- Why did we have a housing bubble?
- Why did lending standards decline?
- Why did the housing bubble lead to a financial crisis?
- Why did the financial crisis lead to an especially harsh and protracted recession?
The primary insight that informs the answer to all of these questions is: The crisis was rooted in an error about the riskiness of mortgages. Everyone from regulators to bankers to home buyers misread the risks embodied by the housing bubble, resulting in a calamity.
Which is to say, the Primer rejects the compensation and incentives theory of the crisis, according to which bankers knowingly became wildly reckless in search of higher bonuses and profits, while regulators were asleep at the switch.
It goes even further than this: it points out that regulators were worse than asleep at the switch. They were some of the primary causes of the crisis. Whether it was loading the dice in favor of their risk views when it came to bank capital requirements, or foolishly believing they could expand home-ownership without expanding the risk of mortgage lending, regulators were not just passive participants in the crisis—they were actively bringing it about.
This is a disquieting message for many, who hope that there might be a regulatory path to salvation. But if the regulators helped cause the crisis, what hope do we have that this time regulators will get things right?
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