Economist's View

Reagan Did It, by Paul Krugman, Commentary, NY Times:

For the more one looks into the origins of the current disaster, the clearer it becomes that the key wrong turn ... took place ... during the Reagan years. ...

Federal debt as a percentage of G.D.P. fell steadily from the end of World War II until 1980. But indebtedness began rising under Reagan... The increase in public debt was, however, dwarfed by the rise in private debt, made possible by financial deregulation. The change in America’s financial rules was Reagan’s biggest legacy. And it’s the gift that keeps on taking.

The immediate effect of Garn-St. Germain, as I said, was to turn the thrifts from a problem into a catastrophe. The ... fact is that deregulation in effect gave the industry — whose deposits were federally insured — a license to gamble with taxpayers’ money, at best, or simply to loot it, at worst. By the time the government closed the books..., taxpayers had lost $130 billion, back when that was a lot of money.

But there was also a longer-term effect. Reagan ... essentially ended New Deal restrictions on mortgage lending ... that, in particular, limited the ability of families to buy homes without putting a significant amount of money down.

These restrictions were put in place in the 1930s by political leaders who had just experienced a terrible financial crisis, and were trying to prevent another. But by 1980 the memory of the Depression had faded. Government, declared Reagan, is the problem, not the solution; the magic of the marketplace must be set free. And so the precautionary rules were scrapped. ...

We weren’t always a nation of big debts and low savings: in the 1970s Americans saved almost 10 percent of their income... It was only after the Reagan deregulation that thrift gradually disappeared..., culminating in the near-zero savings rate ... on the eve of the great crisis. ...

All this, we were assured, was a good thing: sure, Americans were piling up debt,... but their finances looked fine once you took into account the rising values of their houses and their stock portfolios. Oops.

Now, the proximate causes of today’s economic crisis lie in events that took place long after Reagan... — in the global savings glut..., and in the giant housing bubble that savings glut helped inflate.

But it was the explosion of debt over the previous quarter-century that made the U.S. economy so vulnerable. Overstretched borrowers were bound to start defaulting in large numbers once the housing bubble burst and unemployment began to rise.

These defaults in turn wreaked havoc with a financial system that — also mainly thanks to Reagan-era deregulation — took on too much risk with too little capital.