When the unraveling is fully underway, there will be a flood of lurid headlines. Amid the avalanche of hearings, lawsuits, arrests, and trials, stories about violent strikes and protests will vie with news of plunging markets and businesses going belly up. Every day, tales of foreclosures and broken lives will blanket the airwaves. Many financial institutions will shut their doors, often with little warning. Rumor-filled bank runs will be commonplace. Finger-pointing will also be widespread, as politicians, regulators, and corporate chiefs scramble for cover in the face of increasingly hostile public opinion.
Meanwhile, Americans will scratch their heads and wonder how it all went so wrong so fast, or why they had not been aware of the dangers before. In reality, we should have seen it coming. Signs of impending doom were everywhere, plain for all to see, in the years leading up to the wide-ranging meltdown. Still, even if people had been aware of the gravity of the situation, it seemed that few cared all that much.
That certainly appeared to be the case when President George W. Bush and the Republican-controlled Congress, in a charade of sober concern, agreed to boost the federal borrowing limit to $9 trillion in the spring of 2006. This was an extraordinary increase of more than 50 percent from five years earlier. It was another regrettable, but now unavoidable, step to fund the latest in a long string of understated multibillion-dollar deficits.
Apathy was also in the air when the U.S. personal savings rate went negative for the first time since the Great Depression and total household debt exceeded 150 percent of disposable income. American consumers were not only spending what they earned, but also a great deal of what they didn’t. And few noticed an April 2006 survey by Phoenix Management that suggested that two-thirds of U.S. lenders thought the country was in the middle of a real estate bubble, and half of them believed the bubble was about to burst—or already had.
Most Americans did not worry when the nation’s top auditor, Comptroller General David Walker, suggested that the United States could be likened to Rome before the fall. Or when he said that the nation was facing “a demographic tsunami” that “will never recede.” Even more surprising was the muted reaction to an article written by Boston University economics professor Laurence J. Kotlikoff for the July/August 2006 Federal Reserve Bank of St. Louis Review. He asked—rhetorically, it would seem—“Is the United States Bankrupt?”
After an initial flurry of concern, people also glossed over Warren Buffet’s warnings about derivatives, which he characterized as “financial weapons of mass destruction.” Yet he would eventually seem prescient after he wrote in Berkshire Hathaway’s 2002 annual report that, “These instruments will almost certainly multiply in variety and number until some event makes their toxicity clear.”
Few paid attention to warnings from Eric Breval, the head of the $15.5 billion Swiss state pension fund, in a November 2005 Bloomberg report. He discussed plans to shift assets away from the United States and referred to the financial “time bomb” that the nation’s largest mortgage lenders, Fannie Mae and Freddie Mac, were sitting on. The same held true in April 2006, when Citigroup vice chairman William Rhodes told the Wall Street Journal, “We are in a situation similar to that which existed in the spring of 1997, when threats existed to market stability and a lot of people didn’t want to see it.”
Perhaps that’s it: Americans just didn’t want to know. Or maybe they actually didn’t see anything wrong or out of the ordinary. Everywhere you looked, policymakers, politicians, and pundits insisted that the financial system and the so-called Goldilocks economy were alive and well, and there was no reason for anyone to believe otherwise.
Then again, perhaps it was just too easy to believe the fairy tale that the good times could last forever.
To be sure, only scant evidence existed in early 2006 that the average Joe had put the brakes on spending, despite increasingly burdensome levels of borrowing and the fact that real—inflation-adjusted—wages had been stagnant for years. “Why call it quits now?” consumers argued. Indeed, Americans had carried on with their profligate ways far longer than many observers had expected. This was partly because consumerism had become an end in itself. It was a new religion—a new American dream supported by an endless stream of advertiser-supported media.
Almost everyone was imbued with a get-it-now, live-for-today perspective, a kind of financial hedonism enabled and repeatedly overstimulated by an aggressively competitive, rapidly innovating, but ultimately self-serving financial services sector. To that end, lenders and borrowers joined hands and helped create a massive real estate and mortgage market bubble, allowing consumers to “extract,” as the euphemism went, $2.5 trillion in debt-financed equity from their homes from 2001 through 2005.
There was a growing sense of entitlement, especially among the 78 million baby boomers—Americans born between 1946 and 1965—as well as a widespread desire for wealth without work. For many, engaging in excessive borrowing, self-deception, and a rejiggering of priorities to support a lifestyle they felt they needed and deserved was just the way life was. A quick read of history suggests this delusion is common among the citizenry of fading and failed empires.
Perhaps it wasn’t so odd, because almost everyone agreed on the script, that few gave clear thought to the dangerous indulgences and unsustainable financial imbalances that had built up over the years.
Of course, it didn’t help that many factors that spawned the multifaceted disaster seemed too complicated and far-reaching for most people to comprehend. Without the benefit of sophisticated financial wisdom, the majority saw the various influences as unrelated to each other. Moreover, few Americans understood how and to what degree globalization, consolidation, innovation, and technology had altered the financial landscape. It was also hard to grasp the paradoxical idea that long periods of stability, which many viewed as inherently positive, were actually destabilizing. As economist Hyman Minsky once noted, the good times tended to foster the complacency and risky behavior that lay the groundwork for upheaval.
Even those who sensed early on that the end was near might not have grasped the significance of certain developments, like changes in state and local government accounting rules for postemployment health care and other nonpension benefits. First implemented by the Government Accounting Standards Board in 2006, these rules were seen as a way to ensure that municipal finances were more transparent than in the past. The new requirements were meant to hold politicians accountable for at least some of their “free lunch” promises.
It seemed like a great idea. But as with several other rules and reforms that came into play up to and after the stock market bubble burst, they would ultimately have unintended—and unwelcome—consequences. In this case, the scale of once-hidden promises to current and former workers would turn out to be $1 trillion dollars, according to an expert cited by the New York Times. Eventually, that revelation will spur widespread credit downgrades, leave many municipalities cut off from financing, force drastic budget cuts, and trigger an ultimately unsustainable push for higher taxes that will only add to the fallout from other catastrophes, including a rapidly deflating credit bubble, a systemic financial crisis, a collapsing economy, and an imploding derivatives market.
By then, the dangers that a few observers had foreseen—which were discounted, misunderstood, or overlooked—will be the only thing that growing numbers of Americans will be able to think about.