The Reason for the 2008 Financial Crisis

Several days ago, someone asked me the reason for the 2008 financial crisis. I think these two paragraphs from Alan Abelson's column sum things up nicely:

"As Jeremy [Grantham] bemoans: 'It took Greenspan. It took zero interest rates. It took an amazing repackaging of mortgage instruments. It took people begging other people to take equity out of their house to buy another one down in Florida.'

And not least, he recalls, it took Fed chief Ben Bernanke right at the peak of the speculative frenzy in October 2006 to calmly assure the masses: 'The U.S. housing market largely reflects a strong economy…the U.S. housing market has never declined.' (Implying, of course, Jeremy interjects, that it never would.)"

Abelson, Alan, 2011. Rolling thunder. Barron's, Jan. 29.

I am convinced that given the same circumstances another asset bubble would form even with what we know today about the 2008 financial crisis, the Great Depression, and the Panic of 1873 (see 1937). Further, the combination of the huge Federal budget deficit along with underfunded liabilities for social security and medicare represent eventualities that are being ignored as much as folks ignored the run-up in housing prices.

In spite of all of the quantification of financial markets, sometimes I think fear and greed remain the most important drivers of stock and bond prices.

I think the only savior for the American standard of living is economic growth through technological innovation. If growth does not accelerate beyond current rates, then at least the first half of this decade might prove to be very hard for Americans from a financial perspective.