AEI 2011: Dissecting the financial crisis

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President Barack Obama greets Rep. Barney Frank (D-Mass.) and Sen. Chris Dodd (D-Conn.) after signing the Dodd-Frank Wall Street Reform and Consumer Protection Act at the Ronald Reagan Building on July 21, 2010, in Washington.

Article Highlights

  • Commission found financial crisis caused by poor regulation; Peter Wallison dissented #AEI2011

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  • Is crisis going to happen again? John Makin on risks compared to #Lehman collapse #AEI2011

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  • 2011 was the year that Occupy Wall Street converged on the financial sector. How gullible #AEI2011

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In the last two weeks of this year, the AEI 2011 series will highlight the institute's work that has made an impact, made a difference and made headlines over the past year.

THE BIGGIE

The Financial Crisis Inquiry Commission issued its majority report in January 2011, stating that the 2007-2010 crisis was "avoidable and was caused by: Widespread failures in financial regulation, including the Federal Reserve’s failure to stem the tide of toxic mortgages; Dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk; An explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis; Key policy makers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; and systemic breaches in accountability and ethics at all levels.“

That was the majority opinion. AEI's Peter Wallison, who sat on the 10-member commission, dissented, provoking frank conversation on the real roots of the crisis and crafting one of the most talked-about AEI pieces of the year. Wallison found that government-mandated subprime loans, not greedy investors, were the force behind the deterioration in underwriting standards.

Like Congress and the Obama administration, the Commission's majority erred in assuming that it knew the causes of the financial crisis. Instead of pursuing a thorough study, the Commission's majority used its extensive statutory investigative authority to seek only the facts that supported its initial assumptions--that the crisis was caused by "deregulation" or lax regulation, greed and recklessness on Wall Street, predatory lending in the mortgage market, unregulated derivatives, and a financial system addicted to excessive risk taking. The Commission did not seriously investigate any other cause and did not effectively connect the factors it investigated to the financial crisis. The majority's report covers in detail many elements of the economy before the financial crisis that the authors did not like, but generally fails to show how practices that had gone on for many years suddenly caused a worldwide financial crisis. In the end, the majority's report turned out to be a just-so story about the financial crisis, rather than a report on what caused the financial crisis.

Wallison discussed his dissent with The American editor Nick Schulz:

MORE ON HOUSING FINANCE: A White House draft proposal for reforming America's housing finance system, released in February, sounded notes of a white paper released in January by Wallison, Alex Pollock and Edward Pinto, "Taking the Government Out of Housing Finance: Principles for Reforming the Housing Finance Market"

CHART-TOPPER

Is it going to happen again? John Makin warned in September that indicators pointed to the U.S. being close to another recession. In "Systemic Risk Returns: Is the Current Crisis Worse Than the Lehman Collapse?" he wrote that current conditions point to a threat of systemic risk: the sudden shock of the US financial crisis, interconnections between the U.S. economy and the European financial system, and the absence of viable policy solutions.

The emergence of systemic risk is tied to three conditions. The first is the suddenness of the onset of shocks hitting the global economy or the global financial system. The second is the pervasiveness and interconnectedness of the effects of the shocks, and the third is the absence of obvious solutions to the problems resulting from the shocks. All three conditions exist now. In terms of suddenness of onset, a financial shock like the collapse of Lehman Brothers constitutes a serious risk. If a financial disruption weakens the real economy enough to weaken the financial sector, an adverse feedback loop can develop whereby the global financial system and economy are put at extreme risk.

AND DON'T MISS...

2011 was the year that Occupy Wall Street converged on the financial sector. Wallison took to The Wall Street Journal to correct the protesters on their misdirected anger, and his piece "Wall Street's Gullible Occupiers" reaped nearly 1,200 comments on the WSJ site.

Sen. Chuck Schumer is still actively pushing a housing proposal with Sen. Mike Lee (R-Utah) intended to repair the housing market that would grant three-year residence visas to foreigners who pay cash to purchase either one home worth at least $500,000 or two homes both worth at least $250,000. Alex Brill and Rohan Poojara opined that this plan comes up short as stimulus (or as an immigration fix).

Bridget Johnson is the managing editor of AEI.org

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