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Causes of the financial crisis, one more time

by Robert Teitelman | Published November 3, 2011 at 1:05 PM

There is currently a video wandering the blogosphere that features New York City Mayor Michael Bloomberg offering up his own critique of what caused the financial crisis. Bloomberg blames the mess on Congress for allowing government-sponsored enterprises -- Fannie Mae and Freddie Mac -- to lend willy-nilly and inflate the housing market. This is a common meme often heard from Republicans and Wall Streeters; Blackstone's Steve Schwarzman has tossed it out time and again. It's a diagnosis of causation that allows its proponents to, as Bloomberg does here, pluck the banks and Wall Street off the hook they've been hanging from for three years now -- and to decry generally demands that the banks loosen lending standards to stimulate the economy. It's also one that satisfies anyone who can only mentally juggle one, perhaps two, culprits at a time.

Bloomberg, as always, is straightforward and confidently omniscient: "It was not the banks that created the mortgage crisis. It was, plain and simple, Congress, who forced everybody to go and give mortgages to people who were on the cusp. ... But they were the ones who pushed Fannie and Freddie to make a bunch of loans that were imprudent, if you will. They were the ones that pushed the banks to loan to everybody." Forced everybody?

Rortybomb, who links to the video, does a pretty good job of dismantling Bloomberg's off-the-cuff analysis. But at the same time, he slips into the same sort of reductionism to a small set of causes that Bloomberg is offering. "My sense is that these are people who can't accept that some markets, especially financial ones, are disasters when completely unregulated -- and thus find any far-fetched excuse to blame the government. But since we are going to hear a lot of it in 2012, how should one respond to the line that Congress and Fannie/Freddie caused the housing crisis?" It's a little unclear, but is Rortybomb arguing that the government -- specifically Congress -- had no role in the crisis? How in other words did financial deregulation occur? Even if you don't see Fannie and Freddie as leading the subprime parade -- see Joe Nocera and Bethany McLean's "All the Devils Are Here" on that subject -- they certainly contributed to the problem, particularly when they crapped out.

As Felix Salmon notes in a post Wednesday about captured regulators -- his blanket belief that regulators are everlastingly captured, which, like most blankets, sometimes fails to cover as much as you wish -- regulators at some level do "work" for Congress, and follow its lead, at least bureaucratically. Not that that lead isn't often murky, particularly in good times; Congress is a veritable porcupine of interests and is rarely coherent or unified in its direction. Nonetheless, it is clear that no matter what you feel about a specific piece of regulatory legislation like Glass-Steagall, Congress over the past few decades has shared a bipartisan belief in loosening the rules, as did nearly everyone else. Part of the deregulation encouraged the mortgage market to go wild; part of that trend took many of the shackles off Wall Street and the banks; and everything from global trade imbalances to Fed interest rate policy made credit abundantly available to nearly everyone, from private equity buyers to consumers. These tendencies spawned some enormous entities that were too big to fail -- from the GSEs to the big banks to AIG -- that came to share the same broad protection of the government as Fannie and Freddie.

This, in fact, is expressed with great clarity by Paul Volcker, one of Salmon's presumably captured regulators, in the new issue of The New York Review of Books. Volcker begins his piece with an aggressively multicausal view of the crisis: "It should be clear that among the causes of the recent financial crisis was an unjustified faith in rational expectations, market efficiencies and the techniques of modern finance. That faith was stoked in part by the huge financial rewards that enabled the extremes of borrowing, the economic imbalances, and the pretenses and assurances of the credit-rating agencies to persist so long. A relaxed approach by regulators and legislators reflected the new financial Zeitgeist." That is paragraph one. He continues in that vein for six more, ending with a description of how "all these developments derive in some part from the complexity implicit in the growth of the so-called shadow banking system." Volcker's entire piece is, as usual, well worth reading and pondering.

Now I'm not about to say Volcker is necessarily more omniscient or more saintly than Bloomberg or, for that matter, Rortybomb, although he has a few more credentials in the area and he long has had a personal policy of keeping his politics tucked neatly away. It is fascinating that Volcker begins his diagnosis, which is not the same as a cure, with three intellectual constructs that emerged from the halls of academe, economic division: rational expectations, efficient markets and techniques of modern finance. (I've written a number of posts on rational expectations, see here and here.) He is establishing a sort of causal primacy for complex and, to the public at large, impossibly arcane, economic ideas. If you believe in a multicausal set of affairs, you then have to establish a hierarchy: What's primary, what's secondary, what's tertiary, what meaningless? In that ordering of cause, sane and reasonable people may disagree and ambiguity may rule. Volcker puts the effect of high compensation high up on his list; I (Mr. Sane and Reasonable) would drop it down a bit. I would elevate what he calls "failures of national economic policy and the absence of a disciplined international monetary system," which would include mistakes over decades by the White House, Congress, regulators and the monetary folks at the Federal Reserve. And I would include, further down and more controversially, the deficiencies of ordinary Americans, that sacred herd, not only for their profligacy and short-term tendencies, which informed our surreal Zeitgeistian politics and consumerist frenzies, but for their unwillingness to grapple with the world much beyond their selves, their homes and their television sets. Somewhere in there advancing inequality plays a role as does the hubris of galloping American exceptionalism.

Identifying and ordering this complex set of factors is a challenge; it's what intellectuals and particularly historians do, which is one reason the practice of that latter craft is so essential. But what we have learned in the last year -- from the Tea Party, from Occupy Wall Street, from politicians, pundits, academics, talking heads -- is that it's far easier to offer the blanket charge, the single cause, the nifty slogan than it is to do the kind of hard work necessary to dig our way out of this mess. In the buzzing dynamic between elites and citizens, simplicity, like so many schemes for postcard tax returns, still wins. - Robert Teitelman

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