Shocking News: The Global Financial Crisis Was Avoidable

It's not really shocking news, but in the spirit of the Onion this headline from today's New York Times  could elicit a chuckle: "Financial Crisis Was Avoidable, Inquiry Finds." (Shocking! Haha!)

As I noted in an earlier post, the now-Oscar-nominated film Inside Job doles out plenty of blame to people who caused the crisis (primarily Wall Street bankers and regulators). Likewise, a host of books reviewed on this blog explain the many things that people could have done differently to avoid the crisis. 

But today's story is news because the Financial Crisis Inquiry Commission, a government study group set up by President Obama and Congress, is set to issue its report tomorrow morning. And the theme of this 576-page report, according to Sewell Chan of the Times, is that real human beings are to blame. According to Chan, the report states that 

the crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire. . . . The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand and manage evolving risks within a system essential to the well-being of the American public. Theirs was a big miss, not a stumble.

It's highly likely that the chair of the commission leaked a copy of the report's conclusions in advance to build interest in tomorrow's press conference announcing the release. 

But there will be some Republican complaints about this report, because the report was approved along party lines. The six Democrats on the panel voted to approve it, but the four Republicans rejected it.

We now have two main interpretations of the crisis: the canonical Democratic view, best expressed in Inside Job, that blames alleged Wall Street greed and an alleged lack of regulation; and the dissenting Republican view, which blames Fannie Mae and Freddie Mac, the two Federal government-supported (and now government-owned) mortgage guarantors, for allegedly pushing poorer, sub-prime borrowers to purchase to take on risky mortgages. 

In the Republican view, individual borrowers demanded cheap credit and caused the crisis. We can call this the demand-side explanation.

In the Democratic view, it was the flood of global money pouring into Wall Street that created an excess supply of capital looking for a return on investment. Wall Street firms were dying to make huge money for themselves and their clients, so they pushed subprime lending. We can call this the supply-side explanation.

Who's right? As I'll explain in a later post, probably both parties. As I tell students, whenever you are presented with Option A and Option B, always choose Option C!