In Econned: How Unenlightened Self-Interest Undermined Democracy and Corrupted Capitalism, Yves Smith, of Naked Capitalism, issues bills of indictment against the economic profession, the financial class and their accomplices in government and regulatory agencies. It is them who caused the financial crisis of 2008 and the book goes into much detail as to how it happened.
The bottom line is that the crisis is not the product of a few greedy individuals (e.g. Madoff) nor is it the product of social policy (CRA) or the poor taking out loans they could not afford (blaming social problems on the bottom of the social ladder is such a common trope that it can be dismissed every time it is invoked) or the supposed global savings glut.
Rather, the causes are cultural and structural.
The first culprit, according to Smith, is what she calls the “mathization” of economics, that is, how the discipline got historically taken over by proponents of abstract mathematical models as opposed to research dealing with the much less clean social reality of economic life (something that has made a comeback with behavioral economic).
The problems related to what Bourdieu used to call “taking the reality of the model for the model of reality” are well-known and Smith goes over them quite extensively. The flip side of this overreliance on mathematical models is the quasi-religious beliefs in the idea that markets are always right and good. So, the starting point is this double intellectual failure: statistical models are scientific and therefore always reliable / markets are always right.
Smith demonstrates that, at some point, in the financial world, the statistical models got so elaborate that (1) few people actually understood what they were representing and (2) the more complex they got, the more prone to error and manipulation they were. And yet, most financial forms relied on them to evaluate risk.
Add to this the securitization (and resecuritization) of everything and you end up with a self-contained universe, closed off to social reality, populated by highly paid individuals, convinced of their brilliance, supervised by managers who did not understand the models their traders are using but who benefited from the supposed profits they were making. That sense of entitlement has contributed to the demonization of the financial class in the wake of economic collapse.
Add to this the triumph of neoliberal economics (based on a completely imaginary vision of economic exchange) in the 1980s and the deregulation of financial products (CDOs, CDSs, SVIs, etc.) and you have a lot of elements in place for catastrophic results (how many financial and economic crises, worldwide, in the past, say 20 years?). It looks very much, from the outside, that the financial world had found illusory ways of generating illusory profits, unconnected to the real economy, by selling pieces of paper back and forth among financial actors, pieces of paper whose value was just just as disconnected from reality.
But Smith also examines the politically-central idea of “cognitive regulatory capture”, that is, when judges and regulators come to think the same way as the financial class, end up believing in the imaginary “free markets”, neoliberalism and the goodness of markets.
‘The widespread acceptance of the notion of ‘free markets’ is not the result of an organic shift in social attitudes, but of a clever, persistent, well-funded marketing plan by business interests that had much to gain from its adoption. The tireless and often faceless promoters of this ideology would have us believe that government is the source of all evil, and that any act to cut it down is a form of patriotism and an obvious win for the collective good. Yet, in Chile and Russia, we have seen the polar opposite: tearing down the state’s restraints on commerce produced a scramble by the wealthy and the well-connected to seize what they could. The result was not trickle-down prosperity, but dislocation, instability and a lower quality of life save for those at the very top. And in America’s ‘free market’ experiment, we have seen a slower but equally relentless devolution.” (126)
The bottom line, for Smith: looting and predation are the logical conclusion of all these developments leading to the economic collapse that resulted from all this financial “innovation” especially on unregulated products that could be conveniently hidden from regulators and auditors thanks to creative and innovative accounting.
More specifically, Smith explains somewhat at length the three financial products that turbocharged the system and primed it for disaster: securitization, repurchase and reserve repurchase agreements (repos), and the now-infamous credit default swaps. She provides one of the clearest explanations I have read. One wonder how anyone could believe in the soundness of these.
Smith concludes her book by a critical examination of TARP (a good example of cognitive regulatory capture) and a list of necessary reforms, although she is skeptical that significant reform will be passed. And Smith offers no real solution to the problem of ideological straitjacket in the economic profession (which has too much power, according to her).
This book is not the easiest read as all this financial wheeling and dealing is deliberately confusing and obscure. But it is a very useful “big picture” explanation of how we got here, politically, ideologically and structurally.