Observations on the Financial Crisis

For the five year anniversary of the 2008 financial crisis, Ed Lazear and I have released a paper titled “Observations on the Financial Crisis,” published through the Hoover Institution. It’s just over 25 pages and also has a fairly detailed timeline of events as an appendix.

Ed was chairman of President Bush’s Council of Economic Advisers when I was director of the National Economic Council.

Here are the 19 observation headlines. I urge you to read our supporting arguments, especially if you’re going to comment on or respond to them.  Each argument takes only about a page.

  1. “The recession that began in late 2007” conflates two distinct time frames.
  2. The financial panic began in September 2008. The financial crisis began long before, and first showed significant signs in August 2007.
  3. The shock and panic of September 2008 were triggered by a sequence of events, not just by the Lehman failure.
  4. Putting Fannie Mae and Freddie Mac into conservatorship likely averted larger shocks.
  5. The “deregulatory cause” hypothesis is flawed.
  6. The financial crisis was caused principally by unprecedented capital flows into the United States.
  7. Dominoes vs. popcorn
  8. TARP was a shift to a systemic solution from a case-by-case approach and was possible only when Congress accepted that inaction would lead to a catastrophic failure. Policy makers traded false negative errors for false positive errors.
  9. TARP is the most successful financial policy for which no member of Congress will admit having voted “aye.”
  10. Capital investment was indeed better policy than buying “toxic assets.”
  11. The financial crisis was largely resolved by the time President Obama took office in late January 2009. President Obama’s task was not to address the financial crisis, but instead to handle the ensuing financial cleanup, financial policy reforms, and the severe macroeconomic recession that resulted from the late-2008 financial crisis.
  12. The financial rescue continuity should not be surprising, since two of the three key players were unchanged.
  13. Some conservatives mistakenly assumed that Chapter 11 restructuring was a viable option for GM and Chrysler.
  14. President Bush’s decision to extend auto loans was in part influenced by the timing of the Presidential transition.
  15. While both were heavily involved in crisis management, Presidents Bush and Obama took different approaches to firm-level decisions.
  16. “The deepest recession since the Great Depression” does not mean the two are comparable in size.
  17. At best, the fiscal stimulus offset about a quarter of lost output in the past five years.
  18. The exceptionally slow recovery has magnified the economic losses of the 2008-09 recession.
  19. While the U.S. economy is growing, it is not returning quickly to its prior level.

If you find this paper interesting I have two other reading suggestions to offer.

  1. As a member of the Financial Crisis Inquiry Commission I wrote a dissent to the main report with Bill Thomas and Doug Holtz-Eakin.  Where the Hennessey/Lazear paper makes a collection of arguments on frequently discussed topics about the crisis, the Hennessey/Holtz-Eakin/Thomas dissent attempts to describe the causes of the 2008 crisis.
  2. I think this paper by Brookings’ Martin Baily and Doug Elliott, Telling the Narrative of the Financial Crisis, does the best job of framing the overall debate about what caused the 2008 crisis.  At a minimum it’s good to read their short blog post about the paper.  The Financial Crisis Inquiry Commission debate fit perfectly into these three narratives: the majority report tracked Narrative 2, Peter Wallison’s dissent tracked Narrative 1, and our dissent tracked Narrative 3 (where Baily and Elliott are).

Two sharp-eyed readers (who are better than I am at proofreading) found our typo.  On page 2 it should read “… steadily worsening to 830,000 jobs lost in March of 2009.”  The printed text says March of 2008.

6 responses

  1. Very good read.

    I think the promise of Obama scared the markets/investors/creditors and was the straw that broke the sub-prime camel’s back; and along with that went the domino effect of the financial institutions involved. When it turned out Obama really was elected and really believed all the populist rhetoric he was spouting to get elected; and, further, that he planned to act on it; the economy took a further hit.

    The TARP loan stopped the run on the Financial institutions and Bernanke’s printing presses were well timed such that he matched the printing of money to real deflation and then bought, with the ‘free’ money, securities in financial institutions at the bottom of the market. These moves lead to a much quicker than expected recovery with TARP being repaid with interest (mostly in the first year – fy2009) and the recession officially ending in June of 2009.

    The stubborn hiring problem and the diminished recovery were exacerbated by the Obama administrations machinations after the fact though. Obama took all of the TARP repayments, which were supposed to be a one time cost, and respent them … then he proceeded to use that exception spending as a new base-line resulting in deficits $1Trillion a year over the earlier trend-line.

    What should have been one time costs of TARP and the winding down of the war in Iraq was replaced with on-going domestic obligations such that the deficits did not return to the low hundred billion range as should have been expected. In the process — over 5 years — another $5Trillion+ dollars plus interest have been subtracted to our grandchildren’s yet to be earned wages.

    Throw in the heavy handed Central Planner anti-business regulatory expansions and you have all you need to know to describe why the jobs have gone down despite all the money that’s being charged to our future generations for non-value added government expansion in both size and scope.

    And all during this uber-Keynsian fiscal malfeasance of the past 5 years Ben Bernanke’s has been having to prop it all up with easing because outside investors aren’t too keen on buying our Treasuries at low enough interest rates and the US needs the cash-flow. Since the value of the dollar is also indivorcibly married to US government fiscal discipline (or lack there-of) Bernanke has to do this rather than using the gains to buy-back some of the money he printed and strengthen the dollar (Though probably this was unlikely and unnecessary over the period anyway, throwing it into the non-value-added bureaucratic furnace of the US government for on going programs was certainly not the optimal use of that gain).

    Hopefully he’s been spending only the gain from those securities he picked up at the bottom of the market in ’08; but when will Bernanke’s stash run out? I don’t know, but what I do know is that I’ll be a happy man when/if the adults are ever in charge again.

  2. I agree with most of your main points, which help clarify the causes of the recession, and justify TARP and other actions taken by the Bush administration and Federal Reserve to prevent a depression or worst recession. But I think you are overly influenced by the Republican talking points in your analysis of the slow growth during the recovery. You give only two explanations for the slow recovery, when there are many more. (this is complex and is being widely studied and you gave it a few paragraphs. You imply that the reason is the lack of pro-growth “republican-type” policies, which you list, but give no evidence that they would work to accelerate growth.

    You set up your thesis that pro-growth policies have been absent by an invalid comparison of the present recovery with past recoveries under much different conditions, i.e. apples of the past to lemons of the present. For example, the 5% growth after the 1980 and1981 recession affecting the early Reagan years will probably never be repeated. It occurred when the baby boomers were entering their more productive and higher spending years, hyper-inflation had just been eliminated by the combination of higher Fed interest rates and a double-dip recession. At that time there was nothing in the way of consumer spending and business investments, and the economy was geared up for a fast recovery.

    By contrast, during the slow recovery after the 2008-2009 recession the baby boomers were aging, retiring and spending much less, and the housing market (prices and new construction) were severely depressed by the deflation of the biggest housing price bubble in our history. And business practices enabled them to become quickly without hiring the unemployed workers whose jobs they had eliminated. Accelerating a long-term trend, the severe recession motivated corporations to succeed with fewer workers in the USA by further automating and streamlining operations, by off-shoring jobs to low-wage countries, and by selling more products overseas. They have been making strong profits without rehiring or replacing the jobs eliminated in the USA.

  3. Capital infusions may have been superior to buying toxic assets, but what about a third alternative — making the income from designated investments tax free for subsequent buyers. This would have gotten the assets off the financial institutions books, provided a way for the public at large to benefit through packaged investments and the costs of the tax deductions would have been accrued over time rather than as a lump sum expenditure which was used to set a new baseline for federal spending.

  4. Your tendency to favor THIS government intervention over THAT government intervention is indeed the true disease from which it appears we may never recover. The real problem is unconstitutional government interfering with business on a Micro level which inherently breeds corruption and crony capitalism; both devastating to overall economic prosperity for average Americans while extremely lucrative for non-principled businessmen. This distortion of the Free Market devastates opportunity. The resulting divide between the ‘have’s’ and ‘have-nots’ are fertile soil for the Marxist Ideology to flourish among the ill-educated youth. A return to our Founding principles of government only for the purpose of protecting individual liberties would be a painful transition initially and would rightly result in the incarceration of many a politician and his cronies. However, long term it would return this nation to the beacon of light it used to be. But alas, this is ever more unlikely to occur peacefully as the power invested in Washington D.C. is astronomical at this point. Subsequently, future administrations regardless of the D or R moniker are most likely to be a repeat of the ‘Bank Heist’ this administration has thus far been, albeit with different cronies sucking the $$ from the Peoples’ Treasury. All of this makes a ‘total’ collapse inevitable with the resulting grasp of ever more power over the People with the expressed intent of ‘protecting’ us from the chaos. With the populace succored with ever more benefits protecting them from the pain of economic collapse, coupled with the social indoctrination of frivolity over virtue, the transition to totalitarianism will be as quiet as an old man slipping into a warm bath.

    • I would like to see Keith Hennessey reply to this you. I’ll only say, I’m surprised that someone with apparent economic credentials would make a completely ideological and non-economic reply to economist Hennessey who usually present facts (even if I sometimes detect bias in their selection) to support his positions. Hennessey has more faith than I do in what Republicans claim to be pro-growth policies, but you explain the nation’s slow and largely jobless economy recovery on a purely ideological basis, leaning on your misinterpretation of the Constitution as a substitute for an economic argument. Since I see no substantial economic or financial points (except for the generality that government somehow distorted the Free Market, which seems to distort itself periodically), I’ll address the false claims about our Constitution and our history.

      You assert that the “Founding principles of government” were “ONLY for the purpose of protecting individual liberties.” If that were true why did the Federalist Papers and other statements by our founding fathers, including Washington, concentrate on empowering the national government and eliminating the weakness of the Article of Confederation, such as dependence on the state governments. Why were personal liberties and rights added as amendments after the Constitution was signed? The main body of the Constitution empowers the national (federal) government of the United States, the Union, to tax, borrow, fund a military commanded by the President, and, yes, regulate interstate and international commerce.

      And I think we have more real problems than the supposed “social indoctrination of frivolity over virtue”, especially since the President is a good family man, and serious about such things as the use of killer drones and raids on the leaders of al-Qaeda, trying to speed up the economic recovery, and implementing once Republican ideas of covering more middle class Americans with PRIVATE healthcare insurance.

  5. In re: point number 13, on Chrysler. First off, “insolvency” and “a liquidity crunch” are the same thing, so what you cite as a second premise for your argument is merely a recitation of something you already said. Next, your argument really amounts to “it was a false choice” to assume chapter 11 was a viable option, which sounds suspiciously like “shut up” and not much more.

    The issues surrounding the Chrysler bankruptcy particularly are deserving of a much more rigorous and extended analysis, and my instinct (having a bit of experience in financing companies about to enter bankruptcy and in bankruptcy) is that the issues in the financial markets themselves had a lot to do with the result.

    The poor management of Chrysler and GM became apparent just as so much else also was going wrong in the economy (American Express had been frantically warning of a collapse in household debt repayments for much of the preceding year, and so credit extended to auto buyers was abnormally being constricted) and because at the moment in time the auto industry problems became obvious, banks themselves were becoming fearful of a liquidity crunch munching their own balance sheet funding efforts. These factors meant that the banks interested usually most interested in risk underwriting, ie, those banks who normally would have jumped at the opportunity to refinance such large balance sheet issues as the Chrysler management group delivered to the market, were themselves in the early throes of crisis would have made the financing very difficult to undertake.

    I don’t know the real issues, I certainly acknowledge, but this brief argument you make is not persuasive and I look forward to reading a more extensive treatment that draws in greater part upon people with market experience.


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