The Financial Crisis: What We (Still) Haven’t Learned

It’s over a year now since the 2008 financial crisis spread havoc throughout the global economy. Dozens of books and articles have appeared to explain what went wrong. They identify culprits ranging from Wall Street financiers overleveraging assets, to ACORN lobbying policy-makers to lower mortgage standards, to politicians closely connected to government-sponsored enterprises such as Freddie Mac and Fannie Mae failing to exercise oversight of those agencies.

As time passes, armies of doctoral students will explore every nook and cranny of the 2008 meltdown. But if most governments’ policy responses to the crisis are any guide, it’s apparent that many lessons from the financial crisis are being ignored or escaping most policy-makers’ attention. Here are five of them.

Perhaps the most prominent unlearned lesson is the danger of moral hazard. The message conveyed to business by many governments’ reactions to the financial crisis is this: if you are big enough (or enjoy extensive connections with influential politicians) and behave irresponsibly, you may reasonably expect that governments will shield you from the consequences of your actions. What other message could businesses such as AIG, Citigroup, Royal Bank of Scotland, Lloyds, and Bank of America have possibly received from all the bailouts and virtual nationalizations?

A second unlearned lesson is that once you allow governments to increase their involvement in the economy to address a crisis, it is extremely difficult to wind that involvement back. Indeed, the exact opposite usually occurs.

Who today remembers the stimulus and bailout packages so heatedly debated in late-2008? They pale next to the fiscal excesses of governments in America and Britain throughout 2009. Recessions and subsequent government interventions create an atmosphere in which the hitherto implausible – such as trillion-dollar, 1900 pages-long healthcare legislation in an era of record deficits – becomes thinkable. Likewise the Bush Administration’s bailout of Chrysler and GM morphed into the Obama Administration’s virtual appropriation of the same two companies.

Third, we seem unwilling to accept that government policies initially presented to us as the only thing standing between stability and economic Armageddon invariably have unforeseen (or sometimes very predictable) negative consequences that are not easily resolved.

Federal Deposit Insurance Corporation Chairman Sheila Bair recently claimed, for example, that the American government’s decision to purchase capital in failing banks was, in retrospect, a mistake. Not only has government semi-ownership further complicated the moral hazard problem, but it has created dilemmas that flow directly from the fact of government intervention. “Do we contain the bonuses and the compensation,” Bair asked, “because they are partially taxpayer owned, which might make things worse because they can’t bring in new and better management, which in some cases might be necessary?”

Fourth, there is the knowledge predicament. Today there is widespread acknowledgement that the 2008 financial crisis owed much to the Federal Reserve keeping interest rates too low for too long. Yet we persist in imagining that a group of people – the Fed’s seven governors – can somehow manage the credit and monetary environment of a $14.4 trillion economy (2008) in pursuit of often mutually exclusive goals: stable prices, optimal employment, and moderate long-term interest rates.

Fifth, there is reluctance to acknowledge how much the financial crisis reflects the breakdown of concepts of fiduciary responsibility: i.e., the moral and legal responsibility that someone acquires when entrusted with another person’s resources.

Many CEOs have been rightly pilloried for their failures. But what, for example, of those boards of directors who presided over fiascos such as Lehman Brothers, Fannie Mae, Freddie Mac, and the 147 American banks that failed between January 2008 and November 2009?

Why were board directors not asking questions about a bank’s heavy reliance for its profits upon the alchemy of mortgage-based securities and other financial products that no-one apparently could understand? Why did they not query reports advising that particular investment models could mathematically fail only once in a million years? Why did boards only take action to replace fund managers when companies were teetering on bankruptcy? Why did some directors imagine that a firm’s generation of quarterly profits was sufficient indication that they were fulfilling their fiduciary responsibilities?

Of course, it’s usually counterproductive for directors to immerse themselves in the micro-details of a firm’s operations. But it is part of their fiduciary obligation to investors to question company employees and take action when the answers are not forthcoming or unsatisfactory. Indeed it’s more than a fiduciary responsibility: it’s the moral obligation of anyone placed in a position of stewardship of others’ resources.

One measure of a society’s inner strength is its willingness to learn from mistakes and alter behavior appropriately. Sadly, in the case of America and most Western countries, the 2008 financial crisis’ long-term significance may be its illustration of how unwilling to learn we seem to be.

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  • cpageinkeller

    Another great article from the pen of Dr. Gregg of the Acton Institute. That concludes with the statement: “One measure of a society’s inner strength is its willingness to learn from mistakes and alter behavior appropriately. Sadly, in the case of America and most Western countries, the 2008 financial crisis’ long-term significance may be its illustration of how unwilling to learn we seem to be.”

    I think that “ordinary Americans” have learned. Most are behaving quite rationally in our current economic setting: personal savings are up, personal spending is down, and small businesses while struggling to stay afloat are waiting to see what happens.

    Sadly however, the messages of the recession and its causes are lost on our government and large financial institutions. Government is proposing more of the same things that got us into trouble in the first place, and the big boys of finance feel “bullet proof” because of government actions.

    Equally devastating is the fact that this recession is superimposed on record levels of personal and government debt. In this setting, the very rich are quantitatively better off, the very poor are largely supported by government programs, and the middle class bears the brunt of debt, a cheap dollar, increased taxation, and uncertainty. I think the overall result will be the the destruction of the middle class in America.

    Furthermore, I am convinced that the ideologues in the Federal Government are not necessarily opposed to this scenario. Both their pronouncements and actions support chaos, grow government at the expense of the private sector, increase spending, and suggest that unbearable taxation “by a thousand cuts” is at hand. and are counterproductive.

    In essence, we are seeing the mistakes of the Hoover and Roosevelt administrations on steroids. Like the 30′s I expect a double dip or “W” shaped recession.

  • elkabrikir

    I reject the premise of this article that we have failed to learn the lessons….

    Every power broker has done quite the opposite. Indeed they have learned that corruption, bribery, theft, etc….DO pay, and pay QUITE well!

    cpageinkeller has it right: The socialist/facisit appartchik prosper and thrive on man-made social and financial chaos. They, OUR SAVIORS will see us through, however, straight to our nameless grave.

  • kent4jmj

    The article fails to cite Austrian school economics versus the Keynesian model we currently use.

    It also fails to credit the tremendous work and energy of one lone senator from Texas who has studied economics and government involvement for many years. Who has been predicting our present ills for a long time and who probably has the best solutions as well.

    Constitutionally limited Government, a properly functioning court system, Free Markets (not the managed “free” markets we have now) and yes a gold standard would go a long way.

    The article is OK for as far as it goes but I’m not impressed. Others have already covered this a long time ago and did a better job.

    mises.org Go take a look for yourself.

  • kent4jmj

    Excuse me for not commending Dr. Greggs most powerful and what I believe its most insightful analysis.

    ” Sadly, in the case of America and most Western countries, the 2008 financial crisis’ long-term significance may be its illustration of how unwilling to learn we seem to be.

  • cpageinkeller

    kent4jmj you said, “work and energy of one lone senator from Texas”

    I believe you are talking about Dr. Ron Paul, Representative from the 14th Congressional District of Texas. Ron Paul is right on many issues, and perhaps the leading Constitutional Scholar in the House.

    Here is the latest on his amendment to “Audit the Fed.”
    http://www.texasinsider.org/?p=18731

  • kent4jmj

    Thomas Woods probably best expresses Austrian School solutions and incorporates a Catholic perspective not found anywhere else.

    I am hoping to read, The Church and the Market: A Catholic Defense of the Free Economy (Studies in Ethics and Economics) sometime soon.

  • kent4jmj

    cpage
    Yes I have a very high regard for Dr. Paul.
    As far as his amendment goes the last I heard it had been so changed that it is doubtful that Dr. Paul will be able to vote for it.

    followed your link. nice to see Paul’s influence gaining even to the point that language from his ‘audit the fed’ is entering into new legislation.

    We missed a tremendous opportunity this last election cycle. I guess the man that was of no consequence and therefor unelectable has more to him than many thought.

  • catholic mom

    “Do we contain the bonuses and the compensation,” Bair asked, “because they are partially taxpayer owned, which might make things worse because they can’t bring in new and better management, which in some cases might be necessary?”

    I think Ms. Bair and others are wrong on this concern over compensation caps and I am concerned that it reflects an unwarranted sympathy for corporate robbers.

    First of all the collapse of financial institutions has left many execs out of a job. Secondly the kind of salaries they had been earning are so far out of line with their worth that reducing the salaries opens up opportunities to attract more responsible and ethical CEOs. I say someone that won’t work for $1 mil/year and stock options frozen for 10 yrs isn’t the kind of CEO we want running taxpayer semi-owned institutions anyway.

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