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Causes of the Financial Crisis

By Matthew Yglesias on January 1, 2010 at 8:27 am

"Causes of the Financial Crisis"

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The news that Matt Cooper is going to go work for the Financial Crisis Inquiry Commission established by congress to be a kind of 9/11 Commission for the Panic of 2008 reminds me to say that I think debating what “caused” the recession has been one of the most overrated topics of 2009.

The big problem with this, I guess, is that the scope is just too undefined. If you want to make a claim like “the market didn’t cause the crisis, the government did!” then you can draw a plausible enough argument to that effect. After all, there are lots of regulations on the financial system, even in our era of deregulation. And if none of those regulations existed, financial institution business practices would look very different from how they looked in 2005-2008. And if financial institution business practices had looked very different, then we wouldn’t have had the Panic of 2008. Ergo, overregulation caused the crisis.

So you can get pointlessly wide-lens: If the whole structure of the banking system or the world economy were totally different, then things would have been different. But you can also get pointlessly narrow-lens. Whatever we do in the future, we can pretty sure that the exact same crisis isn’t going to recur.

I think the issues we really need to grapple with don’t have that much to do with understanding the “causes” of the crisis per se. For one thing, we urgently need to work out in advance a widely understood system of what do we do if a large financial institution fails. We need to consider what aspects of the policy environment led to such a low savings rate. We need to ask if a “brain drain” into the FIRE sector hurts economic performance. We need to ask if the search for macroeconomic stability actually makes things worse by creating tail risk. We ought to ask whether 2 percent inflation is so low that interest rates will regularly hit the zero bound during downturns. I don’t think you would want to say that the crisis occurred “because” we did any of these things wrong. But I think these are the big questions that were not being asked in 2007 that need to be addressed in 2010 and beyond.

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