The Great Recession was a failure of capitalism, not politics

Our collective understanding of the financial meltdown that nearly cratered the US economy in 2007 and 2008 has already gone through a couple of big revisionist treatments.

Michael Lewis’s “The Big Short” — a new history of the disaster — corrects a lot of the nonsense and puts the blame squarely back where it belongs: Wall Street.

First, let’s dispense with one of the biggest myths promulgated over the last 24 months, that the disaster was caused by over regulation.

Conservative and libertarian analysts argue that politicians, led by the Democratic Party, forced or at least strongly encouraged bankers to lend money to home-buyers who couldn’t afford to pay back their loans.

There is some truth to the idea that Democrats pushed overzealous home-ownership policies.

But that didn’t cause the meltdown.

As Lewis’s book makes crystal clear, the problem was that Wall Street firms “bundled” piles of those crappy mortgages into big collective funds, which they could sell to unwitting investors.

They then convinced rating agencies to rate those funds at AAA levels, even though many were junk, thereby making it impossible for those investors to know what they were buying.

And then the big banks convinced insurance companies like AIG to cover any losses that might be incurred by the banks themselves if their funds tanked.

By the time they were done, the octopus of Wall Street had entangled every corner of the economy in the sub-prime debacle.

The problem, as Lewis makes clear, was that most of these investment mechanisms had no government regulation or oversight.

Those risky insurance maneuvers — unregulated. The crooked ratings system — unchecked.

And when the dance finally ended, taxpayers were forced to bail out these gangsters.

The worst part is that the con-men will do it again. Why? Because the bonus system still in place incentivizes risky, short-term profits.

Lewis couldn’t find a single top executive culpable for the meltdown who didn’t walk away rich.

What we need now is a major overhaul, one that offers clear oversight and regulation, while providing transparency for investors.

We need to break up the big banks, so that their size and the complexity of their portfolios don’t transform them into lumbering elephants.

We also need to develop a new class of regulators, educated well enough to understand the complicated mechanisms they’re policing.

If anything, the big mistake made by politicians was scrapping systems of oversight and regulation created after the Great Depression.

That’s an error we have to reverse.

But the Bush and Obama administrations got one bipartisan thing right:

They agreed that many of these banks were too big too fail. They propped them up, and prevented another Great Depression.

The politicians on both sides of the aisle were the good guys. But their jobs is only half done.

By rebuilding some of the regulatory muscle stripped away over the last fifteen years, we can also rebuild a sound and stable capitalist economy.