Why Wall Street Collapsed
Searching for the roots of the 2008 financial crisis.


At long last, the ten-member Financial Crisis Inquiry Commission (FCIC) has issued its gargantuan report on the credit meltdown that pulverized Wall Street and triggered the worst U.S. economic slump since World War II. Its official conclusions reflect the opinions of the six Democratic commission members: Phil Angelides (the chairman), Brooksley Born, Byron Georgiou, Bob Graham, Heather Murren, and John Thompson. The four Republican members released two dissenting statements: one by Keith Hennessey, Douglas Holtz-Eakin, and Bill Thomas (the vice chairman), the other by Peter Wallison.

In ascribing blame for the crisis, the majority report points to “the captains of finance and the public stewards of our financial system,” in particular the Federal Reserve. Specifically, it rebukes the Fed for failing to establish “prudent mortgage-lending standards” that could have curbed the proliferation of risky loans, noting that the Fed “was the one entity empowered to do so.” The report argues that deregulation “had stripped away key safeguards, which could have helped avoid catastrophe,” but it affirms that regulatory authorities still had “ample power” at their disposal — power that went unexercised.

Wall Street comes in for a lashing (“dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis”), as do the credit raters (“This crisis could not have happened without the rating agencies”). The six Democrats also take swipes at “predatory lending” and inadequate oversight of the derivative market, singling out the 2000 Commodity Futures Modernization Act — which limited federal regulation of most over-the-counter derivatives — as “a key turning point in the march toward the financial crisis.”

All told, they depict the meltdown as a wholly preventable consequence of regulatory mistakes and corporate irresponsibility. While there is obviously some truth to that — every boom-bust cycle is marked by government blunders and reckless behavior — the FCIC majority narrative either neglects or minimizes critical parts of the story, making it woefully incomplete and more than a bit misleading.

Hennessey, Holtz-Eakin, and Thomas put the U.S. housing crash in its proper international perspective. During the late 1990s, developing countries such as China began accumulating massive current-account surpluses. This “global saving glut” (as Fed chairman Ben Bernanke famously described it) unleashed a flood of cheap capital into the high-consuming West that — combined with increased risk tolerance — helped generate credit bubbles, which in turn spawned housing bubbles.

America was hardly the only rich country to experience a major property boom. Real-estate prices also skyrocketed — and collapsed — in Britain, Ireland, Spain, Iceland, and elsewhere. Major financial companies with diverse investment portfolios failed all across Europe. Today, Britain is implementing a tough fiscal-austerity program; Ireland has been forced to accept a gigantic multilateral bailout; the Spanish unemployment rate is a mind-boggling 20 percent; and Iceland has become a byword for economic cataclysm.

Whereas many conservatives — most prominently, Stanford economist John Taylor — have fingered excessively loose monetary policy as the chief source of the U.S. bubble, Hennessey et al. contend that the underlying roots were actually “global capital flows and risk repricing.” In their estimation, monetary laxity “may have been an amplifying factor, but it did not by itself cause the credit bubble, nor was it essential to causing the crisis.”