The Busts Keep Getting Bigger: Why?

Was the 2008-2009 financial crisis a historical anomaly? Is it empirically accurate to categorize the crisis as a black swan? Or was this financial crisis simply the latest event in what has become a reoccurring, and increasingly more harmful, pattern of "engineered" economic shocks? If so, what are the social and political forces driving these harmful economic shocks? In this month's New York Review of Books, Paul Krugman and Robin Wells have a excellent review of new research by Jeff Madrick that sheds light on these questions. 

PRINCETON: Suppose we describe the following situation: major US financial institutions have badly overreached. They created and sold new financial instruments without understanding the risk. They poured money into dubious loans in pursuit of short-term profits, dismissing clear warnings that the borrowers might not be able to repay those loans. When things went bad, they turned to the government for help, relying on emergency aid and federal guarantees—thereby putting large amounts of taxpayer money at risk—in order to get by. And then, once the crisis was past, they went right back to denouncing big government, and resumed the very practices that created the crisis.

What year are we talking about?

We could, of course, be talking about 2008–2009, when Citigroup, Bank of America, and other institutions teetered on the brink of collapse, and were saved only by huge infusions of taxpayer cash. The bankers have repaid that support by declaring piously that it’s time to stop “banker-bashing,” and complaining that President Obama’s (very) occasional mentions of Wall Street’s role in the crisis are hurting their feelings.

But we could also be talking about 1991, when the consequences of vast, loan-financed overbuilding of commercial real estate in the 1980s came home to roost, helping to cause the collapse of the junk-bond market and putting many banks—Citibank, in particular—at risk. Only the fact that bank deposits were federally insured averted a major crisis. Or we could be talking about 1982–1983, when reckless lending to Latin America ended in a severe debt crisis that put major banks such as, well, Citibank at risk, and only huge official lending to Mexico, Brazil, and other debtors held an even deeper crisis at bay. Or we could be talking about the near crisis caused by the bankruptcy of Penn Central in 1970, which put its lead banker, First National City—later renamed Citibank—on the edge; only emergency lending from the Federal Reserve averted disaster.

You get the picture. The great financial crisis of 2008–2009, whose consequences still blight our economy, is sometimes portrayed as a “black swan” or a “100-year flood”—that is, as an extraordinary event that nobody could have predicted. But it was, in fact, just the most recent installment in a recurrent pattern of financial overreach, taxpayer bailout, and subsequent Wall Street ingratitude. And all indications are that the pattern is set to continue.

Jeff Madrick’s Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present is an attempt to chronicle the emergence and persistence of this pattern. It’s not an analytical work, which, as we’ll explain later, sometimes makes the book frustrating reading. Instead, it’s a series of vignettes—and these vignettes are both fascinating and, taken as a group, deeply disturbing. For they suggest not just that we’re seeing a repeating cycle, but that the busts keep getting bigger. And since it seems that nothing was learned from the 2008 crisis, you have to wonder just how bad the next one will be.

The first thing you need to know about the cycle of financial overreach, crisis, and bailout is that it was not always thus. (read more)