In the aftermath of the financial panic of September 2008 and the ongoing economic malaise of the global economy, economic historians need to identify the best sources for understanding what happened, the immediate causes and responses, the deeper causes, and longer-term consequences. The implications are profound for our current institutions, organizations, and related professions in government, banking, stock brokering, and even academia. In this article, I provide a preliminary guide to the material now available from a variety of sources—official, academic, and by journalists or former bankers. Already, the next generation of financial historians has a treasure trove of material to work through and it will be a challenge to keep up with new sources as they emerge.

For general background, and possibly as an assigned text for courses, the best bet is the 2011 report of the Financial Crisis Inquiry Commission, Financial Crisis Inquiry Report, downloadable at http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf as well as available in other media. Well-written and clearly intended for the general public, the FCIC report gives a general background to the crisis and the economic consequences. The story line, comforting to the Democrat majority on the commission, is that repeated failures of regulatory oversight, especially by the Republican appointees—Alan Greenspan at the Fed, and John Dugan at the Office of the Comptroller of the Currency—encouraged opportunistic mortgage brokers and subprime lenders to manipulate lower-income people into commitments for mortgages they clearly could never afford. Unscrupulous sales continued despite repeated alarms raised by consumer protection agencies at the state level. But state regulators were overruled again and again on grounds that federal regulation took precedence and they had no jurisdiction, especially after the laws passed in the mid- to late 1990s that imposed federal regulations on commercial banks that subscribed to the FDIC and on thrifts (formerly savings and loans limited to local areas) now regulated by the Office of Thrift Supervision. By effectively eliminating competition among regulatory agencies at the state level, the federal regulators undercut one of the historic advantages of American federalism—the possibility of experimentation among individual states to find more effective regulation. Unstated is that one motivation for federal deregulation was to give U.S. banks reciprocal access to the European Union's single financial market, established in 1992, in exchange for allowing European banks into the U.S. market.

The bias against the Republican-appointed regulators in the main body of the report was so obvious, however, that the Republican members of the commission entered two separate dissenting reports. The first simply defends the good intentions of the leading policymakers, especially Ben Bernanke as Greenspan's replacement; Henry Paulson, the ex-CEO of Goldman Sachs investment bank; and Tim Geithner, President of the New York Federal Reserve Bank. It makes the argument that housing bubbles occurred in other countries as well, which had stronger regulations. On that point, they are surely mistaken as far as financial regulation goes, as lack of European-wide financial regulation is a continuing problem for the European Central Bank, but they could have a point about lack of regulation in the housing mortgage market, which clearly was unique to the U.S. market.

The second dissenting report, written by Peter Wallison, a research fellow at the American Enterprise Institute and a member of the commission, is much more serious. Using evidence accumulated independently by a former official of Fannie Mae, Wallison argues that the problem really arose from directives imposed by the Department of Housing and Urban Development on Fannie Mae and Freddie Mac to broaden their base of insured mortgages. Starting in the mid-1990s, HUD directed them to include lower-income households. The goal was to increase homeownership in the United States from 64 percent to a higher level, which eventually topped out at over 69 percent. The evidence consists of reevaluating the mortgages either held directly by these Government Sponsored Enterprises or bundled into the Residential Mortgage Backed Securities that were insured by the GSEs. The Community Reinvestment Act, made stronger in 1995 by looking at the amount of loans actually made locally rather than simply the “good faith” efforts to invest locally, made the problem worse. Fannie Mae counted the mortgages initiated by banks as prime, even if the FICO scores of the borrowers would make them subprime, thereby misleading the commission on the extent of its culpability early on in the housing bubble or the extent to which the CRA mandates contributed to the problem. Clearly, instructors have a wealth of material at their disposal within the Commission Report and the two dissenting reports, which can be used as they wish!

The FCIC report was followed in April 2011 by the report of the bipartisan Senate Permanent Investigative Committee, which is available at http://hsgac.senate.gov/public/_files/Financial_Crisis/FinancialCrisisReport.pdf. The Senate report gives detailed case studies of practices leading to the crisis, pinpointing ill-advised, high-risk behavior by mortgage lenders (Washington Mutual), regulatory failure (the Office of Thrift Supervision), inflated credit ratings (Moody's and Standard and Poor's), and investment bank abuses (Goldman Sachs and Deutsche Bank). The individual case studies provide the justification for many elements of the Dodd-Frank bill that were specifically designed to remedy the practices that led to the financial crisis of 2008. Notably, however, the report overlooks the role of Fannie Mae and Freddie Mac in providing the background support for the housing bubble in the first place.

The third authoritative source I would recommend for graduate research papers is the report filed by the Lehman Brothers bankruptcy examiner, available online at lehmanreport.jenner.com. In its three volumes, the report provides details of the various assets acquired by the most aggressive of the Wall Street investment banks and the possible claims of creditors. Especially instructive is the insight into Lehman's regular use of Repo-105, a bit of international regulatory arbitrage that allowed Lehman Brothers to shift dubious assets from its U.S. office to London when quarterly reports were due in the United States. As the assets of Lehman are parceled out to the various creditors over time, students will have a wealth of material for evaluating in hindsight the investment strategies of that company and the assessments made in September 2008 by potential investors and regulators when Lehman was forced into bankruptcy.

The fourth and ongoing official source for uncovering the villains as well as the victims of the subprime crisis is the quarterly reports of the Office of the Special Inspector General for Oversight of the Troubled Asset Relief Program, available at http://www.sigtarp.gov/reports.shtml. The report of July 2011 (p. 5), for example, trumpets the success of the office in charging “65 individuals and 18 entities … in criminal or civil actions…with 25 individuals criminally convicted.” Although most attention is on the billions of dollars still invested in AIG, General Motors, and Ally Financial Inc., more than 500 of the 700 banks receiving TARP funds had not repaid the Treasury nearly three years later. Investigations by the new and newly empowered regulatory agencies will provide additional source material for years to come. Eventually, even a special investigation by the Department of Housing and Urban Development into the widespread practice of “robo-signing” mortgage documents without any pretense of due diligence in the origination of loans by both banks and specialized lenders may come into the public domain.

Turning to the more academic contributions to date, Jeffrey Friedman, ed., What Caused the Financial Crisis, follows up the dissenting view in the FCIC report that it was not lack of regulation but rather misguided regulation that lay at the heart of the crisis. The individual contributors provide a wealth of material, both pro and con on the role of government in the crisis. Friedman introduces the volume with a philosophical discussion of the role of repeated crises in the history of capitalism and the culpability of either capitalists (bankers in this case) or government (regulators in this case). Despite the incentives for each set of players to undertake risky activities, Friedman argues that ignorance of the uncertainty surrounding any future venture is ultimately the more powerful explanation of how and why both regulators and capitalists led us into the crisis. Perhaps, but would former President Bush be satisfied by this appraisal?

Particularly well done, however, is Friedman's explanation how international bank regulations, first Basel I as interpreted in the United States and then Basel II as implemented in Europe, led to commercial banks taking on more risk in the form of mortgage-backed securities. At first, these securities were rated highly enough to warrant reduced capital requirements, and off-balance sheet commitments were subject to even lower capital requirements (as BISTRO is explained below). When the ratings turned down and off-balance sheet items had to be brought back to the originating banks, however, capital requirements suddenly increased sharply—leading to the “deleveraging” process for commercial banks that is still going on as of 2011 and is likely to continue for several years. When government bonds within the eurozone started to lose their triple-A ratings in 2010, deleveraging became widespread for foreign banks as well.

The selections that follow in the Friedman volume focus on each author's favorite culprit for explaining the crisis, starting with a historical perspective dating back to the New Deal regulations imposed on commercial and investment banks. The regulations separated out not only their loan customers, but also their sources of finance—deposits for commercial banks and short-term “repo” loans for investment banks. Several chapters echo the themes in the FCIC report on lax regulation or misguided incentives, but most focus on regulatory miscues, starting with the cartel of authorized rating agencies and ending with housing mortgage subsidies. At the end, the economics profession is criticized for not harping earlier or more effectively on the dangers posed by the housing asset bubble or on asset bubbles and their consequences generally.

Gary Gorton, Slapped by the Invisible Hand: The Panic of 2007, takes up in detail the “rational ignorance” argument suggested by Friedman. Gorton argues that while many individuals felt (or knew) that the housing bubble could not last, there was no way for any of them to know when it would burst, much less how severe would be the consequences. Only very deep-pocketed and committed investors could afford to short the bubble. For example, Lawrence G. McDonald, A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers, tells how he and a fellow trader in Lehman shorted the most egregious case of New Century, a major subprime lender in southern California, only to give up after repeatedly covering their wager as New Century's stock kept rising through 2007. This contrasted with the deep-pocketed and more astute traders highlighted by Michael Lewis, The Big Short: Inside the Doomsday Machine. Even Lewis’ heroes, moreover, were loners unable to convince many investors to back them, and those who did invest with them wanted to withdraw their money before the market collapsed. When they finally did see large winnings on their accounts, they were not grateful for the wrenching experience when their money was kept financing a short position while the markets continued to rise.

According to Gorton, only the creation of an index that could be transparently traded and priced—the ABX-HE indexes of average values of 20 large subprime securitization packages that were completed in the previous six months—allowed market participants to know how the rest of the market valued the underlying mortgage assets. Introduced in January 2006, these indexes provided investors for the first time the market consensus of how cash flows were holding up for the different tranches of subprime CDOs, vintage by vintage. As the indexes began to plummet in 2007, the value of repo collateral based on the CDOs fell as well, leading to a collapse of the funding based on bonds backed by residential mortgages for the most active investment banks. Panic ensued, as lending banks had no way of knowing the extent of shortfalls in the cash flow for the particular collateral on offer. Gorton hammers home the point that the “repo” market, which provides the financing for investment banks and the emerging “shadow banks” in lieu of deposits requires triple A rated bonds as collateral. The downgrading of securities used as collateral for repo financing, whether they are mortgage-backed securities in the United States or government bonds in Europe, creates the equivalent of a bank run and possible insolvency for financial institutions that use these securities for access to short-term credit markets.

Gorton's exposition is enlightening but complex and his argument might be more persuasive if written by a journalist. The most useful of the books by financial journalists are Gillian Tett, Fool's Gold: How the Bold Dream of a Small Tribe at J. P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe and Bethany McLean and Joe Nocera, All the Devils are Here: The Hidden History of the Financial Crisis. Fool's Gold lays the background for understanding how a financial innovation, initially known by its acronym BISTRO (broad index secured trust offering), led the way into a proliferation of CDO's (collateralized debt obligations) increasingly composed of RMBS's (residential mortgage-backed securities), and finally to the end of Wall Street with the panic of 2008. JPMorgan Chase, perhaps, is given more credit than deserved for the innovation, but deserves credit for not leveraging it to the extent that Bear Stearns and Lehman Brothers did to their ultimate regret. Poetic justice then that JPMorganChase has ended as the strongest of the U.S. banks after the crisis.

All the Devils are Here gives the best continuous story of the development of the crisis, starting with the emphasis on making housing affordable by easing the constraints on financing residential mortgages during the Great Depression, a policy intensified after World War II. The eventual role of Fannie Mae and Freddie Mac in continuing the housing bubble beyond 2006 is convincing and told well. The role of the Greenspan Fed in providing the cheap credit needed for Wall Street to exploit the gullibility (or policy excess) of Fannie Mae and Freddie Mac is given due credit, although the role of the Bernanke Fed in absorbing the toxic assets created by Fannie Mae and Freddie Mac when the two GSEs were nationalized is not given the credit it deserves.

Gretchen Morgenson and Joshua Rosner, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon, takes the indictment against the GSEs to the extreme by focusing on the maneuvers of James Johnson, the CEO of Fannie Mae, 1991–1998 and later a director of Goldman Sachs, who expanded the remit of Fannie Mae while entitling himself to ever-larger executive bonuses. Other authors agree that the continued expansion of Fannie Mae and Freddie Mac in buying mortgage-backed securities that catered more toward lower-income households did extend the housing bubble in 2006 and 2007, but most of them assign it a secondary role overall.

The missteps of the regulators, and the egregious errors of the Wall Street opportunist provide ample ammunition for would-be pundits such as Roger Lowenstein, The End of Wall Street, who hails the collapse of the investment banks as a good thing, but fears the next disaster looming. John Cassidy, How Markets Fail: The Logic of Economic Calamities, takes the structural weakness revealed in the financial markets a step further in arguing that the irrational behavior of crowds dooms the efficiency of markets in general leading to repeated macroeconomic disturbances. Certainly, reading the fevered descriptions of the key players in the 2008 crisis found in Andrew Ross Sorkin, Too Big to Fail, replete with frequent injections of the f-word in the imputed conversations under stress, shakes one's confidence in Wall Street expertise or policymaker's sagacity.

A calmer vision of the role played by the Federal Reserve System is David Wessel, In Fed We Trust: Ben Bernanke's War on the Great Panic. The subtitle gives away the theme, “How the Federal Reserve became the fourth branch of government.” Essentially, Wessel's argument is that Bernanke had to backstop the repeated missteps of the Treasury as the crisis developed in 2007, culminating with acquisition of much of the so-called toxic assets on the Fed's balance sheet with the nationalization of Fannie Mae and Freddie Mac. The Fed's balance sheet blossomed in response and the role of the Fed moved well beyond that of a domestic or even international lender of last resort to become the investor of last resort.

This enhanced role of the Fed for the future is the theme of Perry Mehrling, The New Lombard Street: How the Fed Became the Dealer of Last Resort. Mehrling argues persuasively that the enhanced role of the Fed in the increasingly complex credit markets created since the collapse of the Bretton Woods system and the globalization of finance is a logical outcome of the interplay between traders and regulators. Traders want to make profits from intermediation; regulators want to keep those profit opportunities viable, but within bounds, essentially by serving as a buyer of last resort, at knockdown prices, just as the lender of last resort was supposed to be at penalty rates. Mehrling traces the evolution of the Fed's increasing role in the U.S. financial system from its origins to the present crisis.

An even longer historical perspective is taken by Simon Johnson and James Kwak, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown. They argue that the concerns raised by Thomas Jefferson over the potential political power of Alexander Hamilton's Bank of the United States have been a recurring theme in American economic history, but that the pendulum has swung far too much in favor of Hamilton's financial elite. Currently, these politically powerful financiers are epitomized by the 13 banks whose CEOs met with newly elected President Obama at the White House on March 27, 2009, where the new administration assured the bankers of the continuation of the previous administration's bailout policy despite Obama's reported comment to them, “My administration is the only thing between you and the pitchforks.” Johnson and Kwak argue strongly in favor of breaking up the largest banks (now numbering nine) and setting definite limits to their size. Their message is, “If banks are too big to fail, they are too big.” Johnson, former chief economist at the IMF, notes that the United States argued for exactly that policy during the Asian financial crisis of 1997/98, and that the South Korean economy has benefited since these reforms.

Another former chief economist at the IMF, Raghuram Rajan, Fault Lines: How Hidden Fractures Still Threaten the World Economy, takes the international dimension a step further while drawing even more dire implications for the future. Essentially, he argues that underlying domestic political imperatives drive the U.S. financial system to support cheap domestic credit and the Chinese financial system to support cheap exports (and accumulated foreign reserves to lend to the U.S. government). Neither policy makes sense for sustaining long-run economic growth, or for sustaining political legitimacy. Averting the next financial crisis (and/or political crisis) for the world economy requires both countries to recalibrate the relationship between government and the financial sector. For staying abreast of the international repercussions of the financial crises, the IMF's semiannual Global Financial Stability Report with monthly updates is still the essential source, regardless of who happens to be the chief economist at the IMF. The annual reports of the Bank for International Settlements provide excellent data on financial flows internationally as well to supplement the monthly and annual reports of the European Central Bank and the regular reports of the Federal Reserve System.

Carmen M. Reinhart and Kenneth S. Rogoff, This Time is Different: Eight Centuries of Financial Folly, belies their title with the argument that this time is really not so different. Their overview of historical episodes of financial crises internationally starts with the emergence of city-state debts in late medieval Italy and they argue that each had similar causes leading to overissue and eventual crash. The ensuing recoveries were protracted and painful in each case. Their argument is bolstered with quantitative data taken from the work of generations of financial historians but focused on the nineteenth and twentieth centuries, where it is possible to have annual data. Given the breadth of their cases, it is natural that specialists will find fault with their interpretation of specific episodes, but to overturn any of their conclusions will require more detailed work by others.Footnote ²

Their efforts at generalization, much as those in the late Charles P. Kindleberger's classic, Manias, Panics, and Crashes: A History of Financial Crises,Footnote ³ are subject to the caveat issued by Gary Gorton, who argues that each crisis has its unique pattern of events leading to a crisis made evident in the market for short-term credit, but the unwinding of events follows its particular course depending on the historical circumstances. Gorton argues for more in-depth studies of particular crises to see how information flows are disseminated among the various players in each case. An initial effort along these lines, with deep historical case studies united by a common theme, is the book edited by Jeremy Atack and Larry Neal.Footnote ⁴ The bank run on Northern Rock in the United Kingdom was the motivation for the introductory chapter by Atack and the evolving subprime crisis in the United States provided the backdrop for the concluding chapter by Neal.

Echoing the theme of Reinhart and Rogoff, we argued that this crisis had its historical antecedents, going back at least to seventeenth-century Amsterdam. But each author developed his own interpretation of a particular episode. At the heart of each story was the severing of the personal ties that had always been the basis of banking and then substituting reliance upon government agency oversight of the impersonal financial markets that allowed effective securitization for assets in secondary capital markets. Gorton and Friedman each argue that ignorance rather than incentives, whether looking at bankers, investors, or regulators, was the ultimate cause of the subprime crisis. More generally, the authors in Atack and Neal argue that credit institutions, capital markets, and governments always had difficulty in learning how to coordinate effectively the role of all three sets of organizations in the financial sector when financial innovations occurred, usually from the pressures of war finance upon governments. The concluding chapter, mea culpa, argues pessimistically that policymakers usually misread the supposed lessons derived from previous crises. But it also notes optimistically that the current set of policymakers both in the United States and Europe had studied a number of past crises, some quite recent, and perhaps they could learn more quickly from their mistakes than was often the case in the past!