When the Financial Crisis Inquiry Commission was established in May of 2009, the hope was that a bipartisan group of financial experts could arrive at an explanation of the causes of the financial crisis that would rise above the partisan bickering prevalent at the time. Last week, the FCIC issued a report that does just that. Comprehensive in its scope and detailed, if somewhat unfocused, in its findings, the report makes clear that the "Bush deregulation" Democrats like to rail against had all too many Democratic supporters. And, while it does not endorse the popular Republican argument that misguided housing policy was the primary cause of the crisis, it gives the argument serious attention and is scathing in its criticism of the government sponsored enterprises, Fannie Mae and Freddie Mac, and their enablers in Congress and the federal government. Unfortunately, only the Democratic members of the Commission were willing to sign on to this non-partisan narrative.
So what is it that the Republicans on the Commission found so objectionable in the report that they felt it necessary to dissent? I will leave aside Peter Wallison's solo dissent, which continues to insist that U.S. housing policy is the only relevant cause of the global economic crisis -- an argument rejected by all other members of the Commission. The other three Republican members of the Commission have adopted a more sophisticated and nuanced approach to the question, "What Caused the Financial Crisis?" In their dissent and the Wall Street Journal op ed summarizing it, Bill Thomas, Keith Hennessey, and Douglas Holtz-Eakin outline ten factors that "only when taken together can... offer a sufficient explanation of what happened."
These start with the existence of a broad credit bubble in the United States and Europe, a sustained housing bubble in the United States, and an increase in "nontraditional mortgages... that were in some cases deceptive, in many cases confusing, and often beyond borrowers' ability to pay." From there, they run through failures in credit rating and securitization, "enormous concentrations of highly correlated housing risk" at large and mid-size financial institutions, and practices that "amplified this risk," including "holding too little capital relative to the risks" and funding these exposures with short-term debt. When a number of important firms failed, the existence of "counter-party credit risk exposures" at some institutions and the fact that "a number of firms had made similar bad bets on housing" threatened a cascade of failures. And that, in turn, caused "a financial shock and panic" that resulted in "a severe contraction in the real economy."
There is nothing particularly remarkable about this explanation. In fact, I doubt the Democratic members of the Commission would find much if anything to disagree with in this account. What is extraordinary - and what appears to explain the reason for the dissent - is the determination with which the Republican commissioners ignore the clear implications of their own findings. "It is dangerous," they argue, "to conclude that the crisis would have been avoided if only we had regulated everything a lot more, had fewer housing subsidies, and had more responsible bankers." But, if you accept their own basic assumption, that all ten factors they describe were essential to cause the crisis, it requires an act of will (or of willful ignorance) to avoid reaching the conclusion that more regulation or better regulation at key points in the chain of causality could have prevented the bursting of a U.S. housing bubble from threatening a collapse of the global economy. And if that is the case, then figuring out how to better regulate the financial system would seem like the most obvious way to prevent a recurrence.
Some of the more obvious examples of how regulation could have stemmed the crisis include better upfront regulation of mortgages to ensure that they are underwritten based on the borrower's ability to repay, decoupling the securitization process from its reliance on credit ratings as a substitute for full disclosure, setting higher capital and liquidity standards for financial institutions, requiring greater transparency on bank balance sheets, and, of course, regulating over-the-counter derivatives to reduce the domino effect that allowed the failure of a relatively small investment bank, Lehman Brothers, to threaten to bring down the global financial system and, with it, the broader economy. In short, the Republican dissent makes a very good argument for the range of legislative fixes included in the Dodd-Frank Wall Street Reform and Consumer Protection Act. (I am hardly the first to reach this conclusion. Economist Mark Thoma makes a similar argument in a recent blog post on the Finance and Markets Economonitor.)
The key difference then between the majority and minority accounts is the majority's willingness to point fingers and its insistence that the crisis was preventable, in part through better regulation. At a point when the Republican Party has staked its political future on opposition to "job-killing regulations" -- which in the Republican lexicon appears to mean any regulation the business community opposes -- the last thing Republicans can afford to do is acknowledge that lack of effective regulation was a root cause of a financial crisis that has left 26 million Americans unemployed, under-employed, or too discouraged to continue looking for work. It is frankly discouraging that these three smart men, who spent 18 months studying the causes of the crisis, clearly understand what went wrong, and surely recognize how close we came to an economic collapse of nightmare proportions are still unwilling to accept a narrative that challenges their party's ideological opposition to regulation. It is hard to avoid the conclusion that, when so many of our leaders have failed to learn from these events, we are doomed to repeat them.