Ten years ago this month, a recession began in the U.S. that would metastasize into a full-fledged financial crisis. A decade is plenty of time to reflect on what we have learned, what we have fixed, and what remains to be done. High on the agenda should be the utter unpreparedness for what came along.
The memoirs of key decision-makers convey sincere intentions and in some cases, very adroit maneuvering. But common to them all are apologies that today strike one as rather lame.
“I was surprised by the sudden crisis,” wrote George W. Bush, “My focus had been kitchen-table economic issues like jobs and inflation. I assumed any major credit troubles would have been flagged by the regulators or rating agencies. … We were blindsided by a financial crisis that had been more than a decade in the making.”
Ben Bernanke, chairman of the Fed wrote, “Clearly, many of us at the Fed, including me, underestimated the extent of the housing bubble and the risks it posed.” He cited psychological factors rather than low interest rates, a “tidal wave of foreign money,” and complacency among decision-makers.
Timothy Geithner said that, “failures of foresight were primarily failures of imagination … our visions of darkness still weren’t dark enough.”
And Henry Paulson explained that “we believed the problem was largely confined to subprime loans. … (Then) the problems were coming far more quickly.”
Surprise, underestimation, poor imagination, and disbelief in an adverse outcome are hallmarks of the onset of a financial crisis.
My studies of the 17 major financial crises since the founding of the Republic reveal that over-optimism is an important driver of the bubbles that eventually become busts. As the legendary investor, Sir John Templeton, once said, “The four most dangerous words in investing are ‘This time is different.’” Such was the mindset that real estate prices could only rise (2008), dot-com companies would forever grow and be profitable (2001), or that the Russian government would never default (1998).
These days, the blogosphere chatters about a coming crash and financial crisis, for the obvious reason that conditions feel bubble-ish. We are in the late stage of the third longest economic expansion and second-longest bull market in U.S. history. Stock prices are high: The cyclically-adjusted price-earnings ratio is at the third-highest since 1880. Consumer confidence is buoyant. The personal saving rate, 3.1 percent, is near the all-time low. According to the Fed, financial conditions are looser than average. House prices have broken above their peak at the last housing bubble. A Saudi prince paid $450 million for a painting. And nearly every day, Bitcoin sets record prices.
To be sure, regulatory reforms since 2008 have produced more strongly capitalized banks, tests of resilience to shocks, more inter-agency coordination, and some consumer protections. But like the generals who are prepared to fight the last war, these reforms don’t persuade me that we’ll be ready for the next crisis.
History shows that crises arise unexpectedly from corners of the economy that fell beyond the conventional radar screen — in such corners, regulations are light or nonexistent, information is scanty, players are relatively unknown, and flows of capital in and out are particularly hot. Human ingenuity will always create such corners of the economy, either to serve new needs or to arbitrage around regulations. To eliminate every scintilla of systemic risk in the financial sector would be extraordinarily costly and would breed an intolerable regime of surveillance.
Yet I believe that there is one thing that the president and other leaders could do that would help to mitigate the risk of a financial crisis: reinforce a national culture of prudence — this includes the virtues of earning your money before you spend it; saving for a rainy day; investing wisely; honoring your debts; using resources carefully; respecting the property rights of others; and providing for the welfare of family and community. For the president and leaders of Congress to say all of this would evoke gales of laughter in the wake of recent action. Yet the bully pulpit of leadership can set a powerful tone.
At the outset of this tenth anniversary of the Global Financial Crisis, it is well worth remembering that we require not only vigilance from our leaders, but also the ability to articulate enduring values that will assure the sustainability of our society. We have had a culture of prudence in America before: “Use it up, wear it out, make it do, or do without” was the simple rhyme of the 1930s upon which America built an episode of extraordinary growth to the 1970s.
A culture of prudence is a culture of resilience. Prudence and resilience can trump surprise. Would that the president set this tone.