How a Great Power Falls Apart
Decline Is Invisible From the Inside
In July 2007, the U.S. economy looked fairly healthy. There had not been a recession in more than five years, and the unemployment rate was under five percent. Housing prices had been rising at an unsustainably rapid rate, but this was generally seen as a containable problem. Then, almost out of the blue, came what will probably turn out to be the longest and deepest U.S. recession since the Great Depression. As with the Depression, the causes and lessons of this crash will be studied for decades and spur new understandings of the interactions of government, private markets, and financial institutions. The works below constitute a first draft of the history of what happened and what it meant.
Everyone knows that the financial crisis stemmed from risky subprime-mortgage lending. But this book details exactly how the housing and financial markets veered wildly off track. James Barth begins by discussing how mortgage markets had traditionally worked and then explains the rise of subprime mortgages and how the financial pain reverberated through the financial sector. The culprits include greed, misguided regulation, overenthusiastic encouragement of homeownership, poor leverage and accounting practices, complicit ratings agencies, and runaway financial innovation.
"The Origins of the Financial Crisis." By Martin Neil Baily, Robert E. Litan, and Matthew S. Johnson. Initiative on Business and Public Policy at Brookings, Fixing Finance Series, Paper 3, November 2008.
This report focuses on the origins of the financial crisis: how the inflation of housing prices fed into the growth of the subprime market. The paper does an especially nice job explaining how the bubble was financed -- namely, through the issue of complex financial securities, many of which received AAA ratings and were held by banks. When the bubble burst, these financial securities lost value, spreading the crisis throughout the financial
sector and eventually the economy at large.
In Fed We Trust: Ben Bernanke's War on the Great Panic: How the Federal Reserve Became the Fourth Branch of Government. By David Wessel. Crown Business, 2009.
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As the financial crisis began in late 2007 and continued into 2008 and 2009, the major policy response did not come from President George W. Bush, President Barack Obama, or Congress, but from the unelected economists and bankers at the Federal Reserve. For starters, the Fed rapidly cut interest rates to near-zero. In the past, the Federal Reserve had made loans primarily to commercial banks with high-level collateral such as Treasury bills. But during this crisis, the Fed began lending to all sorts of entities -- investment banks, insurance companies, broker-dealers -- and accepting all kinds of collateral. Fed leaders have been involved at every critical policy juncture, including the failures of Bear Stearns and Lehman Brothers and the request to Congress for $700 billion in TARP (Troubled Asset Relief Program) funds to recapitalize banks. Ben Bernanke took over as Fed chairman in February 2006, heading to Washington from Princeton University, where he was a highly respected economist well-known for his work on the Great Depression. This readable book tells the story of an institution and its leader at a time when the Fed seemed like a fourth branch of government and Bernanke was determined to do whatever it took to abort a financial meltdown.
"The Long Climb: A Special Report on the World Economy." By Simon Cox. Economist, October 3, 2009.
In this special 28-page feature article in The Economist, Simon Cox lucidly portrays the aspects of the economic situation in late 2009: American consumers and banks paying off their debts; China's potential role in leading the world economy out of recession; the pluses and minuses of stimulus packages; the lasting lessons for the world of finance. His bottom line is that since economic recoveries after periods of financial turmoil tend to be slow, sluggish growth with high unemployment seems likely to persist for the next several years.
Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe. By Gillian Tett. Free Press, 2009.
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Gillian Tett begins this entertaining book by asking, "Were the bankers mad? Were they evil? Or were they simply grotesquely greedy?" The answer, of course, is more complex than any of the above. Tett explains how, in the 1990s, financiers at J.P. Morgan invented new financial instruments with names such as "credit default swaps" and "synthetic collateralized debt obligations." In their early incarnations, these tools seemed a bit arcane but benign, even reasonable. But as they were adopted elsewhere, they gradually assumed forms and risks that they were not designed to bear. This book takes you inside the world of high finance and provides a readable and interesting tour of the securities that financed the housing bubble and spread the destruction when the bubble burst.
"Causes of the Financial Crisis." Critical Review 21, nos. 2-3 (2009).
This special issue of Critical Review includes a dozen articles by prominent economists with differing beliefs and emphases. Together, they yield a helpful and important guide to serious debates over what happened and why. Joseph E. Stiglitz argues that the roots of the crisis lay in decisions made by banks facing misguided incentives and lackluster regulation. John B. Taylor, conversely, argues that the crisis was "caused, prolonged, and worsened by a series of government actions and interventions." Articles by Jeffrey Friedman, Viral Acharya and Matthew Richardson, and Amar Bhidé detail how the crisis evolved from a set of regulations and practices that were well adapted to old situations but not new ones. Peter Wallison argues that credit-default swaps were not to blame for the financial crisis, while Lawrence White asserts that the peculiar authority granted by the government to credit-ratings agencies like Standard and Poor's, Moody's, and Fitch was very much part of the problem.