Explaining the Financial Crisis: Why Do We Still Not Know What Happened?

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Associated Press

Five years after the Lehman Brothers bankruptcy kicked off the largest economic dislocation in the U.S. since the Great Depression, we are still debating what needs to be done to make the financial system safer. We are also still trying to figure out what exactly happened and who is to blame.

It’s not for a lack of trying. We now have more than 300 books on the financial crisis — and the housing bubble and lending crunch that preceded it — but as MIT economist Andrew Lo observes in a review of 21 of those books, “No single narrative emerges from this broad and often contradictory collection of interpretations.” We’re building history, even if we’re not building truth or a more financially stable world. That’s because, as humans, we need the stories just as much as we need the facts.

How can we still not have a clear explanation of the crisis five years later? To be fair, many accounts, including that of the Congress-created Financial Crisis Inquiry Commission, draw from the same set of story lines and cast of villains. A composite might go something like this: Risk-happy executives at big financial firms, enjoying the freedom of hands-off regulators and aiming to satisfy return-greedy institutional investors, drove the growth of ill-conceived mortgage securities, which were enabled by credit-ratings agencies abdicating the responsibility of good judgment and house-hungry Americans wooed by collapsed lending standards — a situation magnified many times over by the financial wizardry of an unregulated shadow-banking system.

It’s a mouthful.

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Yet plenty of accounts of the crisis tell a much more narrow or high-level story. Some make the case that a crisis could have been avoided entirely, if only a Clinton-era Congress hadn’t repealed the 1933 Glass-Steagall Act, which for most of the 20th century separated commercial from investment banking. Others go far beyond talk of individual bankers and home buyers, like economist (and new Indian central-bank head) Raghuram Rajan’s argument that the roots of the crisis lie in how the world economy and U.S. political system have become dependent on Americans buying things, like houses, with easy credit. While it’s possible to come up with a typical account of the crisis, there are many experts who would consider it cluttered or incomplete.

In his book review, Lo chides economists who think of their work in this department as scientific to think again. When it comes to complex events like the financial crisis, that conceit is wishful thinking. Even the economists can’t agree on a story line. One reason is that locking down cause and effect in the social world, where so much human action is situational, is mighty hard, especially when events are happening on a global scale. Plus, as sociologist Robert Merton once pointed out, social scientists, a product of the late 19th century, haven’t been on the job nearly as long as the natural scientists. Understanding planetary motion and chemical reactions took centuries of basic research. Along those lines, Lo argues that economists seeking to explain the financial crisis should forsake “super-narrative” and instead focus on establishing a consistent set of ground-level facts.

Another possible way to understand the crisis is to think less about what happened and more about the underlying social processes at play. For instance, explanations of the financial crisis are rife with the idea that, in all sorts of realms, people stopped holding one another accountable. Mortgage brokers didn’t vet borrowers, credit-rating agencies rubber-stamped junk-laden mortgage securities with AAA ratings, and federal regulators refused to establish transparency in the quickly growing yet murky market for over-the-counter derivatives. If a main reason to understand the crisis is to prevent another, then knowing when accountability broke down — and, just as important, when it didn’t — could go far in helping both industry and government build more crisis-proof social structures.

The problem with giving up the grand narrative for fact-finding is that we often prefer storytelling over truth. People want to know the story of the financial crisis. How did it start, who were the bad guys and good guys, and why did it play out the way it did? People naturally think in stories, and stories help us assign meaning to the world — a useful function when we’re talking about a time that was economically traumatic for many Americans.

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Stories are also a politically savvy way to establish one’s own version of the facts as the truth. The bevy of contradictory accounts of the crisis might be taken to indicate competing political agendas and worldviews just as much as confusion over what actually happened and why.

All of which is to say that while comprehensive and neatly packaged explanations of the financial crisis may serve important social-psychological and political needs, they don’t necessarily get us to a science-like understanding of what happened and how we might try to prevent a similar crisis in the future. As it turns out, 300 books on the financial crisis may not be enough.

Barbara Kiviat, a former TIME staff writer, is pursuing a Ph.D. in sociology and social policy at Harvard University.

5 comments
ChhajuramInduscharwak
ChhajuramInduscharwak

Political economy and transparency must go hand in hand. Another but not secondary is globalization when compromised then transparency bound to suffer.Clear meaning is that to avoid economic crises it is most imperative that world must unite further politically and it demands that sovereignty of nation States some how decreases and and responsibility of democratically U.N.O. is bound to be increases. There is no alternate except the above  and it is regretful to note that no single word is visible through out the bulk of books mentioned above.

mary.waterton
mary.waterton

We know exactly what caused the crisis of 2008. It can be traced back these two pieces of legislation:

[1] "Financial Services Modernization Act of 1999" (repealed Glass-Steagall) 

[2] "Commodity Futures Modernization Act of 2000" (outlawed the regulation of derivatives).

Repeal of Glass-Steagall allowed investment bankers (gamblers) and commercial bankers (savers) to intermingle the money types. So when the gamblers went broke, the Government had to bail out the gamblers to save your savings account per the FDIC clause of the Banking Act of 1933.

Derivatives are a form of insurance and thus are not regulated like the banking system or the stock market. This allowed for gambling on steroids. The derivatives were what triggered the chain reaction in 2008.

Frank-Dodd changed none of this, which is exactly what Wall Street wanted and precisely why we will have another systemic banking crisis within the decade. This time the national debt will double from about $20 TRILLION to $40 TRILLION almost overnight and there will be QUANTITATIVE EASING on a commensurate scale. Printing money robs from the poor and gives to the rich by means of inflation, so the outcome will be unimaginable poverty for the bottom 50% of America who won't be able to outrun the price inflation that monetary inflation always creates eventually.

JimCopeland
JimCopeland

For markets to work, there has to be concequences . Each player needs some skin in the game. Public funds are too easy a scapegoat. They encourage reckless behaviour.


humm64
humm64

The movie Inside Job which won an oscar for best documentary gives a pretty clear view of what happened, who is to blame.

It should be no surprise that politicians and their friends do not want the pubic to know what happened and who is to blame.