Chairman Phil Angelides and the Democratic majority on the Financial Crisis Inquiry Commission have released their report, a textbook-worthy example of the “Evil Man School of Economics.” Something went wrong, and a villain must be identified. This is tediously familiar territory for those who have followed the political establishment’s years-long attempt to evade responsibility for the crisis of which it was a cause.
“We conclude this crisis was avoidable,” they write. “The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire.” That much is hardly objectionable. But which human actions? On that question, the commission’s report is both implausible and nakedly political: The Evil Men are greedy corporate executives and Wall Street moneymen, and the crisis might have been averted if only they had been endowed with sufficient moral fiber — or had an appropriately mindful policeman appointed over them, which is the real point of the Angelides report. Which is to say, the Democrats have produced an analysis that relies upon and reinforces the mythology of the Left, producing a document that may as well have been written by Rolling Stone’s Matt “Vampire Squid” Taibbi, minus the literary flair.
Yes, this crisis was avoidable. To avoid it, we would have had to do a number of things differently. The first is to alert the authorities, beginning in the 1930s, that federal policies designed to encourage homeownership — well-intentioned though they have been — would create, and today continue to sustain, a set of economic incentives driving vast amounts of capital from around the world into the U.S. residential real-estate market. From the Federal Housing Administration to Fannie Mae and Freddie Mac to the mortgage-interest deduction, U.S. government policies distorted the market, creating a massive misallocation of capital under the naïve theory that housing prices only move in one direction: up.
The second action would be to prevent the dot-com bubble of the 1990s, of which the housing-market meltdown was both an echo and a consequence. Like the real-estate bubble, the dot-com bubble was cheered on by the American government, the American consumer, and the American banker, because nearly everybody likes appreciating asset prices and the illusion of wealth that accompanies them. When the dot-com bubble burst, Washington responded the way Washington always responds: by slashing interest rates, hoping that a sluice of cheap money and easy credit sloshing through the economy would stimulate productive economic activity, or the illusion of productive economic activity, sufficient to disguise the damage done by the bubble. Having been burned by unprofitable start-ups at home and disappointing emerging-market investments abroad, a great many Americans decided to invest that easy money in houses. Washington was keeping interest rates down and encouraging the loosening of mortgage-lending standards; at the same time, Washington’s creatures, Fannie Mae and Freddie Mac, helped give the mortgage market enough liquidity to alarm Noah. They were helped mightily in that endeavor by the rise of massive savings in China and elsewhere in the developing world, all of which went looking for somewhere to invest: Where better than the American mortgage market, where a great many of the underlying loans were insured by the government or its proxies?
Third, we would need to convince a great many Americans not to take out mortgages they could not afford should their houses fail to appreciate, and convince a great many financial managers not to make bad investments large enough to bring down their firms.
Mr. Angelides, formerly the treasurer of California, should know something about man-made financial disasters. And the truth is that Goldman Sachs did not cause this crisis, and neither did Barney Frank. Bad investments, economics, and well-meaning government policies caused it. There were, and are, bad actors in this story. But the main problems have been the natural limitations on human knowledge, including the knowledge of government officials and the managers of large financial institutions.
The dot-com bubble actually destroyed more wealth than did the decline in housing prices; the housing meltdown became a crisis because the related securities losses were concentrated in a small number of firms, and because those firms were dramatically over-leveraged. If there is a public-policy proposal to be extracted from this mess, it is that in a world of “too big to fail” banks — and, like it or not, that is the world in which we live — large financial institutions should be subject to tighter leverage controls, with higher standards for capital reserves and liquidity. That dry, technical reform would solve most of the problems that we might hope to solve with new financial regulation, but it would not provide any emotional satisfaction to those who wish to use this crisis to rail against executive bonuses, which had almost nothing to do with the problem, or to those who wish to sermonize about the alleged moral failings of capitalism. Still less would it offer any political opportunity to former real-estate developer Phil Angelides and his Wall Street–backed Democratic colleagues, who wish to use the crisis as an opportunity to expand the size and scope of the managerial state that did so much to create it.