In This Review
After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead

By Alan S. Blinder

The Penguin Press HC, 2013, 496 pp.

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead BY ALAN S. BLINDER. Penguin Press, 2013, 476 pp. $29.95.

Alan Blinder is only the most recent in a series of prominent economists who have produced analytic accounts of the U.S. economic downturn. His crisp narrative lays out the policy options that were available at each stage of the crisis, and his analysis is infused with a deep understanding of macroeconomics. Overall, it is the best general volume on the subject that has been published to date.

Despite its many virtues, however, the book paints an overly optimistic portrait of the state of the U.S. economy. “More than four years after Lehman Brothers went under,” Blinder writes, “policy makers are still nursing a frail economy back to health.” But the U.S. economy is worse than “frail,” and there are few signs that it is being nursed “back to health.” Most economists claim at least one silver lining in the economic downturn: that it was not as bad as the Great Depression. Up until recently, I agreed; I even took to calling the episode “the Lesser Depression.” I now suspect that I was wrong. Compare the ongoing crisis to the Great Depression, and there is hardly anything “lesser” about it. The European economy today stands in a worse position compared to 2007 than it did in 1935 compared to 1929, when the Great Depression began. And it looks as if the U.S. economy, when all is said and done, will have faced certainly one lost decade, and perhaps even two.

The U.S. economy has enjoyed a recovery only in the sense that conditions have not gotten worse. Blinder notes that the unemployment rate jumped to ten percent at the height of the crisis and is now hovering around eight percent, nearly halfway back to economic health. But this assessment is misleading. In the middle of the last decade, the percentage of American adults who were employed was roughly 63 percent. That figure dropped to about 59 percent in 2009. It remains there today. From the perspective of employment, the U.S. economy is not recovering but flatlining.

Look at the GDP figures: in the 12 years between the beginning of the Great Depression and the United States’ entry into World War II, the U.S. economy saw its production drop by an amount equal to 180 percent of the output of one average pre-crisis year. If one assumes, as the Congressional Budget Office does, that U.S. production will return to its pre-2008 form by 2017, the economy will have suffered a shortfall equivalent to only 60 percent of one average pre-crisis year. But it is unlikely that the economic downturn will be over by 2017: no war or major innovation appears to be looming on the horizon that could propel the country into an economic boom the way World War II did at the end of the Great Depression. If the downturn drags on into a second lost decade, the United States will incur further losses equal to the output of a full average pre-crisis year, bringing the total cost of the crisis to 160 percent of an average pre-crisis year and nearly equal to that of the Great Depression.

Of course, the present downturn has caused far less human misery than the Great Depression did. But that is because of political factors, not economic ones. The great network of social insurance programs established by President Franklin Roosevelt’s New Deal, President Harry Truman’s Fair Deal, President John F. Kennedy’s New Frontier, and President Lyndon Johnson’s Great Society, and defended by President Bill Clinton, sharply limits the amount of poverty a downturn can cause.

And what of the future? Only ambitious political action of the kind that created those programs can insure the country against suffering an equal economic calamity down the line. Yet the U.S. political system is dysfunctional. Congress will not support the kind of financial regulation the country sorely needs. Blinder concludes his narrative with a number of smart forward-looking recommendations, but his book’s biggest weakness is its lack of a road map out of the present impasse that takes into account the political climate. Without a more dramatic set of actions, the United States is likely to suffer another major economic crisis in the years ahead.


Some will argue that I am assuming the pose of Dr. Gloom. They are likely to be wrong. For one, the U.S. bond market agrees with my assessment. Since 1975, the yield on 30-year Treasury bonds has averaged 2.2 percentage points higher than that of short-term Treasury bills. Given that the current 30-year Treasury bond yields 3.2 percent per year, the typical financial market participant anticipates that short-term Treasury bill rates will pay out interest at an average of barely more than one percent per year over the next generation. The Federal Reserve keeps the short-term Treasury bill rate at that low level only when the economy is depressed -- when capacity is slack, labor is idle, and the principal risk is deflation rather than inflation. Since World War II, whenever the yield on the short-term Treasury bill has been two percent or lower, the U.S. unemployment rate has averaged eight percent. That is the future the bond market crystal ball sees: a sluggish and depressed economy for perhaps the entire next generation.

Meanwhile, barring a wholesale revolution in the thinking (or personnel) of the U.S. Federal Reserve and the U.S. Congress, so-called activist policies, such as multitrillion-dollar asset purchases or sustained large-scale investments in infrastructure, are not going to be put in place to rescue the economy. Policymakers are too concerned about rising U.S. government debt. Their worries, of course, are misplaced right now, as Blinder well understands. He shares the consensus of reality-based economists that debt accumulation -- whether through the Federal Reserve’s buying government bonds or through the U.S. Treasury’s issuing them -- is not the U.S. economy’s most serious problem as long as interest rates remain low.

The deficit hawks seem to have forgotten the basic principle of macroeconomic management: that the government’s job is to ensure that there are sufficient quantities of liquid assets, safe assets, and financial savings vehicles. Over the past several years, this principle has gone out the window. A majority of the voting members of the Federal Open Market Committee, which oversees the Federal Reserve’s buying and selling of government bonds, believe that the Fed has already extended its aggressive expansionary policies beyond the bounds of prudence. Blinder rightly disagrees: “The Fed’s hawks seem more worried about the inflation we might get than about the high unemployment we still have. I’m rooting for the doves.”

Worse still is the attitude of the U.S. Congress. “America’s budget mess is starting to look Kafkaesque,” Blinder writes, “because the outline of a solution is so clear: we need modest fiscal stimulus today coupled with massive deficit reduction for the future.” Republicans must accept that tax rates will be higher a decade from now, he argues, and Democrats must accept lower government spending than is currently projected. A deficit-reduction package, perhaps in the mold of the Simpson-Bowles plan (a proposal by Erskine Bowles and Alan Simpson, co-chairs of the president’s deficit commission, that combines spending cuts and tax increases), should be adopted in the future, Blinder argues, but not yet. Blinder is preaching the right message, but he is preaching it to an audience of ravens and vultures. Congress is taking its cues from Steve Martin’s Saturday Night Live character Theodoric of York, Medieval Barber: no matter what the ailment, all the patient needs is another good bleeding. In this case, the tool of bloodletting is rigorous austerity, which only puts further downward pressure on employment and production.


As U.S. policymakers cling stubbornly to wrong-headed policies, what can economists do? In such an environment, they can no longer realistically expect to push policy toward an appropriate posture. So what else should occupy economists’ time? At the juncture in the Great Depression most similar to today’s point in the current crisis, John Maynard Keynes turned away from policy to attempt to reconstruct macroeconomic thought from the ground up. By writing The General Theory, Keynes intended to force economists to think differently when the next crisis struck. Up until 2009, it looked like Keynes had succeeded. But today, it is clear that his task was only half finished, if that. The same ritual incantations that were made during the 1930s -- summoning the “confidence fairy,” through the magic of austerity, to shower the blessings of prosperity on the economy -- are now recited repeatedly and ever more frantically. This is worrisome, to say the least.

Speaking at the London School of Economics in March, the economist Lawrence Summers called for the reconstruction of macroeconomic thought, on the one hand, and the reconstruction of the institutions and orientation of central banking, on the other. But no living economist is smart, bold, or arrogant enough to try to be Keynes, and Blinder wisely takes a more modest approach. He frames his recommendations for reform in ten commandments: three that are addressed to the government and seven that are addressed to financiers. The first set urges policymakers to remember that the cycle of profit, speculation, exuberance, crash, bankruptcy, panic, and depression has been a constant feature of industrial market economies since at least 1825; that self-regulation by financiers is a disaster; and that financiers should have very strong incentives not to walk up to the edge of defrauding the public. The second set of commandments exhorts financiers to remember that their shareholders are their real bosses, that managing and limiting risk are essential, that excessive borrowing is dangerous, that complex financial instruments are equally dangerous, that trading should be carried out using standardized securities in public markets, that the balance sheet is a picture of a firm’s position and not a toy, and, finally, that perverse compensation systems must be fixed.

It is clear that the U.S. government ought to obey Blinder’s first three commandments and strictly regulate finance. It should hold Wall Street liable for its past misrepresentations and omissions to encourage better behavior in the future. But Blinder does not emphasize enough just how difficult that task has proved to be and how little political will exists to face it. Some economists assume that this job will be easier for future generations because even people who are currently in their 20s will never forget the orgies of fraud that were committed in the housing, mortgage, securities, and derivatives markets. Others, meanwhile, think that the political will to rein in financial excess will only continue to wane. According to this camp, Wall Street finds it easy to buy influence on Capitol Hill. Although financial firms have a collective long-term interest in being regulated, financiers are too stupid to recognize this -- or they simply expect to make their pile and then say, “Après moi, le déluge.” If this argument is indeed correct, the United States is in awful trouble.

Sound regulation of Wall Street will depend on a different, less money-dominated form of politics -- like the kind that was generated by the more egalitarian income distribution of the post–World War II years. But how to get to such an income distribution today? After World War II, the United States made a successful commitment to mass education, which sharply increased the number of those competing for high-salary jobs and thus reduced their income edge over the working class. Such a renewed commitment to education, coupled with a severe strengthening of the progressivity of the U.S. tax system, could create the type of politics and Capitol Hill that would support the kind of financial regulation that 2008–9 revealed was desperately needed.

Blinder’s next seven commandments, addressed to financiers, are less useful than the first three. Blinder is right to identify perverse compensation systems as a major problem. They give financiers incentives to take large risks in the belief that they can make a killing and then get out before the crash. The truth is that there are three ways to make money in finance, and only one of them is simple. The first is to possess better information than other market participants and use that information to buy low and sell high: this is nearly impossible to do on a regular basis. The second is to match necessary risks with investors for whom it makes sense to bear extra risk: this is very difficult. The third, and simplest, is to match necessary risks with investors who do not understand what those risks really are. This is especially easy when information in the financial markets is scant -- when securities are complex, when trading is proprietary and secret, and when balance sheets do not accurately represent firms’ performance.

As long as perverse compensation systems for financial executives exist, the United States’ financial problems will remain nearly, if not completely, intractable. Reforming such systems would fix many, if not all, of these problems. In an ideal world, financial professionals would earn amounts similar to other professionals -- such as doctors, lawyers, architects, and engineers -- until near retirement, at which point they would be amply rewarded if their judgment had been superb and their clients had received good value. In a past generation, this was accomplished via their late-career ascension to lucrative partnerships at private investment banks. Today, shareholders of financial corporations could impose such a compensation system if they so wished. But they are not organ­ized, and they do not so wish. Financiers, therefore, have no pocketbook reasons to obey any of Blinder’s commandments, only their regard for the public interest.

Mindful that his prescriptions might not take hold and that another calamity could well befall the economy, Blinder concludes his book by suggesting how policymakers ought to act during the next crisis: they must focus on heading off risks before they materialize, communicate their policies clearly, make sure to distribute the pain fairly, and never promise that there will be less pain than there will be. (It is difficult to imagine a bigger disaster for the public’s understanding and the Obama administration’s credibility than then Treasury Secretary Timothy Geithner’s August 2010 New York Times op-ed, “Welcome to the Recovery” -- save, perhaps, for President Barack Obama’s premature sighting of “glimmers of hope.”)

Policymakers must impose distributions of pain that not only are fair but also are seen to be fair. Bank executives and directors who fail to properly oversee their firms’ investments should lose their jobs, their stock options, and their past years’ bonuses -- and if shareholders will not impose such penalties, the government needs to do so. Shareholders who voted for such executives and directors should lose their equity. And the president needs to speak to the people, explaining the crisis and the government’s response, over and over again, in language the average voter can grasp.


Despite the U.S. economy’s feeble recovery, it is difficult to evaluate the Obama administration’s handling of the fallout from the financial crisis. On the one hand, the president and his team made enormous errors -- believing that the recovery would take hold rapidly, that banker opposition to financial reform could be neutralized and overridden, and that the housing sector needed neither reorganization nor large-scale foreclosure relief, to list just three. On the other hand, it is important to remember that reacting to a crisis is a lot harder than it looks. Moreover, as economists in the Obama administration are quick to point out, Congress has placed extraordinary obstacles in Obama’s path. It is also worth nothing that even though the crisis originated in the United States, Europe is suffering more. In other words, it could have been much worse, as it is right now across the Atlantic. Still, it is undeniable that Obama’s management of the crisis has not produced a real recovery, that institutional rebuilding has stalled, and that the proper lessons of the financial crisis have not penetrated the United States’ money-dominated politics.

But this does not mean that policymakers and economists can give up. In the short run, little can be done except to take down the names of those policymakers and economists who have been predicting inflation and national bankruptcy from monetary and fiscal stimulus and growth from austerity -- and remind voters and journalists of who was right and who was wrong. In the medium term, policies will shift. By 1935, six years after the outbreak of the Great Depression, all the major economies had adopted programs along the lines of the New Deal, except for France, whose continued attachment to the gold standard served as a horrible warning. Should its coalition government survive and double down on its austerity policies, the United Kingdom may serve a similar role as a warning against prioritizing spending cuts over economic recovery when demand is missing -- a warning of the consequences of, as the British Depression-era economist Sir Ralph Hawtrey put it, “cry[ing], Fire, Fire, in Noah’s Flood.” The political moment to prioritize recovery and full employment may yet come, if those who understand can recognize and seize it.

In the long run, however, the task remains to educate shareholders that it is unwise to provide the traders and managers who supposedly work for them with fortunes based on short-term accounting, and to educate politicians that such compensation systems create risks too large to be acceptable. It ought to be possible to carry out that task. Someday. Maybe.

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  • J. BRADFORD DELONG is Professor of Economics at the University of California, Berkeley, a Research Associate at the National Bureau of Economic Research, and a Visiting Fellow at the Kauffman Foundation. Follow him on Twitter @delong.
  • More By J. Bradford DeLong