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Home , Great Recession

WQ16-24 1/5/11 1:17 PM Page 16

THE WILSON QUARTERLY

Rethinking the Great

In embracing a victims-and-villains explanation of the recession, Americans are missing important lessons about the future of the U.S. economy.

BY ROBERT J. SAMUELSON

We Americans turn every major crisis into of double-digit in the early 1980s, an event a morality tale in which the good guys and the bad guys that unleashed a quarter-century of what seemed to be are identified and praised or vilified accordingly. There’s steady and dependable prosperity. There were only two a political, journalistic, and intellectual imperative to find , both of them short and mild. Unemploy- out who caused the crisis, who can be blamed, and who ment peaked at 7.8 percent. As inflation fell, interest rates can be indicted (either in legal courts or the court of pub- followed. The soared. From 1979 to 1999, lic opinion) and, if found guilty, be jailed or publicly hum- stock values rose 14-fold. Housing prices climbed, bled. The great economic and financial crisis that began though less spectacularly. Enriched, Americans bor- in 2007 has been no exception. It has stimulated an out- rowed and spent more. But what started as a justifiable pouring of books, articles, and studies that describe response to good economic news—lower inflation— what happened: the making of the housing bubble, the slowly evolved into corrupting overconfidence, the cat- explosion of complex mortgage-backed securities, the alyst for the reckless borrowing, overspending, financial ethical and legal shortcuts used to justify dubious but speculation, and regulatory lapses that caused the bust. profitable behavior. This extended inquest has produced In some ways, the boom-bust story is both more inno- a long list of possible villains: greedy mortgage brokers cent and more disturbing than the standard explanations and investment bankers, inept government regulators, of blundering and wrongdoing. It does not excuse the naive economists, self-serving politicians. What it has- financial excesses, policy mistakes, economic miscalcula- n’t done is explain why all this happened. tions, deceits, and crimes that contributed to the collapse. The story has been all about crime and punishment But it does provide a broader explanation and a context. when it should have been about boom and bust. The People were conditioned by a quarter-century of good eco- boom did not begin with the rise of home prices, as is nomic times to believe that we had moved into a new era usually asserted. It began instead with the suppression of reliable . Homeowners, investors, bankers, and economists all suspended disbelief. Their Robert J. Samuelson, a columnist for and The Washington heady assumptions fostered a get-rich-quick climate in Post, is the author, most recently, of The Great Inflation and Its Aftermath: The Past and Future of American Affluence (2008). which wishful thinking, exploitation, and illegality flour-

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What were they thinking? From Sandy Springs, , where this house went into foreclosure in 2008, to Wall Street, which traded in mortgage- backed securities,Americans before the Great Recession acted as if the nation would never again experience significant economic turbulence.

ished. People took shortcuts and thought they would get standard weapons (low interest rates, huge government away with them. In this sense, the story is more under- budget deficits) have already been deployed leaves open standable and innocent than the standard tale of calcu- the disquieting question of what would happen if the lated greed and dishonesty. economic system again lurched violently into reverse. But the story is also more disturbing in that it batters The economic theorems and tools that we thought could our faith that modern —whether of the Left forewarn and protect us are more primitive than we or Right—can protect us against great instability and imagined. We have not traveled so far from the panic- insecurity. The financial panic and subsequent Great prone economies of 1857, 1893, and 1907 as we Recession have demonstrated that the advances in eco- supposed. nomic management and financial understanding that supposedly protected us from violent business cycles— ruling out another —were oversold, ur experience since 2007 has also revealed a exposing us to larger economic reversals than we thought huge contradiction at the center of our pol- possible. It’s true that we’ve so far avoided another Oitics. Prosperity is almost everyone’s goal, depression, but it was a close call, and the fact that all the but too much prosperity enjoyed for too long tends to

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destroy itself. It seems that periodic recessions and lation, misaligned pay incentives, and a mindless burst bubbles—at least those of modest proportions— devotion to “free markets” and “efficient markets” serve a social purpose by reminding people of eco- theory. The result, it’s said, was an orgy of risk taking, nomic and financial hazards and by rewarding pru- unrestrained either by self-imposed prudence or sen- dence. Milder setbacks may avert less frequent but sible government oversight. Mortgage brokers and larger and more damaging convulsions—such as the others relaxed lending standards for home mort- one we’re now experiencing—that shake the country’s gages because they were not holding them but pass- very political and social foundations. But hardly any- ing them on to investment bankers, who packaged one wants to admit this publicly. What politician is them in increasingly arcane securities, which were going to campaign on the slogan, “More Recessions, then bought by other investment entities (pension Please”? funds, hedge funds, foreign banks). These investors In a more honest telling of the story, avaricious were in turn reassured because the securities had Wall Street types, fumbling government regulators, received high ratings from agencies such as Moody’s, and clueless economists become supporting players Standard & Poor’s, and Fitch. All along the financial supply chain, people had incentives to minimize or ignore risks because the THE PROBLEM WAS NOT absent volume of loans, securiti- zations, or ratings deter- regulation; it was that regulators were no mined their compensa- tion. The more they smarter than the regulated. ignored risk, the more they earned. The result was a mountain of bad in a larger tragedy that is not mainly of their making. debt that had to collapse, to the great peril of the If you ask who did make it, the most honest answer entire financial system and the economy. is: We all did. Put differently, the widely shared quest The Right’s critique blames the crisis mainly on for ever-improving prosperity contributed to the con- government, which, it is alleged, encouraged risk ditions that led to the financial and economic col- taking in two ways. First, through a series of inter- lapse. Our economic technocrats as well as our politi- ventions in financial markets, it seemed to protect cians and the general public constantly strive for large investors against losses. Portfolio managers and expansions that last longer, that falls lenders were conditioned to expect . Profits lower, economic growth that increases faster. Amer- were privatized, it said, and losses socialized. In 1984, icans crave booms, which bring on busts. That is the government bailed out Continental Illinois National unspoken contradiction. Bank and Trust Company, then the nation’s seventh- Naturally, it’s unwelcome and unacknowledged. largest bank. In the early , the Treasury rescued What we want to hear is that we were victimized and , thus protecting private creditors who had that, once the bad actors and practices are purged, we invested in short-term Mexican government securi- can resume the pursuit of uninterrupted and greater ties. The protection continued with the of prosperity. So that’s what most crisis postmortems the hedge fund Long-Term Capital Management in aim to do. They tell us who’s to blame and what we 1998. After the tech bubble burst in 2000, the Fed- must accomplish to resume the quest for ever greater eral Reserve again rescued investors by lowering prosperity. Good policies will replace bad. To simplify interest rates. only slightly, the theories of the crisis into two The second part of the Right’s argument is that camps—one from the Left, one from the Right. government directly inflated the bubble by keeping From the Left, the explanation is greed, deregu- interest rates too low (the ’s key rate

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fell to one percent in 2003) and subsidizing housing. almost failed. They had lent billions of dollars to In particular, and — Mexico, , and other developing countries— government-created and -subsidized institutions— loans that could not be repaid. If banks had been underwrote large parts of the mortgage market, forced to recognize these losses immediately, much of including subprime mortgages. the banking system would have been “nationalized,” We can test these theories of the crisis against writes William Isaac, who headed the Federal Deposit the evidence. Note: Each aims to answer the same Insurance Corporation between 1981 and 1985, in questions. Why did the system spin out of control? his recent book Senseless Panic. Losses would have What caused the surge in borrowing by households depleted banks’ reserves and capital. Instead, regu- and financial institutions? What led to the decline in lators temporized. They allowed bad loans to be refi- lending standards and, as important, the misreading nanced until banks’ capital increased sufficiently to of risk, even by supposedly sophisticated players and bear the losses. Still, regulators weren’t smart enough observers? to prevent the loans from being made in the first place. As for greed and dishonesty, their role in the cri- et’s start with the critique from the Left. The sis is exaggerated. Of course, greed was widespread presumption is that with adequate regula- on Wall Street and elsewhere. It always is. There was L tion, problems would have been identified also much mistaken analysis about the worth of mort- and corrected before they reached crisis proportions. gages and the complex securities derived from them. Although this analysis seems plausible—and has been But being wrong is not the same as being dishonest, embraced by many journalists, economists, and and being greedy is not the same as being criminal. politicians, and by much of the public—it rests on a In general, banks and investment banks weren’t uni- wobbly factual foundation. For starters, many major versally offloading mortgage securities known to be players were regulated: Multiple agencies, including overvalued. Some of this happened; testimony before the Federal Reserve, supervised all the large bank- the Financial Crisis Inquiry Commission shows that holding companies, including , Bank of some banks knew (or should have known) about the America, and . , a large poor quality of mortgages. But many big financial mortgage lender that had to be rescued and was institutions kept huge volumes of these securities. merged into JPMorgan Chase, was regulated by the They, too, were duped—or duped themselves. That’s Office of Thrift Supervision. Fannie and Freddie were why there was a crisis. Lynch, , regulated. To be sure, gaps existed; many mortgage and Wachovia, among others, belonged to this group. brokers were on loose leashes. But there was enough If anything, the Right’s critique—Wall Street oversight that alert regulators should have spotted became incautious because government conditioned problems and intervened to stop dubious lending. it to be incautious—is weaker. It’s the textbook “moral The problem was not absent regulation; it was hazard” argument: If you protect people against the that the regulators were no smarter than the regu- consequences of their bad behavior, you will incite lated. By and large, they didn’t anticipate the troubles bad behavior. But this explanation simply doesn’t that would afflict subprime mortgages or the devas- fit the facts. Investors usually weren’t shielded from tating financial and economic ripple effects. The idea their mistakes, and even when they were, it was that regulators possess superior wisdom rests mainly not possible to know in advance who would and on the myth that tough regulation in the 1970s and wouldn’t be helped. In 1984, the shareholders of Con- ’80s prevented major financial problems. History tinental Illinois weren’t protected; when the FDIC says otherwise. In the 1980s, more than 1,800 banks rescued the bank, it also acquired 80 percent of the failed, including savings and loan associations. Their company’s stock. When the Federal Reserve orches- problems were not anticipated. trated a bailout of Long-Term Capital Management More important, many of the largest U.S. banks in 1998, most of the original shareholders lost the

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majority of their stake. After the bursting of the stock Greenspan and ), most investors, most market bubble in 2000, most investors weren’t traders, most bankers, the rating agencies, most gov- spared massive paper losses, even with Alan ernment regulators, most corporate executives, and Greenspan’s easy money. From the market’s peak in most ordinary Americans. There were, of course, early 2000 to its trough in October 2002, stock val- exceptions or partial exceptions. ues dropped 50 percent, a wealth loss of about $8.5 warned against the dangers of financial derivatives— trillion, according to the investment advisory firm but did not anticipate the problem of mortgages. In Wilshire Associates. The Big Short (2010), journalist chron- Likewise, many investors weren’t protected in the icled the tale of professional investors who were dis- current crisis. The share prices of most major finan- missed as oddballs and deviants when they correctly cial institutions—even those that survived—declined questioned the worth of subprime mortgages. Econ- dramatically. The stockholders of Bear Stearns and omist foresaw the connections suffered massive losses, and their between fragile financial markets and the real econ- executives and employees were among the biggest omy, but his early pessimism was a minority view. losers. Fannie and Freddie’s shareholders met a sim- People are conditioned by their experiences. The ilar fate. Institutions that were “” did fail most obvious explanation of why so many people did in a practical sense. It is true that, both before and not see what was coming is that they’d lived through after the present crisis, some creditors were shielded. several decades of good economic times that made Foreign lenders in the Mexican of the them optimistic. Prolonged prosperity seemed to sig- early 1990s were protected, and most (though not all) nal that the economic world had become less risky. Of lenders to major financial institutions were protected course, there were interruptions to prosperity. Indeed, in the present crisis. But to repeat: The protections for much of this period, Americans groused about the were not pervasive or predictable enough to inspire economy’s shortcomings. Incomes weren’t rising fast the sort of reckless risk taking that actually occurred. enough; there was too much inequality; unemploy- As for interest rates, it is probably true that the ment was a shade too high. These were common very low rates adopted by Greenspan (the one percent complaints. Prosperity didn’t seem exceptional. It rate on overnight loans lasted from June 2003 to seemed flawed and imperfect. June 2004, and even after that, rates remained low That’s the point. Beneath the grumbling, people of for several years) contributed to the speculative cli- all walks were coming to take a basic stability and mate. Some investors did shift to riskier long-term state of well-being for granted. Though business bonds in an attempt to capture higher interest rates, cycles endured, the expectation was that recessions and the additional demand likely reduced the return would be infrequent and mild. When large crises on these bonds somewhat. But a bigger effect on loomed, governments—mainly through their central long-term rates, including mortgages, seems to have banks, such as the Federal Reserve—seemed capable come from massive inflows of foreign money over of preventing calamities. Economists generally con- which the Federal Reserve had no control. Moreover, curred that the economy had entered a new era of rel- the fact that housing booms also occurred in , ative calm. A whole generation of portfolio man- , and , among other countries, seems to agers, investors, and financial strategists had profited exonerate the Fed’s interest rates policies as the main from decades of exceptional returns on stocks and cause of the housing bubble. bonds. But what people didn’t realize then—and still don’t—is that almost all these favorable trends flowed in one way or another from the suppression of high he central question about the crisis that must inflation. be answered is, Why was almost everyone It’s hard to recall now, but three decades ago, T fooled? “Almost everyone” includes most inflation was the nation’s main economic problem. It economists (starting with Fed chairmen Alan had risen from negligible levels of about one percent

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in 1960 to about six percent at the end of the 1960s lasted a total of 49 months, or about four years out of and to 12 to 14 percent in 1979 and 1980. Hardly any- 13. Peak unemployment, 10.8 percent as noted, was one believed it could be controlled, although it was a much higher than in the following quarter-century, source of deepening havoc, spurring four recessions when it topped out at 7.8 percent. Economists called since 1969, a stagnant stock market, and rising inter- this subdued “the ,” est rates. And yet, the pessimists were proven wrong. and wrote papers and organized conferences to A wrenching recession—deliberately engineered by explore it. But the basic explanation seemed evident: then–Federal Reserve chairman Paul Volcker and High and rising inflation was immensely destabiliz- supported by the newly elected Ronald Reagan— ing; low and falling inflation was not. smothered inflationary psychology. It did so in a con- Declining inflation also stoked stock market and ventionally destructive way. Volcker tightened credit. housing booms. By the end of 1979, the Standard & Banks’ prime interest rates, the rates they charged on Poor’s 500 index had barely budged from its 1968 loans to their best customers, averaged 19 percent in level; by year-end 1999, it had risen by a factor of 14. 1981. There were gluts of jobless workers (unem- The rise in housing prices was less steep, though still ployment reached 10.8 percent in late 1982), under- impressive. In 1980, the median-priced existing home utilized factories, and vacant stores and office build- sold for $62,000; by 1999, the median price had ings. But by 1984, inflation was down to four percent, climbed to $141,000. Declining interest rates pro- and by 2000 it had gradually declined to the pelled these increases. As inflation subsided—and as unthreatening levels of the early 1960s. Americans realized that its decline was permanent— When Americans think of this inflation—if they interest rates followed. From 1981 to 1999, interest think of it at all—they focus on inflation’s rise and rates on 10-year Treasury bonds fell from almost 14 ignore the consequences of its fall, . But percent to less than six percent. Lower rates boosted these consequences were huge and mostly benefi- stocks, which became more attractive compared with cial. The two recessions that occurred between 1982 bonds or money market funds. Greater economic and 2007—those of 1990–91 and 2001—each lasted stability helped by making future profits more cer- only eight months. Over an entire quarter-century, tain. Lower interest rates increased housing prices by the economy was in recession for a total of only 16 enabling buyers to pay more for homes. months, slightly more than a year. By contrast, the Millions of Americans grew richer. From 1980 to four recessions that struck between 1969 to 1982 2000, households’ mutual funds and stocks rose in

12%

Inflation rate 9 10-year Treasury bond rate

6

3

0 1960 1970 1980 1990 2000 2009 Sources: Bureau of Labor Statistics and Department of the Treasury Disinflation and declining interest rates beginning in the 1980s lulled Americans into thinking economic wizardryhad eliminated economic instability.

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value from $1.1 trillion to $10.9 trillion. The 10-fold riskier strategies, because markets were less frenetic. increase outpaced that of median income, which In particular, they could add “leverage”—i.e., borrow roughly doubled during the same period, reaching more—which, on any given trade, might enhance $42,000. Over the same years, households’ real estate profits. wealth jumped from $2.9 trillion to $12.2 trillion. So, paradoxically, the reduction of risk prompted Feeling richer and less vulnerable to recessions, Americans to take on more risk. From 1995 to 2007, Americans borrowed more (often against their higher grew from 92 percent to 138 percent of disposable income. Bear Stearns, Lehman Brothers, and other AMERICANS DIDN’T THINK they were financial institutions became heavily depend- behaving foolishly because so many people ent on short-term loans that underpinned lever- were doing the same thing. age ratios of 30 to 1 or more. (In effect, firms had $30 of loans for every home values). This borrowing helped fuel a con- $1 of shareholder capital.) Economists and govern- sumption boom that sustained . ment regulators became complacent and permissive. Disinflation had, it seemed, triggered a virtuous cir- Optimism became self-fulfilling and self-reinforcing. cle of steady economic and wealth growth. Americans didn’t think they were behaving foolishly It was not just the real economy of production and because so many people were doing the same thing. that seemed to have become more stable. Finan- This—not or investor “moral hazard”— cial markets—stocks, bonds, foreign exchange, and was the foundry in which the crisis was forged. securities of all sorts—also seemed calmer. Volatility, What now seems unwise could be rationalized a measure of how much prices typically fluctuate, then. Although households borrowed more, their declined in the early . Sophisticated investors wealth expanded so rapidly that their net worth—the and traders understood this. Studies confirmed it. difference between what they owned and what they Finally, government economic management owed—increased. Their financial positions looked seemed more skillful. The gravest threats to stability stronger. From 1982 to 2004, households’ net worth never materialized. In October 1987, the stock mar- jumped from $11 trillion to $53 trillion. Ascending ket dropped a frightening 20 percent in a single day, home prices justified easier credit standards, because but that did not trigger a deep recession. Neither did if (heaven forbid) borrowers defaulted, loans could be the 1997–98 Asian financial crisis (when some coun- recouped from higher home values. Because the rat- tries defaulted on loans) or the bursting of the tech ing agencies adopted similarly favorable price bubble in 2000. In each case, the Federal Reserve assumptions, their models concluded that the risks of seemed to check the worst consequences. Faith in the mortgage-backed securities were low. No less a figure Fed grew; Greenspan was dubbed the “maestro.” than Greenspan himself dismissed the possibility of Well, if the real economy and financial markets a nationwide housing collapse. People who sold a were more stable and the government more adept, house usually had to buy another. They had to live then once risky private behaviors would be perceived somewhere. That process would sustain demand. as less hazardous. People could assume larger debts, “While local economies may experience significant because their and repayment prospects were bet- speculative price imbalances,” he said in 2004, “a ter and their personal wealth was steadily increasing. national severe price distortion seems most unlikely.” Lenders could liberalize credit standards, because As time passed, the whole system became more borrowers were more reliable. Investors could adopt fragile and vulnerable. If the complex mortgage secu-

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rities held by banks and others began to default—as If this explanation of the crisis is correct, it raises they did—then the short-term loans that were used to momentous questions. Since World War II, American finance the purchase of these securities would be democracy has been largely premised on its ability to curtailed or withdrawn, threatening the banks’ sur- create ever greater economic benefits—higher living vival. Because no one knew precisely which banks standards, more social protections, greater job and held which securities (and, therefore, which banks income —for most of its citizens. The prom- were weakest), this process—once started—could ise has largely succeeded and, in turn, rests heavily on cause a panic within the financial system. Banks, the belief, shared unconsciously by leaders in both hedge funds, pensions, and corporations would parties, that we retain basic control over the economy. retreat from trading and lending for fear that they Until recently, the consensus among economists was might not be repaid. As banks and companies that another Great Depression was unthinkable. We hoarded cash, production and jobs would decrease. could prevent it. As for recessions, we might not be Basically, that’s what happened. The initial reaction able to eliminate them entirely, but we could regulate to disinflation, reflecting its real benefits, had disin- them and minimize the damage. Economic knowl- tegrated into overborrowing, speculation, and self- edge and management had progressed. These com- deception. forting assumptions now hang in doubt. The great delusion of the boom was that we mis- took the one-time benefits of disinflation for a per- t’s worth noting that this explanation of the pres- manent advance in the art of economic stabilization. ent crisis is neither widely held nor original. It We did so because it fulfilled our political wish. Iron- Ivindicates Charles Kindleberger, the late eco- ically, the impulse to improve economic perform- nomic historian who argued in his 1978 book ance degraded economic performance. This hap- Manias, Panics, and Crashes that financial crises pened once before, in the 1960s and ’70s, when occur in three stages. First comes “displacement”: a academic economists—among them Walter Heller favorable development such as new technology, the of the University of Minnesota, James Tobin of end of a war, or a change in government that Yale, and Robert Solow of MIT—sold political lead- improves the economic outlook. Next is “euphoria”: ers on an ambitious agenda. Despite widespread the process by which a proportionate response to the post–World War II prosperity, there had been reces- original development becomes an artificial “bubble.” sions every three or four years. Invoking John May- The last stage is “revulsion”: the recognition of nard Keynes, the economists said they could—by excesses, which leads to panic and a collapse of spec- manipulating budget deficits and interest rates— ulative prices. smooth business cycles and maintain “full employ- Beginning in the 1980s, the U.S. economy fol- ment” (then defined as four percent unemployment) lowed exactly this pattern. The decline of double- most of the time. They couldn’t, and the effort to do digit inflation was the original “displacement.” The so created the inflation that crippled the economy for ensuing prolonged prosperity spawned “euphoria,” 15 years. which culminated in the “revulsion” and panic of We still haven’t forsaken the hope for perfected 2008. But Kindleberger’s views—which built on those prosperity. After the recent crisis, both liberals and of Hyman Minsky—have never com- conservatives offered therapeutic visions. Liberals manded center stage among academic economists. promoted expanded regulation to curb Wall Street’s Though widely read and respected, Kindleberger was excesses. Conservatives wanted a less activist gov- always something of a renegade. He expressed skep- ernment that would let markets perform their disci- ticism and even contempt for the mathematical mod- plining functions. Both may achieve some goals. Lib- els and theoretical constructs that have defined main- erals have already engineered greater regulation. stream macroeconomics for decades, while paying Banks will be required to hold more capital as a cush- great attention to historical conditions and events. ion against losses. The new financial reform legisla-

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tion would allow government to shut large failing Great Recession constitute a watershed for global financial institutions, such as Lehman Brothers, with- capitalism, which has been (it’s said) permanently out resorting to disruptive bankruptcy. Conserva- discredited. Around , the political pendulum tives may take solace from fewer bailouts. They are so is swinging from unfettered competition toward more unpopular that investors must know that the chances government oversight. Markets have been deemed of getting one have diminished. Together, these incorrigibly erratic. Greed must be contained, and the changes may make the financial system safer. greedy must be taxed. These ideas reflect a real shift The trouble is that, like generals fighting the last in thinking, but in time that may not be seen as the war, we may be fighting the last economic crisis. main consequence of the . These Future threats to stability may originate elsewhere. ideas imply that capitalism was unsupervised and One danger spot is . Economies are untaxed before. Of course, this is not true. Businesses intertwined in ways that are only crudely understood. everywhere, big and small, were and are regulated Supply chains are global. Vast sums of money rou- and taxed. Future changes are likely to be those of tinely cross borders and shift among currencies. degree, in part because countervailing forces, mobile Countries are mutually dependent and mutually vul- capital being the most obvious, will impose limits. nerable through many channels: Supplies of oil and Countries that oppressively regulate or tax are likely other essential raw materials may be curtailed; cyber- to see businesses go elsewhere. attacks could cripple vital computer networks; manipulated exchange rates might disrupt trade and investment flows. Economic activity has grown more hat looms as the most significant legacy of international, while decision making remains largely the crisis is a loss of economic control. with nation-states. Although the global economy has W Keynes famously remarked that “practical remained basically stable since World War II, there men” are “usually the slaves of some defunct econo- is really no good theory as to why it should stay so— mist.” By this he meant that politics and public opinion and there are some signs (currency tensions, for are often governed by what economists (living and dead, instance) that it may not. actually) define as desirable and doable. In the years after Overcommitted welfare states pose another threat. World War II, the prevailing assumption among econ- Most affluent nations face similar problems: High omists, embraced by much of the public, was that we had budget deficits and government debts may portend a conquered the classic problem of booms and busts. loss of investor confidence, but the deficits and debts Grave economic crises afflicted only developing countries have been driven higher by massive social spending— or developed countries that had grossly mismanaged on pensions, health care, unemployment insurance, their affairs. This common view is no longer tenable. It education—that people have come to expect. Eco- has been refuted by events. nomics and politics are colliding. If the debt and Our economic knowledge and tools came up short. deficits aren’t controlled, will investors someday Either they were overwhelmed by change or their desert bond markets, jolting interest rates upward power was always exaggerated. This does not mean and triggering a new financial crisis? But if many that economic growth will cease. Chances are that the countries try to control deficits simultaneously, might and the other prosperous nations of the a tidal wave of spending cuts and tax increases cause developed world will, over time, get wealthier as a a global depression? (The United States, , and result of technological changes that are now barely still constitute about half the world’s econ- glimpsed. But the widespread faith—and the sense of omy.) These are all good questions without good security it imparted—that economic management answers. The underlying problem is that economic would forever spare us devastating disruptions has change seems to have outrun economic understand- been shattered. Just as there has never been a war to ing and control. end all wars, there has yet to be an economic theory It’s widely believed that the financial panic and that can end all serious instability. ■

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