WASHINGTON -- Four years after the onset of the financial crisis -- in March 2008 Bear Stearns was rescued from failure -- we still lack a clear understanding of the underlying causes. Hundreds of studies and books have given us an increasingly detailed picture of what happened without conclusively answering why. Conventional wisdom has advanced competing theories: Wall Street types took too many risks, encouraged by lax government regulation; or, pro-homeownership policies eroded mortgage-lending standards and created the housing bubble.
Actually, both theories are correct -- and neither is. It's true that Wall Street took too many risks while government regulators watched passively; it's also true that the government's aggressive promotion of homeownership contributed to real estate speculation. But the fact that these theories are not mutually exclusive suggests that both were consequences of some larger cause. Just so. What ultimately explains the financial crisis and Great Recession is an old-fashioned boom and bust, of which the housing collapse was merely a part.
The boom started with the decisive defeat of double-digit inflation in the early 1980s. Consumer price increases dropped from 14 percent in 1980 to 3 percent in 1983. As inflation fell, interest rates gradually followed (from 1982 to 1989, rates on 10-year Treasury bonds fell from 13 percent to 8 percent) when investors realized the decline was lasting. With interest rates falling, stock prices rose (from 1982 to 1989, they nearly tripled), and with a lag, housing prices did too. Consumer spending surged, as Americans skimped on saving and borrowed against swelling home values and stock portfolios.
All the good news (low inflation, high employment, rising stock and real estate prices) drove economic growth. Between 1982 and 2007, there were only two mild recessions. When prosperity was jeopardized -- by the 1997 Asian financial crisis, the tech crash in 2000, the 9/11 attacks -- the Federal Reserve seemed to defuse the threats. The economy seemed less risky. Economists announced the Great Moderation of business cycles.
Booms become busts because justifiable confidence becomes foolish optimism. So it was. Believing the world less risky, people took more risks. Investment banks and households increased their debt. Lending standards eroded, because borrowers' repayment prospects were thought to have improved. Regulators relaxed oversight, because markets seemed more stable and self-correcting. On the fringes, ethical standards frayed; criminality increased. The rest, as they say, is history.
Confession: I have written all this before. It is a lonely view. The latest issue of the academic Journal of Economic Literature has two review articles; one summarizes 21 books on the crisis by economists and journalists, and the other analyzes 16 scholarly papers and studies. None -- so far as I can tell -- suggests this long boom-bust crisis explanation. The only "boom" that matters is the housing boom. There is no sense of history: a recognition that today's events may ultimately result from events years or decades ago.
Among the public, the press and politicians, the disdain for historical explanations is no mystery. The crash was a crime against society; the public wants culprits. The press pursues wrongdoing. It's a good story. President Obama blames his predecessor's policies. It's good politics. A narrative rooted in mass and bipartisan delusion does not serve these purposes. Everyone wants blood.
The case of economists is more curious. They presumably crave truth; most aren't hankering for political appointments. But their blind spot is their self-identity. Modern economists portray their discipline as a "science" that can better manage the economy for growth and stability. In particular, this repudiates the fatalism of the 1920s that, as Sylvia Nasar describes in her book "Grand Pursuit: The Story of Economic Genius," saw business cycles as unavoidable and, in part, desirable:
"Judging by newspaper headlines of the early 1930s, popular wisdom viewed economics through a biblical lens: recessions were the wages of sin. When good times lasted too long, businesses and individuals threw caution to the wind and behaved badly. Recessions ... occurred when private businesses and households unwound past excesses, wrote off bad investments, and behaved with restraint once again. ... (Recessions) were regrettable but necessary correctives, like a detox program for a drunk."
The problem for economists is that the crisis has, to some extent, reaffirmed this dour and previously discredited view. Prolonged prosperity from 1983 to 2007 bred bad habits and overconfidence. This does not mean that we know nothing or that we have no tools to combat savage recessions; after all, we did avoid a second Great Depression. But it does mean that one promise of modern economics -- to extend economic expansions and shorten slumps -- can create the conditions for its own failure. Although the conclusion is obvious, economists ignore it. The most likely reason is that it undermines their self-appointed role as agents of social progress.