Lehman three years later: what we haven't learned

Dean Baker

15/09/2011

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As we prepare to celebrate the third anniversary of the Lehman bankruptcy and the ensuing financial crisis, it's a good time to assess the situation and ask what has changed. The answer is not encouraging.

Very little has changed about either the realities on the ground or the intellectual debate on economic issues in the last three years. The too-big-to-fail banks are bigger than ever as a result of crisis-induced mergers. Financial industry profits now exceed their pre-crisis share of corporate profits, and executive pay and bonuses are again at their bubble peaks.

None of the executives who pushed and packaged fraudulent mortgages have gone to jail. Even those who have faced civil actions, like Countrywide's Angelo Mozilo, have almost certainly still come ahead after making large payments to settle suits.

And all the top policy people who guided us to this economic disaster are still doing just fine. When Alan Greenspan isn't collecting his seven-figure salary from PIMCO, the country's largest bond fund, he is sharing his wisdom with the world on the Sunday morning talk shows.

More importantly, little of their perceived wisdom has been questioned. Central banks around the world are still targeting 2.0 percent inflation as their main, if not only, policy goal. They are acting as though nothing in the world has happened that might cause us to question this policy.

In some ways this is an incredible turn of events. However it also should have been entirely predictable. The same people who controlled the key levers of power before the collapse continued to control them after the collapse. They created an official story and ensured that people heard little else.

In this official story, the cause of the economic downturn was the financial crisis. This in turn was caused by the proliferation of complex financial instruments that it turns out in retrospect no one fully understood. In this view, it was just bad luck that overtook Greenspan, Bernanke and the rest. They may have been overly optimistic about self-regulation in financial markets, but no one could have known that anything like the financial tsunami following Lehman could happen.

In fact, in the official story we are supposed to be thankful that we did not get a second Great Depression. While this prospect is absurd on its face (the first Great Depression was the result of 10 years of failed policy, not just the mistakes made at its onset), those in positions of power and responsibility repeat this line endlessly.

It is quite disturbing that the high-flyers in the financial industry and their supporters in the policy world can wreck the economy and ruin tens of millions of lives but still maintain their control over policy and suffer almost no consequences themselves. But why would we expect anything else?

All the Greenspan sycophants in the media [http://www.amazon.com/Maestro-Greenspans-Fed-American-Boom/dp/0743204123] and the policy world were not going to own up to the fact that they had been worshipping a guy who was clueless about the fundamentals of the economy. Therefore they had every reason in the world to perpetuate the unpredictable disaster story.

The same applies to the economics profession. After all, the Greenspan gospel had been widely embraced by central bankers and central banker wannabes everywhere. The Federal Reserve devoted its 2005 gathering of the world's central bankers and top economists to a Greenspan retrospective [http://www.kansascityfed.org/publications/research/escp/escp-2005.cfm]. They debated [http://www.kansascityfed.org/publicat/sympos/2005/pdf/Blinder-Reis2005.pdf] whether Greenspan was the greatest central banker of all-time. This gang had an enormous investment in the Greenspan line.

Neither the highly credentialed economists nor the economics and business reporters at top news outlets could say that the guy they had revered had problems with basic arithmetic. And, let's be really really clear, he had problems with basic arithmetic.

It took nothing more than third grade arithmetic to recognize a housing bubble that had grown hugely out of line with the fundamentals of the housing market. There was no explanation that passed the laugh test for the fact that house prices had diverged sharply from their long-term trend, and from rents, creating a housing bubble that peaked at more than $8 trillion. This was recognizable at least as early as 2002 [http://www.cepr.net/index.php/publications/reports/the-run-up-in-home-prices-is-it-real-or-is-it-another-bubble].

And, it was easy to see that this bubble was driving the economy, both by pushing construction to record levels as a share of GDP and leading to a consumption boom that depressed the savings rate to zero. There was nothing in the Fed's bag of tricks that could replace the 8 percent of GDP (@ $1.2 trillion) of bubble-driven demand that the economy stood to lose when the housing bubble burst.

Therefore this disaster was 100 percent predictable to those who knew arithmetic; the only question was the timing and the exact nature of the process. But the post-crisis story has been told almost entirely by the people responsible for the crisis. And they certainly had no intention of owning up to the fact they almost completely lack the ability to think for themselves.

This meant highlighting the financial crisis and the complexity of credit default swaps, collaterized debt obligations, and other complex financial instruments and burying the simple story of the housing bubble. Until progressives have enough power impose the laws of arithmetic on economic debates, we will not be able to make headway in influencing policy. Unfortunately, arithmetic is every bit as far removed from economics today as it was before Lehman.