Last weekend my son said he was binge watching movies about the 2008 financial crisis such as The Big Short. Despite this movie watching, he seemed to be struggling with the government’s proposed fixes for the crisis. I think he wants to believe that the government was trying to do the right thing but his gut is telling him something else. It has been eight years and our gut says we still have “too big to fail” banks and a derivative market with unknown financial risks. It looks like we did not fix anything but chose to kick the can down the road. The traditional approach to a financial crisis is to separate the good assets into a good bank and the bad assets into a bad bank. The good bank is smaller and less risky. The shareholders take the financial hit under this approach. Instead of this approach, our government chose policies very similar to those that led to Japan’s Lost Decade.
Like most economic problems, Japan’s lost decade was largely caused by speculation during its boom cycle. Record low interest rates fueled stock market and real estate speculation that sent valuations soaring throughout the 1980s. In fact, property and public company valuations more than tripled to the point where a small area in Tokyo was worth more than the entire State of California.
When the Finance Ministry realized that the bubble was unsustainable, it raised interest rates to try and stem the speculation. The moved quickly led to a stock market crash and debt crisis, as many debts fueled by the rampant speculation turned out bad. Finally, the issues manifested themselves in a banking crisis that led to consolidation and several government bailouts.
Sensing my son’s struggles I offered three resources that should provide him with additional insight into the crisis.
Unlike the typical explanation that corporate greed caused the crisis, the majority opinion said:
In our inquiry, we found dramatic breakdowns of corporate governance, profound lapses in regulatory oversight, and near fatal flaws in our financial system.
There were two dissenting opinions.
- The first dissenting opinion focused on a worldwide credit and housing bubble that was largely composed of nontraditional mortgages and supported by questionable credit ratings.
- The second dissenting opinion focused on government housing policy and is best summarized with this statement.
As a result of these policies, by the middle of 2007, there were approximately 27 million subprime and Alt-A mortgages in the U.S. financial system —half of all mortgages outstanding— with an aggregate value of over $4.5 trillion.
Senator Warren’s Letter About the Unindicted
In 2016 a part of the Financial Crisis Inquiry report was declassified that indicated that nine people were referred to the Judicial Department for possible indictment. According to Senator Warren these people were “former Fannie Mae CEO Daniel Mudd, former Fannie Mae CFO Stephen Swad, former Citigroup CEO Chuck Prince, former Citigroup Board of Directors Executive Committee Chair Robert Rubin, former Citigroup CFO Gary Crittenden, former AIG CEO Martin Sullivan, AIG CFO Stephen Bensinger, former Merrill Lynch CEO Stanley O’Neal, and former Merrill Lynch CFO Jeffrey Edwards-may have violated securities or other laws. Mr. Prince and Mr. Rubin were each cited in two referrals.” If President Obama was correct in describing the 2008 financial crisis as “the worst economic downturn since the Great Depression” then someone should have been indicted. By comparison, the 1980s S&L crisis resulted in 839 convictions.