How'd we get in this mess? A look back

"Foreclosure" is hung on a For Sale sign in front of a townhouse in Herndon, Va.

TEXT OF REPORT

KAI RYSSDAL: Today is, interestingly enough, Constitution Day -- the 221st anniversary of the signing of that document. I'm pretty sure there's nothing in there about the secretary of the Treasury and the chairman of the Federal Reserve setting themselves up in private business. That sounds kind of strange. But with the Feds' bailout of the insurance company AIG last night, that's effectively where we are. Fortunately, you don't have to go all the way back to the founding fathers to understand how we got here. You just need to remember the words of a man almost as revered.

ALAN GREENSPAN: The Federal Open Market Committee stands ready to maintain a highly accommodative stance of policy for as long as it takes to achieve a return to satisfactory economic performance.

Alan Greenspan, of course, saying in that way he has that he's going to keep interest rates low as long as it takes. When he gave that congressional testimony five years ago, he was about to lower the Fed short-term interest rate to 1 percent and leave it there for more than a year. That, in and of itself, wasn't a bad thing. It's what people did with all that cheap money that's gotten us into trouble.

They borrowed. They borrowed a lot. And then they got creative, using things like collateralized debt obligations to bundle risky mortgages into something they could sell off in the markets. But when the value of the houses behind those mortgages began dropping? Well, here's financial analyst Peter Cohan.

PETER COHAN: Nobody knows what's in these bundles of mortgages. And they have a very, very low value because nobody can open them up and figure out which ones are paying and which ones are not paying. It's like Superman trying to look inside of a box that's wrapped in lead. You just can't see inside.

If there's one thing we've learned over the past year-and-a-half, when the markets don't know what's inside. they just stop. They stop lending. They stop buying. Nobody trusts anybody. And, presto, a credit crisis.

There's an argument to be made -- and lots of really smart people have made it -- that all those financial innovations, things like CDOs, were inevitable. That once you had basically free money, thanks to Alan Greenspan, and a crowd on Wall Street that's always looking for an edge, abuses were bound to happen. That what we've got here is a failure of regulation.

Kathleen Keest at the Center for Responsible Lending calls it a culture of anti-regulation.

Kathleen Keest: Well, I think the mantras were: "We know what we're doing," and "Government will stifle access to credit and we don't want to do that."

Even today, after all the economy's been through the past year-and-a-half, Treasury Secretary Hank Paulson still isn't convinced regulation's the answer. Here he is from two days ago, the day Lehman Brothers went under and Merrill Lynch was bought out by Bank of America.

HENRY PAULSON: Well, I think there's got to be a balance between regulation and market discipline. You can't rely on one to solve the problem.

The Dow Industrial Average disciplined itself down 500 points that day. And since then the govenment's added insurance to its business portfolio.

About the author

Kai Ryssdal is the host and senior editor of Marketplace, public radio’s program on business and the economy.

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