Of all the books in this review, Zandi’s ranges most widely over the economic causes of the meltdown. He discusses the sources of the surge in subprime lending; the American obsession with home ownership; the tax breaks that promote borrowing of all kinds; the roles of financial engineering, loan securitization, and exotic financial instruments; attitudes toward risk; the role of the rating agencies; monetary policy before and after the credit crunch; fiscal policy; regulatory policy — you name it.
Lacking the flair of a David Wessel, Zandi nonetheless writes clear, straightforward prose and puts this bewildering mass of material in some kind of order. He ends with a 10-point checklist of actions we can take to avoid the next crisis. The seventh one is “Fix Securitization, Don’t Scrap It.” That is, regulate the complex repackaging of assets more carefully, don’t regulate it out of existence. This is characteristic of Zandi’s calm approach. He does not hyperventilate. He recognizes the benefits that modern finance has brought, as well as the damage done in this crisis.
Before we leave books that concentrate on causes, John B. Taylor’s Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis deserves honorable mention. It is as narrow in its focus as Zandi’s is wide, concentrating almost exclusively on interest rate policy before the crisis, and arguing that this is where the critical mistake was made. Taylor disagrees, for instance, that the Lehman decision was the pivot on which everything turned. He is not even very interested in subprime mortgages — they were a symptom, in his view, not the cause. Everything went wrong for one simple reason: the Fed abandoned its tried-and-true rule for setting interest rates — a rule, it so happens, that Taylor, a senior fellow at the Hoover Institution and a Stanford University professor, first formulated.
The Taylor rule was devised as a recommendation to central banks, and was later seen as a way to predict how the Fed actually will behave. It says that central banks should set interest rates equal to one and a half times the inflation rate, plus half of the gap between actual and potential gross domestic product, plus 1. So if inflation is 5 percent and the output gap is 3 percent, the rule says to set the short-term interest rate at 10 percent: one and a half times 5, plus half of 3, plus 1. From the late 1980s onward, deliberately or otherwise, the Federal Reserve followed the rule. Earlier this decade, it stopped.
Aiming to speed the recovery from the previous recession, the Fed cut interest rates in 2002 and kept them low even when the Taylor rule said to raise them. Hence the boom in house prices, hence the boom in mortgage borrowing. Taylor presents a simulation that shows what would have happened with “normal” interest rates: no meltdown.
This mono-causal explanation is not altogether persuasive. A once-in-a-half-century crisis, which this is, must be a perfect storm of multiple forces. A lot has to go wrong at once; otherwise, such wrenching events would be commonplace. Yet Taylor believes in the one true cause. Questionable as this approach may seem, in fact he makes a powerful case. At the very least, he establishes the centrality of monetary policy earlier in the decade among the various causes, a perspective that is lacking in many other accounts. Extra marks for brevity, too. The main text runs just 60 pages. They are well worth reading.
A Fly on the Wall
Fool’s Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe, by Gillian Tett of the Financial Times, and House of Cards: A Tale of Hubris and Wretched Excess on Wall Street, by William D. Cohan, investment banker turned financial writer, zoom in, minutely reporting a fragment of the action, hoping to clarify the bigger picture, ever in search of a ripping good yarn.