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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