Botching the Great Recession

It has been ten years since the failure of Lehman sent the global financial system into freefall. Why is this date different from any other date? No particular reason. But round-number anniversaries do have the virtue of giving people a reason to look back at experience, and maybe even learn from it.

So how does the crisis response look 10 years later? Well, it could have been worse. But it could and should have been much better.

And the question is, do we understand that? To which the answer is, what do you mean “we,” white man? Some of us understand the inadequacy of crisis response — but we pretty much always did. Meanwhile, those who stood in the way of doing what should have been done have, with notably rare exceptions, failed to face up to their errors and the consequences.

Let’s start with what went kind of right. Faced with an imminent financial meltdown, policymakers by and large did what needed to be done to limit the damage. Their actions included bank bailouts, which should have been fairer — too many bankers got bailed out along with their banks — but were effective. There were also many emergency provisions of credit, including little-known but crucial things like maintaining dollar credit lines to non-U.S. central banks.

The result was that the acute phase of the financial crisis — what I still think of as the “Oh God we’re all gonna die” phase — was relatively brief. It was scary and did immense damage — America lost 6 ½ million jobs in the year after Lehman fell. But as you can see in Figure 1, measures of financial stress fell off rapidly in 2009, and were more or less back to normal by the summer.

Rapid financial recovery did not, however, produce rapid recovery for the economy as a whole. As the same figure shows, unemployment stayed high for many years; we didn’t return to anything that felt remotely like full employment (leaving aside the question of whether we’re there even now) until late in Obama’s second term.

Why didn’t financial stability bring a rapid bounceback? Because financial disruption wasn’t at the heart of the slump. The really big factor was the bursting of the housing bubble — of which the banking crisis was a symptom. As Figure 2 shows, the housing bust led directly to a dramatic drop in residential investment, enough in itself to produce a deep recession, and recovery was both slow and incomplete.

The plunge in home prices also destroyed a lot of household wealth, depressing consumer spending in general.

So what should we have done to produce a faster recovery? Private spending was depressed; monetary policy was ineffective because we were at the zero lower bound on interest rates. So we needed fiscal expansion, some combination of spending and tax cuts.

And we did, of course, get the ARRA — the Obama stimulus. But it was too small and, even more important, faded out much too quickly; see Figure 3.

You could say that nobody could have predicted such a sustained slump. You could say that — but you would be wrong. Many people, myself included, predicted a slow recovery, because this was a different kind of recession from those of the 70s and 80s — one brought on by private-sector overreach, not inflation.

Why, then, didn’t we get the fiscal policy we should have had? There were, I’d say, multiple villains in the story.

First, we can argue whether the Obama administration could have gotten more; that’s a debate we’ll never see resolved. What is clear, however, is that at least some key Obama figures were actively opposed to giving the economy the support it needed. “Stimulus is sugar,” snapped Tim Geithner at Christina Romer, when she argued for a bigger plan.

Second, Very Serious People pivoted very early from concern about the unemployed — hey, they probably lacked the necessary skills — to hysteria over deficits. By 2011, unemployment was still over 9 percent, but all the Beltway crowd wanted to talk about was the menace of the debt.

Finally, Republicans blocked attempts to rescue the economy and tried to strangle government spending every step of the way. They claimed that this was because they cared about fiscal responsibility — but it was obvious to anyone paying attention (which unfortunately didn’t include almost anyone in the news media) that this was an insincere, bad-faith argument. As we’ve now seen, they don’t care at all about deficits as long as a Republican is in the White House and the deficits are the counterpart of tax cuts for the rich.

The end result was that policy moved quickly and fairly effectively to rescue banks, then turned its back on mass unemployment. It’s a story that’s both sad and nasty. And there’s every reason to believe that if we have another crisis, it will happen all over again.