Market Riot

How the crisis inspired an entirely new set of big ideas on big money.

Mario Tama/Getty Images
Mario Tama/Getty Images

The financial markets may have survived 2009; the same can’t be said for the ideology of the market. No surprise, then, that the big ideas and big thinkers of the year are an entirely different bunch than Foreign Policy might have collected before the Great Recession.

For a generation, mainstream economic policy skewed libertarian. Risk wasn’t just tolerated but embraced, and the assumption was that government could only stifle growth. The Washington Consensus, pushed in tony conferences across the world, held that a country could do no better than reining in government spending and deregulating its economy. That orthodoxy was already under attack, but the collapse of the global economy dealt it a death blow. This was the year that the state made a comeback.

The new consensus: We need government bailouts and radical new central banking powers to save a teetering financial system; massive deficit spending to revive our comatose economies; and constant vigilance to keep Wall Street and Canary Wharf in check. Even Alan Greenspan, a walking symbol of the laissez-faire era if there ever was one, has signed on to that last verdict. "Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity," the former Federal Reserve chairman told a U.S. congressional committee, "are in a state of shocked disbelief."

Perhaps no single person has done more to bury the old worldview than Greenspan’s successor, Ben Bernanke (No. 1).  Bernanke spent his academic career studying the 1930s, concluding that a wave of bank failures transformed a deep recession into the Great Depression. The lesson he drew is that the Fed must do "whatever it takes" to prop up banks in a crisis, according to biographer David Wessel. Even by that standard, though, Bernanke turned out to be ambitious. By the end of this year, he’d effectively printed more than a trillion new dollars to increase the supply of credit. Thanks to this and other unprecedented moves, future Fed chairmen will have almost unchecked authority to intervene in financial markets. Wessel suggests Bernanke has turned the Fed into a "fourth branch" of government, and it’s hard to disagree.

Once Barack Obama (No. 2) took office, Bernanke gained a soulmate in Larry Summers (No. 14), the U.S. president’s chief economic advisor. While fighting the Asian financial crisis as a Treasury Department official in the 1990s, Summers concocted his own version of the Bernanke doctrine: "overwhelming force." This year he put that mantra to work at home. Summers championed the largest stimulus package in history at nearly $800 billion, part of a synchronized spending spree that reached from London ($30 billion) to Beijing (nearly $600 billion).

But though governments responded, it fell to outside experts to mount an autopsy of the crisis. The diagnoses tend to run along a single theme: financial innovation run amok. Back in 2003, Greenspan famously observed that derivatives — basically bets on the value of another asset, like a bond or a currency — are "an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so." Others made a similar case for "securitization," which amounts to slicing up an asset (like a mortgage) and selling it off to investors.

But this year brought vindication to those who argued that, in practice, derivatives and securitization were instead transferring risk to people who didn’t understand it and weren’t prepared to bear it, as economics writer Felix Salmon has put it. University of Chicago finance professor Raghuram Rajan had warned that companies like AIG, which essentially used derivatives to bet that U.S. housing prices wouldn’t fall, failed to see that their losses would be enormous if homeowners started defaulting. Nobel Prize-winning economist Joseph Stiglitz (No. 25) observed that the investors who bought up bits and pieces of subprime mortgages knew far less about the quality of the loans than the banks that originated them. Worse, the banks had little incentive to vet the loans because they knew they were eventually going to sell them.

Why didn’t the world’s biggest financial institutions do their homework? The fact that many were too big to fail had a lot to do with it. Because these banks knew their governments would have to bail them out, they built their business around a series of suckers” bets: Heads, they win; tails, taxpayers lose.

Which brings us to the business of preventing future crises. It was a bumper year for ideas on how to fix the financial world — from new consumer watchdogs to checks on executive pay. But at the heart of the discussion was a debate over how big is too big. In one camp were those like New York Times columnist Paul Krugman (No. 29), who reconciled themselves to bigness and hoped to exact "boringness" in return — in other words, to make banks behave more like local savings-and-loans than highly leveraged hedge funds. In the other camp were those like Simon Johnson, the mit professor and former IMF chief economist, who insisted that bigness can’t be managed. The bigger the bank, the greater its political power, and the more difficult it is to regulate.

In the end, though, maybe the solution to what ails us has less to do with any particular piece of the financial system than with our notions of economic progress itself. In September, Stiglitz and fellow Nobel laureate Amartya Sen (No. 58) released a study questioning the value of gdp as a measure of human welfare. According to Stiglitz and Sen, simply measuring economic output glosses over the things we really care about — namely, the average citizen’s quality of life. It also ignores the toll that growth takes on the environment and whether growth is even sustainable. Worst of all, it encourages the belief that more material goods are always better, the mindset that helped create the bubble. As Stiglitz told reporters, "If you don’t measure the right thing, you don’t do the right thing." Suffice it to say, there must have been an awful lot of mismeasurement going on during the boom.

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