to lax oversight of Wall Street, a traditional liberal position. That keeps her, barely, out of the Four-Pinocchio range. The causes of the Great Recession are complex and debatable, but there’s no debate that she is wrong to put the Bush tax cuts at the top of the list. [Note: an astute reader reminded us that The Fact Checker in 2012 examined a similar statement by President Obama, also awarding it Three Pinocchios.]
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