Another category of books focuses on a narrow aspect of the crisis, such as a single financial institution or an aspect that the author(s) thinks has been ignored in other crisis-related books. Political Bubbles falls in the latter category, detailing the political aspects of the buildup and response to the crisis. Political issues are certainly addressed in small doses in other books, but I am not aware of any other book that is almost completely dedicated to the issue. The promotional materials for this book confidently note that it “reveals how politics are responsible for financial disasters.”
The book’s introduction gets off to a promising start on who gets the blame for the crisis:
We focus on the national government in Washington, D.C. To be precise, we put much of the responsibility for the crisis and the failure to undertake genuine reform of the American financial system squarely on members of Congress, on Presidents Jimmy Carter, Ronald Reagan, George H. W. Bush, Bill Clinton, George W. Bush, and Barack Obama and on those they chose to serve in their cabinets and in the Executive Office in the White House and to run regulatory agencies, including the Federal Reserve and the Securities and Exchange Commission…. [Political actors] allowed the crisis to develop and inhibited response after the crisis was front and center in the public eye.
This sounds good, but it becomes clear as the book advances that, although the authors state that they see “policy errors of commission and omission,” they think a more activist and draconian interventionist response cooked up in Washington was called for: “Policy makers could have avoided the crisis by closely regulating or even prohibiting the [housing finance] products.”
Definitions / One of the first tasks the authors tackle is to define political bubbles:
[Political bubbles are] a set of policy biases that foster and amplify the market behaviors that generate financial crises. Political bubbles are pro-cyclical. Rather than tilting against risky behavior, the political bubble aids, abets and amplifies it. During a financial bubble, when regulations should be strengthened, the political bubble relaxes them. When investors should hold more capital and reduce leverage, the political bubble allows the opposite. When monetary policy should tighten, the political bubble promotes easy credit.
What this definition misses is that political bubbles are most likely to flourish in sectors where the government intervenes and, in the process, distorts decisionmaking by incentivizing certain behavior (i.e., homeownership in the case of the recent housing bubble).
The book’s authors then go to great lengths to define a political model based on three factors (“The Three I’s”) that they argue have been impediments to successful policymaking regarding financial regulation: ideology (Chapter 2), interests (Chapter 3), and institutions (Chapter 4). Ideology is a rigid set of beliefs about how the world works and what is right and wrong (in contrast to pragmatism). The authors demonstrate that the U.S. political system has become more polarized, ideology is more important, and there is no ideological overlap between the parties. Interests are the efforts of those that impede regulation by seeking government relief or attempting to influence political decisionmakers by mobilizing constituencies, financing campaigns, and providing information to legislators or lobbying them. The authors demonstrate that banking, financial, and real estate interests have outsized influence in preserving their interest. Finally, institutions are those government structures—such as regulatory agencies, the courts, the Senate (filibuster), and the president (veto power)—that act as a roadblock to regulation and reform. The authors argue the influence of “free market conservatism” has exacerbated those roadblocks.
This initial discourse regarding the concept of a political bubble and the elements of the authors’ political model takes up the first 115 pages or so of the book (over 40 percent of the book’s narrative). Much of it reads like an undergraduate text in political science, with ideology scores and bar charts analyzing by party some of the key votes during the run-up to the crisis. I consider myself to be interested in the finer details of politics, but I found it difficult to read the detailed discussion of the various models of politics set forth by the authors and I believe most readers will be in that position. This material could have been addressed in a briefer manner and integrated into the narrative about the financial crisis.
Deregulation? / The next chapter (Chapter 5) begins the meat of the discussion, as its focus is on the political bubble of the crisis of 2007–2008. The chapter gets right the causes and properly blames Democrats and Republicans alike for pushing government policy toward increased homeownership. It illustrates this point with two on-point quotations from our back-to-back two-term presidents (Clinton and Bush 43) extolling the virtues of rising homeownership and taking political credit for the phenomenon. The quotations perfectly capture the interventionism of the pair, both of them seemingly unaware of the financial bubble that they are creating in the process.
The quotes segue into a chart showing the result of their interventionism as the overall homeownership rate was unnaturally driven from the mid-60 percent range in the early 1990s up to a bubble-producing level near 70 percent and then, as the bubble burst, back down to where it was in the mid-1990s. This chart allows the reader to visualize the wrenching angst our economy and financial system went through over this 20-year period of failed housing policy, leading the authors to conclude, “In broad categories of American society, no group benefited from the policies of the Clinton and Bush years.” Elsewhere the authors succinctly summarize the political reasons for the housing bubble, giving an example of one of their “Three I’s”: “In short, a variety of government policies favor housing. Interests fight for these policies.”
However, the logic of the chapter deteriorates into a critique of the deregulation “bogeyman.” At the core of the authors’ argument is their claim that about a dozen pieces of legislation or other regulatory actions enumerated at the end of the chapter (so-called “deregulation”) combined with housing policy to produce the bubble. Rather than dedicate an entire chapter to a detailed analysis of each of those actions (which seems logical), there is merely a superficial analysis of the earliest two cited legislative acts, while the many other acts are not thoroughly addressed or explained in detail.
The conclusion from the review of the two legislative acts is clear: “interest rate ceilings and usury laws represent a form of social insurance for the poor,” and “adjustable rate mortgages” prey on “unsophisticated borrowers.” The argument comes down to a form of paternalism (“financial naiveté of many borrowers”) that I would summarize as the poor are not very smart and can easily be taken advantage of, so we have to impose price controls and other restrictions on the mortgage market. The authors even admit the likely consequences of their prescription: “Of course, this rationing may hurt the poor, but there are far better policy responses to poverty than promoting credit and debt.”
Democracy? / Much of the remainder of the book traces the response to the crisis. One questionable line of argument is that delays in responding to the financial crisis were largely attributable to “American democracy.” This ignores the power and role that the financial supervisory agencies possess in the modern regulatory state. These agencies have wide-ranging powers, but in the early stages of a crisis they were consistently in denial regarding the extent of the problems because of their unwillingness to recognize their own inadequacies in their role as an early-warning system for problems in the industry. The classic Bernanke quote of “we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system,” and of James Lockhart (the regulator of Fannie Mae and Freddie Mac) maintaining until weeks before the two housing giants melted down that they were “adequately capitalized,” are two clear examples of this phenomenon.
The authors reveal their political biases throughout the book in comments that at times degenerate into snarky name-calling. The object of their derision is variously described as “free market conservatism,” “fundamentalist free market capitalism,” and an “extreme form of free market conservatism,” and they use such labels as “ardent advocate of free market conservatism,” “extreme conservative,” “extreme libertarians,” “elite fundamentalist free market conservatives,” “pack of ideologues,” “fundamentalists,” “antigovernment ideologues,” and “free market ideologues.” The authors lay most of the blame on political followers of these philosophies for political bubbles and the financial crises that follow: “But the belief structure most conducive to supporting political bubbles is what we term free market conservatism,” which in its simplest form is the belief that “government intervention in the economy is bad per se, no matter what.”
However, the authors only come to this conclusion by wrongly conflating crony capitalism with those that truly extol the virtues of the free market: “The crony capitalism of the 1980s, shrouded in the virtues of free market conservatism, led directly to the blowup in 2008,” and “crony capitalists and free market ideologues would later bond.” A case study of Fannie Mae and Freddie Mac, which are discussed extensively throughout the book, is a perfect example of the distinction. “Crony capitalists” were the beneficiaries of government housing policy that saw Fannie and Freddie as a free lunch, while those truly extolling the “free market” saw the pair as a rigged system of political and industry favoritism combined with excessive leverage that was bound to implode during a housing crisis. True advocates of a free market in mortgage finance, such as Peter Wallison at the American Enterprise Institute and many a scholar writing for the Cato Institute, had been advocating for the destruction of Fannie and Freddie’s government-sponsored status as far back as the early 1990s. In a Venn diagram, true free market advocacy (or any number of the other descriptors the authors use) does not overlap with crony capitalism.
So to return to the claim that the book “reveals how politics are responsible for financial disasters” and to judge the book on that basis, at times it meets this lofty goal and other times it falls short. The book is at its best when its arguments are well conceived, laid out, and supported with relevant quotes by policymakers and explanatory charts and tables. It falls short when it strays from that approach and resorts to name-calling and lapses in logic.
