The 2008 Financial Crisis: A Primer

• The Great American Stickup: How Reagan Republicans and Clinton Democrats Enriched Wall Street While Mugging Main Street by Robert Scheer, Nation Books (September 7, 2010), 304 pages.
  
• All the Devils Are Here: The Hidden History of the Financial Crisis by Bethany McLean and Joe Nocera, Portfolio Hardcover (November 16, 2010), 400 pages.
  
• Griftopia: Bubble Machines, Vampire Squids, and the Long Con That Is Breaking America by Matt Taibbi, Spiegel & Grau (November 2, 2010), 202 pages.
  
• The Big Short: Inside the Doomsday Machine by Michael Lewis, W. W. Norton & Company; (March 15, 2010), 266 pages.
  
• Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System—and Themselves by Andrew Ross Sorkin, Viking Adult (October 20, 2009), 624 pages.
  
• Inside Job, Directed by Charles Ferguson, Sony Pictures Classics (2010)
  The Warning: Frontline PBS (http://www.pbs.org/wgbh/pages/frontline/warning/view/)
  
• Inside the Meltdown: Frontline PBS (http://www.pbs.org/wgbh/pages/frontline/meltdown/view/)
  
• Breaking the Bank: Frontline PBS (http://www.pbs.org/wgbh/pages/frontline/breakingthebank/view/)
  
• The Financial Crisis Inquiry Report, Financial Crisis Inquiry Commission
  

During the heady and depressing days of September and October, 2008, I had the distinct feeling that we were living through something historic. The scope and depth of the crisis that we faced was unprecedented. Now that more than a couple of years have passed, it is clear that the 2008-2009 recession was the most serious economic calamity that the country had faced since the Great Depression in the 1930s. It is also fairly clear that the only thing that kept it from being even worse was the aggressive response from the government and the Federal Reserve. This fact carries with it more than a little irony, since the collective steps taken by the government: TARP, the stimulus, the auto company bailouts, and the Fed pumping billions of dollars into the economy are not particularly popular. The reason for this is easy to understand psychologically. These steps were successful precisely because of what did not happen. On the other hand, what did happen was (and is) clearly perceptible and widely discussed. First, many of the very institutions that were largely responsible for the crisis received enormous amounts of cash and extremely generous terms of credit from the Fed. It is not difficult to understand why people would be infuriated by this. It is as if a bank-robber were patted on the head and asked if he would like more money before he made his getaway. Neil Barofsky, the special inspector general for the Troubled Asset Relief Program, recently wrote that TARP was largely a disappointment because of its failure to successfully address the massive foreclosure problem.

In the final analysis, it has been Treasury’s broken promises that have turned TARP—which was instrumental in saving the financial system at a relatively modest cost to taxpayers—into a program commonly viewed as little more than a giveaway to Wall Street executives.

It wasn’t meant to be that. Indeed, Treasury’s mismanagement of TARP and its disregard for TARP’s Main Street goals—whether born of incompetence, timidity in the face of a crisis or a mindset too closely aligned with the banks it was supposed to rein in—may have so damaged the credibility of the government as a whole that future policy makers may be politically unable to take the necessary steps to save the system the next time a crisis arises. This avoidable political reality might just be TARP’s most lasting, and unfortunate, legacy.

Second, the stimulus and auto bailouts contributed to massive budget deficits—the largest the country has seen since WWII. Third, after spending all of this money, the unemployment rate—the most relevant measure of economic health to average people—has remained stubbornly high.
Given the massive and historic nature of the crisis, it is not surprising that a lot of people have attempted to explain what really happened. Books have been written, films have been made, and the government has issued an official report. I have read several books, watched several documentaries, skimmed the official government report, and read countless news accounts and I now think that I have a fairly good understanding of just what happened.

The "what" of the 2008 crisis is fairly easy to understand. It was a classical negative feedback loop in which bad decisions spawned a series of other bad decisions that collectively resulted in a massive housing bubble. Michael Lewis describes this as a system of "bad incentives". Mortgage originators were incentivized to make loans regardless of the buyer's ability to pay, Wall Street was incentivized to buy these loans and bundle them into securities that they sold to an unsuspecting public, the rating agencies were incentivized to rate these securities AAA when many were worthless, and AIG was incentivized to sell scores of billions of dollars in credit default swaps as insurance on those securities. The result was that the financial system was nearly crippled when it suddenly found itself burdened by hundreds of billions of dollars of worthless assets and/or crushing liabilities and millions of home owners discovered almost overnight that they owed more on their houses than they were worth.

The more interesting and controversial issue concerns the "why". Everyone has an interest in knowing what caused this financial calamity so it can be avoided in the future. One of the most peculiar and perplexing aspects of this question is that how you answer this is greatly influenced by your political persuasion. The most vulgar expression of this appears as attempts by various groups to use the crisis as a partisan bludgeon. Democrats blame G.W. Bush despite the fact that the origins of the crisis go back into the Clinton administration, and Republicans blame Obama despite the fact that the crisis predated Obama's election.

Beyond these examples of partisan sloganeering there is a deeper issue of not political party, but political and economic ideology. It is at this level that conservatives are clearly at a disadvantage. Whatever else you want to say about the crisis, it was clearly a failure of the market. Through an uncountable series of free individual examples of buying and selling, we managed to nearly bring the world's economy to its knees. In many cases, these activities were not even in the best interest of the people who engaged in them. One of the essential characteristics of conservative dogma is that free markets are the best means to rationally and fairly create prosperous societies, and that any government regulation of those markets only interferes with the market's rational allocation of wealth. The experience of 2008 directly challenges this dogma. The market failed spectacularly. Government regulation failed only in its absence. Either the appropriate regulations did not exist (over-the-counter derivatives) or existing regulations were not enforced.