The Global Financial Crisis (GFC) defines how we think about our recent past, our present and our future, yet there is no clear consensus account of why it happened. There have been so many explanations put forward. On the US side these have included the Asian savings glut overwhelming the financial system, a failure of US monetary policy and a US housing bubble (and too much lending to poor people).  On the European side the focus has been on excess borrowing by, or excess lending to, the Eurozone periphery, and sometimes on the poor Eurozone architecture. Yet as I have read more and more on this, it seemed to me that we should be focusing on the financial sector in both the US and the Eurozone, and of course the UK. My view has become that the crisis happened because banks in the US and Europe became too highly leveraged, and were therefore a crisis waiting to happen.
It was for this reason that I found Tam Bayoumi’s presentation of his new book so interesting.
He argues that by 2002 almost all the ingredients for the crisis were in place. In Europe we had very large universal banks (combining retail and investment banking) which were far too highly leveraged. In the US retail and investment banking were separate, with tight regulations on retail banks but little regulation on investment banking leading to shadow banking (deposits effectively moved to investment banks, like Lehmans, that again became too highly leveraged). In 2002 these two were separated by geography, but a small regulation change in 2003 allowed linkages between the two to develop, and then it was only a matter of time before we had the GFC, where ‘Global’ here means the US and Europe.
How did these banks become over leveraged? According to Bayoumi in Europe the creation of Universal Banks represented a flawed attempt to create a single European market in banking. There were subsequent failures in regulation that allowed these banks to expand (increase leverage) by manipulating their own risk weighting. This allowed these banks to move into Southern Europe and North America in a big way. In the US investment banks were not regulated because of a firm belief by the Fed that competition provided its own regulation for this type of bank.
Thus the GFC was the story of an over leveraged, interconnected banking system on both sides of the North Atlantic, just waiting for a shock significant enough to bring the whole system to crisis point. The presumption, which history confirms, is that finance is naturally prone to such crises, which is why the sector is regulated, so this story is also one of regulation errors. Bayoumi argues that each one of these errors can be put down to genuine intellectual mistakes, but he did agree with me that it was sometimes difficult to tell to what extent they were also the result of political pressure from powerful financial interests.
Have governments and regulators on either side of the North Atlantic done enough since the GFC to correct the mistakes that were made? The answer is complex, and it is best you read the book to find out Bayoumi's answer. Instead I want to end by making one observation of my own. Whenever a crisis happens, in the immediate aftermath people bring their own biases to understanding why it happened. So those who had been writing about global imbalances re orientated their analysis to explain the GFC. Those who wanted to attack US monetary policy, sometimes as a way of distracting attention from the culpability of the financial sector, did so. Those that had designed the Eurozone in such a way as to avoid profligate periphery governments talked about excess borrowing by those governments.
You can see the same with Brexit and Trump. Although a protest by the ‘left behind’ played some role, the idea that they are the full story suits some narratives but it is simply incorrect, as the new paper by Gurminder K. Bhambra argues. Over time things become clearer. What this analysis by Tam Bayoumi convincingly shows is that finance always has to be carefully regulated, and failures in regulation can have catastrophic consequences.
 New evidence suggests that the housing crash may have actually had more to do with lending to property speculators than low income mortgage holders.