The Financial Crisis Inquiry Report: Learning from capitalism’s bluff?

Inclusive Economy03 Jun 2011Michiel Verweij

First, take a minute to think about this: ‘a total collapse of our financial system and economy’ (Financial Inquiry Report conclusions page xvi)”. Imagine how the world would have looked like in case this risk had been fully materialized.

As a Westerner (European citizen) I felt emotionally and financially very much connected to the financial crisis. Like many of us, my life is pampered with all kinds of financial arrangements: from a pension scheme for retirement and provisions for the study of the children to insurances for practically anything that can possibly go wrong.

So you’ll understand that my worldview was shaking on its foundations when I saw the world’s greatest insurer AIG struggle to survive. Worries about my own future dominated my mind when stocks and the value of my pension savings tumbled. Wall Street’s Bull at the centre of global finance was stung in the heart when the investment bank Lehman Brothers fell and other financial giants balanced on the verge.

Golden Calf

The next Great Depression was around the corner, it seemed. The drama engulfing the world 15 and 16 September 2008 was symbolically captured in the image of ‘The Golden Calf’, a dead calf preserved in a tank of formaldehyde with gold-plated horns and hooves. This work of Damian Hirst (a favorite artist among investment bankers) was coincidently sold at an art fair for a record breaking price, the very same moment when capitalism suffered a heart attack.

The Financial Crisis Inquiry Report of the United States probably offers the most comprehensive and readable account on the causes of the crisis, so far. A wealth of information produced during the investigation is freely accessible on the web. The report gives a rich and sometimes detailed insight in what happened. At least I am not aware of any European study with comparable depth and width on the financial crisis.

Global financial disaster is not a minor hiccup (people loose jobs and savings, international trade slumps, poor people get poorer). The inquiry report explains: “The crisis was the result of human action and inaction caused by human misjudgments, mistakes and misdeeds”. These two facts give enough reason to delve deeply in the findings of the inquiry report, I would think. However, economist and people from within the financial system are surprisingly silent about the inquiry report. Why? Are they embarrassed about not having foreseen the crisis? Some assert having spent enough time analysing the crisis and highlight the need to move on. I seriously doubt that. I fear that we don’t yet know enough and I share the analysis of the commission: ‘If we do not learn from history, we are unlikely to fully recover from it’.

The Inquiry report states: ‘We encourage the American people to join us in making their own assessments based on the evidence gathered in our inquiry’. I take that recommendation at heart though I am neither an American citizen nor an ‘insider’ from financial world. Reliable and fair financial system is one of the basic conditions for planning my own personal life. In that sense financial stability could be viewed a global public good what makes me a stakeholder as well as a right holder to claim information on what threatens and request solution to improve the system for the future.

‘Our task was first to determine what happened and how it happened so that we could understand why it happened’ reads the objective of the Financial Crisis Inquiry Commission. And indeed, after lecture of the inquiry report one has a picture of what happened and how it happened. However, to me as worried citizen it is not yet evident that with the inquiry report we have learned enough. We are not yet there! I have the feeling that we miss some essential steps to restore faith in the system. Would you let the baker continue baking bread after a massive food poisoning?

Game Over

Let me share one particular point in the report to illustrate my point. To start with the main conclusion of the inquiry commission: ‘the crisis was avoidable’. My immediate reaction was. If the crisis was avoidable why wasn’t it avoided? I would expect the study shedding light on why the crisis was not avoided? But does it? The commission also says: “We conclude there was a systemic breakdown in accountability and ethics”. But again, I would want to see more on the causes behind the breakdown in accountability and ethics? Why did people apparently en masse abandon their values?

How come that individuals and institutions run into multiple mistakes, misdeeds and misjudgements creating a near economic meltdown of the Western market system? Why did estate agents, brokers, bankers, regulators, economists, politicians and home-owners play the game until the game was over?

Thanks to this inquiry report and other studies about the subject we know a lot about the proximate causes of the crisis such as: housing bubble, defaulting home-owners, toxic mortgage products, exotic investment vehicles; failing oversight and regulation. But after each cause and explanation you can still ask further, why this and why that? Why did default rates go up? Why did a social housing policy lead to overly lax lending standards? Why did financial institutions structurally hide risks from balance sheets? Why did trading in dubious mortgage securities continue even after the first damage surfaced?

Invisible Hand

The inquiry report reveals many details about what happened and how it happened but very little about the deeper ultimate causes of why it happened. Let take a look behind all the what’s and how’s. Underneath the first level of causes there seems to be a common denominator of trust and confidence. First it was excess of trust and confidence and secondly a shortage of it. Before the crisis the world was enjoying an era of abundant trust in the financial system. Citizens across the world entrusted their pensions and savings to unknown people of financial institutions at the other end of the world. People trusted home prices to continue to go up and trusted in miracles to pay off the ever increasing mortgage debts. And in case of any contingency…AIG, the insurer at the apex, would be ready to cover the losses of defaulting debtors. We slept well at night, feeling protected as by an invisible hand…

Trust comes by foot and leaves on a horse, they say. The turning point was when upstream investors started losing trust in the diverse financial mortgage products. The money flow of the great financial cycle started to falter. It was as if Wall Streets rain-makers lost their magic overnight. The alchemy of ever more innovative financial instruments was suddenly gone. Bankers who realized this first stopped trusting other bankers. Everywhere trust turned into distrust. Until the public lost confidence in anybody related to the financial system: rating agencies, bankers, real estate agents, brokers, insurers, regulators, governments, auditors and consultancy firms. The whole financial flow practically dried up. The sun tanned smiling masters of finance with a seducing air of ‘trust us’ had turned out to be a great bluff.

The result was a financial disruption that left a huge footprint of distrust in our financial system and even the western development model, I would say. Hard experience showed us that the capitalist market system is (still) able to create destructive monsters that threaten stability of global society. “It was the failure to account for human weakness that is relevant to this crisis” is one of the open-ended conclusions of the inquiry report. It hints to the notion that financial and economic relations are basically human relations of exchange responding to private interests but also to social values of responsibility, solidarity, fairness and justice. Individual and collective behaviour is not yet fully understood. See for example Akerlof and Schiller who in their book ‘Animal spirits’ (2009) identify gaps in the economic theory related to psychological factors.

To restore trust, the learning cycle around the financial crisis has to be closed. This implies first to continue the investigation from where the inquiry commission stopped. We now know fairly well the proximate causes but still lack understanding of the deeper ultimate causes that led to the financial crisis. Secondly, learning implies drawing lessons and applying justice where it is due. It is a universal human expectation that people are hold to account for mistakes, misdeeds and misjudgements. Bakers and bankers alike have to live by the rules that we agreed upon. And finally the learning cycle includes a step where the lessons and feedback are used for correction and improvement of the system.

I ask myself what is the role and responsibility of citizens to ensure all that learning really happens? Who else…?


Michiel Verweij works for SNV Netherlands Development Organisation.