Having read as many 10-year lookbacks on the financial crisis as I could handle, I’ve found two consistent themes. First, they ask: “Could it happen again?” Second, they connect the crisis and its aftermath, especially the bailout of the financial sector, with the rise of anti-elitism that brought us President Trump, Brexit and the anti-establishment politics sweeping across Europe.
On the first question, yes, it will happen again.
I don’t mean that it will be another housing bubble pumped up by reckless finance. Nor am I saying that the heightened oversight of the financial sector won’t work (though congressional actions to reduce that oversight are badly misguided).
I mean there’s a recession-inducing economic shock out there somewhere. Only this time, if the shock is big enough, the outcome could be worse as our politics have deteriorated in ways that may well preclude the necessary reactions.
The consensus among economists when the last crisis hit is that we may have missed it, but we reacted quickly and effectively (disclosure: I was an economist on the Obama team back then). I’d strongly agree with “quickly” (I’ll deal with “effectively” below). But for all the ink spilled on the crisis, the part about missing the housing bubble has gotten woefully little attention. Given that an ounce of economic prevention is worth trillions in resources saved and pain averted, I’ve been struck by this hole in the coverage.
Dean Baker, a rare economist who did see what was happening in real time, recently wrote that “the [housing] bubble and the risks it posed should have been evident to any careful observer. We saw an unprecedented run-up in house prices with no plausible explanation in the fundamentals of the housing market … The fact that prices were being driven in part by questionable loans was not a secret. The fact that lenders were issuing loans to people who had not previously been eligible was widely touted by the financial industry. The fact that many of these loans involved little or no down payment was also widely known.”
In economics, when the naked emperor is praised for his sartorial splendor, look for an indefensible assumption, usually one that totally belies common sense. In this case, it was the assumption that the incentive of lenders to self-regulate would preclude any systematic underpricing of risk.
We also failed to adequately recognize the domino structure of the international banking system, the extent of its interconnectedness, and the reality that a hiccup not in exotic derivatives, but in short-term lending (a historically reliable market), could tip over the first domino.
In this regard, “could it happen again?” is asking “are economists any better at seeing through our assumptions?” and “do we understand the correlations embedded in global finance?”
The U.S. central bank provides some hope. From the early days of her tenure, then-Fed Chair Janet L. Yellen argued that the Fed should be driven more by data than assumptions and had to be more vigilant in tracking bubbles (which it calls “financial excesses”). Her successor, Jerome H. Powell, continues in this tradition. The Fed’s political independence is, thus, increasingly essential. (Side note: Yellen also correctly stressed that stronger regulatory measures, not higher interest rates, should the first line of defense against financial excesses. Worrisomely, recent Fed output seems to be backtracking on this point.)
But global finance is even more integrated, more dominated by even larger institutions and more politically powerful than before the crash. In our pay-to-play system, and especially as the usual amnesia about the last implosion sets in, politicians are actively engaged in the deregulatory bidding of their deep-pocketed masters.
John Cassidy, the author of an early, insightful book on the crisis, recently summed up the political economy of this moment: “Nobody can say for sure where the next financial crisis will come from. But Trump and the G.O.P. are busy hastening it along — even as they’re undermining the architecture needed to deal with it.”
Were a crisis to reoccur on their watch, the likelihood that Trump and the Republicans would countenance the United States again leading the reflation of global credit markets seems awfully remote, as does the chance that the austere German government would pick up the slack. If anything, global powers are leaning more into isolationism than “we’re in this together.”
To what extent, as much commentary maintains, is this situation the outgrowth of the reaction to the crisis, summarized by Paul Krugman thusly: “Policy moved quickly and fairly effectively to rescue banks, then turned its back on mass unemployment”?
The connection is real, but it requires context. For decades before the crisis, too many people and places in advanced economies were beset by the growth of inequality, stagnation of real wages and incomes, diminished opportunity, and rising immobility. Elite politicians and economists argued the causes were “technological change and globalization,” meaningless abstractions to those on the wrong side of the inequality divide.
Then, when the crisis hit, those same elites moved quickly and decisively to save the banks. In fact, there was also a strong and potent dose of fiscal stimulus to help the real economy, but in both the United States and even more so in Europe, the fiscal brakes were applied far too soon.
It was this collision of not dealing with the underlying problems facing the working class before the crisis with the bailout of the banks during the crisis that confirmed the priors of millions of people here and in Europe that the game was hopelessly rigged against them. The ascension of Trump, a faux populist who is busy further enriching the elites and liberating the financial sector from post-crisis regulations, only underscores the depth of the rigging.
So, yes, it could and will happen again, and, yes, the crisis helped deliver the current political regime, one that does not, to put it mildly, inspire confidence as per this regime’s ability to react to the next shock. The fundamental question then becomes: Will enough voters recognize these realities and put competent legislators back in charge before it’s too late?