Inside Job: Story of the Crisis
The Oscar winning movie “Inside Job” is a documentary on the financial crisis of 2008, showing a chain of events leading up to the final crisis and the aftermath following. Inside Job takes its cue from the Reagan administrations move to relax rules on banks and other business during the 1980’s, leading to a huge boom in the financial sector. Over the next 30 years, the gradual removal of rules continued such as the dropping of the Glass-Steagall barrier between deposit and investment banking. The growth of the securitization market at the same time lead to a boom in derivative instruments, especially of the type built on consumer debt. The stage was set for a period of easy credit thanks to the idea that securitization offered protection to banks from the risk of default. Mortgages became a major growth area of banks, confident that derivatives made them profitable and risk-free.
After several years of building increasingly complex derivatives, several funds had to turn down investors who wanted their money back due to cash flow problems. Once it became clear that a huge number of derivative backed investments would not be honored, people scrambled to collect the security money offered by other derivatives, only to find that thanks to duplication and cross-linking of these instruments, many of these were also worthless. The resulting financial panic triggered the financial crisis. Mortgages, lending and spending all collapsed in the aftermath of the sudden credit crunch. Increasing globalization meant that foreign banks were also exposed to the derivative market, and in some cases had duplicated the same structures abroad. This led to a global contagion, and the near collapse of many financial institutions. A government bailout was needed to protect many firms judged “too big to fail” from failing, at the cost of the taxpayer.
Despite the enormous impact of the crisis on people around the world, few were held accountable for the disaster. A number of people did defend their actions, and many senior executives continued to receive extremely high pay and “golden handshakes” upon leaving their companies. Not only that, but the benefit of the government actions to contain or remedy the crisis seems to have gone to the already wealthy, whose wealth has increased significantly while the overall economy and employment stay stagnant or decline. This has led to deepening inequality in all dimensions – economic, social, personal. The culture of personal privilege and excess amongst the financial elite continues, with no end in sight of either the crisis or the power of the people who caused it (Inside Job, 2010).
Inside Job does a good job of analyzing the historical and human elements of the crisis. Undoubtedly, the steady relaxation in business rules and regulations that spurred not just financial expansion, but financial inter-connectedness, had a major role to play in the crisis. This is the 1st major reason for the crisis – that things which would have prevented it were removed. The skewed and disproportionate impact of the crisis upon different groups is also covered well, highlighting that the impact of failure was not felt by those who were making the decisions. The film’s tone is angry, with injustice being a major theme.
However, in some ways the film falls short. The most prominent missing element is that it makes no mention of the people, the public at large, and their role in the fostering the environment of the crisis. The Reagan era moves to free business from regulation were part of a wider ideological agenda with wide support amongst much of the American public (or, at least, the electorate). The housing credit boom was also deliberately encouraged by Fed chief Alan Greenspan, and welcomed by the American people as a sign of prosperity. The credit glut was eagerly bought into by one and all, and the story that a perpetual economic boom was underway, boosted by the apparent victory of Capitalism over Communism during Reagan’s time, was almost an unquestionable holy cow.
It’s therefore not correct to blame only a small group of people. While it is correct that incentives were bad and a lot of bankers committed illegal acts, the financial crisis was caused by instruments and investments that were generally totally legal. The system was supported by economists, commentators, politicians and philosophers (academic and self-styled), and so there isn’t any surprise that individual blame was not assigned to bankers in a legal sense. While the people may be angry and want to see some punishment, it’s not the same as the kind of reflection and critical thinking that can understand the crisis and make differences in the future. In my opinion, the 2nd important reason for the crisis is human nature itself; specifically the short-termism, greed and selfishness that is often the basis for economic rationality.
In connection with this is the peculiar historical significance of housing in America, another subject little covered by the film. In fact, it was during the New Deal period that the government created the modern housing market with the GSE’s supporting 30 year mortgage terms, making housing possible to the middle class. This use of access to property ownership as a social equalizer is close to, or maybe the same motive that Greenspan had 60 years later during the Clinton administration (Hoffman, 1996). Many biases and myths surround property, such as that house prices never fall (correct to “fell” in the post crisis era). Ownership is also linked to intangible ideas such as the American Dream, family, maturity, responsibility, all of which would have contributed to banks and rating agencies’ confidence in instruments with property values underlying them. This cultural impact, with many small biases in the decisions of thousands of bankers and others, is the 3rd major reason behind the crisis.
In the Aftermath, or Repair and Prevention
The bailout to the banks may well be justified, it is hard to know for sure whether they were too big to fail or not. However, the damage caused is clear and huge. In many ways, the financial collapse has triggered massive and permanent changes, possibly including permanent economic and political polarization in the US. However, the financial sector itself remains caught in the derivative web. Further, the regulations upon the sector are still weaker than they were before Reagan started loosening them. Case in point: the separation between deposit and investment banking, the return of which is stridently opposed by financial institutions.
One of the key reforms proposed, the Brown-Kaufman amendment, failed to become part of the bill. The amendment called for the breakup of too-big-to-fail banks (CSM, 2010). There is plenty of precedent in the US for the forced breakup of huge companies, such as Standard Oil and Bell Communications in the past. However the proposal was defeated. A milder restriction on risky investments by deposit holding banks, commonly called the Volcker rule, was adopted, but has been delayed due to opposition from banks. The Federal Reserve has continuously extended the deadline to implement the rule. The current deadline is July 21, 2016, but the Fed has hinted it may extend it further to 2017.
In the meantime, economic growth and job creation have been problematic issues since the crisis. Central banks have poured money into the system in an attempt to spur growth, but have largely seen the impact restricted to rising prices of gold and stock markets and property (again). Unemployment figures have not returned to their pre-crisis levels, and economists are wondering whether we are at a “new normal” of unemployment levels. Wages have hardly risen in real terms, while the cost of essential services such as medical care has risen fast. Overall inflation however, is still low. The government has lacked the political will to tackle the long-term problems, and has not proved adept enough (or lucky enough) to tackle the short term problems.
Thoughts and Suggestions
The rise and rise of the financial sector over the decades up to the crisis was not only a bubble building but, while it lasted, a major source of jobs and income growth and other positive externalities. The demand from the people is really to find a new source of jobs and income as fast as possible, but the need from the economy is really for structural reforms that change the balance of the economy away from financial to real work and employment generating activity.
Leadership bias however, is definitely towards the first, since it is the immediate future that worries and frightens people (short-termism again). In several countries, asset price rise driven by monetary policy has hidden the huge cost of unemployment and loss of livelihoods. While it is right that people’s concerns be addressed, some thought needs to be given to more fundamental issues.
For instance, the breakup of big firms in the US is an essential part of any solution. Banks which are too large are not just a risky because of their size, but because of their complexity. In turn, the issue of breakup is not just a matter of riskiness but of size, meaning that some limits to company size may have to be adopted.
Also, economists might do well to study bubbles. It may be that there are other bubbles already existing that are ready to pop – perhaps the venture/start-up bubble.There has already been a dot-com bust before, but such losses are restricted in scope and impact, though some may be hurt more than others.
Works Cited
CSM. (2010, April 27). The weak spot in the financial reform bill. Christian Science Monitor. Retrieved March 23, 2016, from http://www.csmonitor.com/Commentary/the-monitors-view/2010/0427/The-weak-spot-in-the-financial-reform-bill
Ferguson, C. (Director). (2010). Inside Job [Motion picture on DVD]. United States: Sony Pictures Classic.
Hoffman, A. V. (1996). High Ambitions: The Past and Future of American Low-Income Housing Policy. Housing Policy Debate, 7(3). Retrieved March 23, 2016, from http://content.knowledgeplex.org/kp2/img/cache/documents/2336.pdf
