Origins of the Present (Financial) Crisis

Mark Thoma sends us to Paul Krugman, who argues that American financial regulation went off on the wrong track with Reagan-Garn-St. Germain:>Economist’s View: Paul Krugman: Reagan Did It: Reagan… essentially ended New Deal restrictions on mortgage lending… that, in particular, limited the ability of families to buy homes without putting a significant amount of money down. These restrictions were put in place in the 1930s by political leaders who had just experienced a terrible financial crisis, and were trying to prevent another. But by 1980 the memory of the Depression had faded. Government, declared Reagan, is the problem, not the solution; the magic of the marketplace must be set free. And so the precautionary rules were scrapped…. We weren’t always a nation of big debts and low savings: in the 1970s Americans saved almost 10 percent of their income… >It was only after the Reagan deregulation that thrift gradually disappeared…, culminating in the near-zero savings rate … on the eve of the great crisis…. All this, we were assured, was a good thing: sure, Americans were piling up debt… but their finances looked fine once you took into account the rising values of their houses and their stock portfolios. Oops. Now, the proximate causes of today’s economic crisis lie in events that took place long after Reagan… — in the global savings glut… and in the giant housing bubble that savings glut helped inflate. But it was the explosion of debt over the previous quarter-century that made the U.S. economy so vulnerable. Overstretched borrowers were bound to start defaulting in large numbers once the housing bubble burst and unemployment began to rise.>These defaults in turn wreaked havoc with a financial system that — also mainly thanks to Reagan-era deregulation — took on too much risk with too little capital. There’s plenty of blame to go around… But the prime villains behind the mess we’re in were Reagan and his circle of advisers — men who forgot the lessons of America’s last great financial crisis, and condemned the rest of us to repeat it…

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