The best analysis to date of the short-term causes of the crisis

Here is IMO a must-read for anyone interested in the short-term causes of this financial crisis.  The long-term buildup of debt guaranteed problems for America, but a long series of public policy errors produced a severe crisis.  I recommend clicking on the link to read it in full.

“Capitalist Fools“, Joseph E. Stiglitz, Vanity Fair, January 2009 — “Behind the debate over remaking U.S. financial policy will be a debate over who’s to blame. It’s crucial to get the history right, writes a Nobel-laureate economist, identifying five key mistakes-under Reagan, Clinton, and Bush II-and one national delusion.”

From Wikipedia:  “Joseph Eugene Stiglitz  is an American economist and a professor at Columbia University. He is a recipient of the John Bates Clark Medal (1979) and the Nobel Memorial Prize in Economic Sciences (2001). He is also the former Senior Vice President and Chief Economist of the World Bank.

Excerpt

There will come a moment when the most urgent threats posed by the credit crisis have eased and the larger task before us will be to chart a direction for the economic steps ahead. This will be a dangerous moment. Behind the debates over future policy is a debate over history-a debate over the causes of our current situation. The battle for the past will determine the battle for the present. So it’s crucial to get the history straight.

What were the critical decisions that led to the crisis? Mistakes were made at every fork in the road-we had what engineers call a “system failure,” when not a single decision but a cascade of decisions produce a tragic result. Let’s look at five key moments.

1. Firing the Chairman 
2. Tearing Down the Walls
3. Applying the Leeches
4. Faking the Numbers
5. Letting It Bleed

The administration talked about confidence building, but what it delivered was actually a confidence trick. If the administration had really wanted to restore confidence in the financial system, it would have begun by addressing the underlying problems-the flawed incentive structures and the inadequate regulatory system.

Was there any single decision which, had it been reversed, would have changed the course of history? Every decision-including decisions not to do something, as many of our bad economic decisions have been-is a consequence of prior decisions, an interlinked web stretching from the distant past into the future. You’ll hear some on the right point to certain actions by the government itself-such as the Community Reinvestment Act, which requires banks to make mortgage money available in low-income neighborhoods. (Defaults on C.R.A. lending were actually much lower than on other lending.) There has been much finger-pointing at Fannie Mae and Freddie Mac, the two huge mortgage lenders, which were originally government-owned. But in fact they came late to the subprime game, and their problem was similar to that of the private sector: their C.E.O.’s had the same perverse incentive to indulge in gambling.

The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, “I have found a flaw.” Congressman Henry Waxman pushed him, responding, “In other words, you found that your view of the world, your ideology, was not right; it was not working.” “Absolutely, precisely,” Greenspan said. The embrace by America-and much of the rest of the world-of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.

Afterword

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To read other articles about these things, see the FM reference page on the right side menu bar.  Of esp relevance to this topic:

• about the Financial crisis – what’s happening? how will this end?
• about the End of the post-WWII geopolitical regime
• some Good News about America!

Post on the FM site about diagnosis, causes, and the larger context of the crisis: