Making Sense of the Credit Debacle

Dan, that's a great beginning question. It's funny, because it comes up all the time in the form of "Should the Fed/Treasury have let Lehman Bros. fail?" Hey, if you are going to give me the power to go back in time and change major governmental decision-making, well, then I'm not going to go back only six months and alter the Lehman Bros. decision—rather, I am going to be much more comprehensive and far-reaching than that.

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The perfect-storm metaphor is imperfect; rather, what led to the current situation were numerous legislative, ideological, and business decisions that worked together to create a systemic failure. Consider each of the following:

• The Commodities Futures Modernization Act (2000) allowed unregulated derivatives to run wild.
• The repeal of Glass-Steagall (1999) allowed depository banks to become far more intertwined with Wall Street.
• From 2001-03, Fed Chair Alan Greenspan took rates down to unprecedented levels, causing 1) a mad scramble for yield and 2) an enormous housing boom.
• In 2004 the SEC allowed the five big investment banks to leverage up from 12-to-1 to 35-to-1 or more.

Reverse each of the above and the total systemic damage is far, far less. There were several other factors—the changing business model of the ratings agencies from customer-financed research to a form of payola and the misaligned compensation system on Wall Street that pays people for short-term gains despite ongoing long-term risks. There's a lot more, but I cannot forget the misguided deification of markets—a false belief system that led to a radical deregulatory philosophy that ignored the abdication of lending standards ("Innovative," said Greenspan) among the subprime lenders.

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Jesse Eisinger is a columnist at Portfolio. Daniel Gross is the Moneybox columnist for Slate and the business columnist for Newsweek. You can e-mail him at and follow him on Twitter. His latest book, Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation, has just been published in paperback. Duff McDonald is a contributing editor at New York and Portfolio and is completing a biography of Jamie Dimon of JPMorgan Chase. Barry Ritholtz is a money manager, proprietor of The Big Picture blog, and author of the forthcoming Bailout Nation. Gillian Tett is an assistant editor at the Financial Times, and author of the forthcoming book on how financial innovation went so wrong: Fools Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe.

Photograph of falling Dow chart on Slate's home page by Mario Tama/Getty Images.

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