Viewing the Financial Crisis from 20,000 Feet Up

Abstract

The U.S. economic crisis is systemic but the system is so complicated that commentators, policy makers, and the general public are focusing on details rather than on the big picture. This article offers a different perspective: An overview of the whole system, as if from 20,000 feet above it, that allows us to see the systemic nature of the crisis without being distracted by its complex details. The primary focus is on the problems with subprime mortgages, and I suggest a general approach to defuse that major driver of the crisis. But conditions have worsened so quickly since September 2008 that actions, which might have arrested the decline at that time, are now inadequate. However, one central message—that it will be hard to get the financial system back on its feet without resolving the problems in the mortgage market—still holds, and our general approach of government intervention at the point where the real-economy risk connects to the financial system still offers a way to do that. And while real estate remains the largest and most disrupted sector of the economy, the principles outlined in this article are potentially applicable to other areas, as well.

TOPICS: MBS and residential mortgage loans, financial crises and financial market history, tail risks