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What Caused the Crisis?

Most assessments of the 2007–2009 financial crisis identify as the source of the problem such issues as poor risk controls, too much leverage, and an almost willful blindness to the bubblelike conditions in the housing market. Well, maybe. These issues were certainly the proximate causes of the crisis we still find ourselves in, and if only one or two firms had drunk the Kool-Aid—a Drexel Burnham, let's say, or a Long-Term Capital Management—we could buy the usual nostrums as the full story.

But I suspect that the financial firms and their executives aren't quite so collectively stupid as this explanation would imply. I think there was something else going on, something that allowed intelligent people to persist in unintelligent behavior. In my view, poor risk controls, massive leverage, and the blind eye were really symptoms of a much worse disease: The root cause of the crisis was the gradual but ultimately complete collapse of ethical behavior across the financial industry. Once the financial industry came unmoored from its ethical base, financial firms were free to behave in ways that were in their—and especially their top executives'—short-term interest without any concern about the longer-term impact on the industry's customers, on the broader American economy, or even on the firms' own employees.

By a “collapse of ethical behavior” I mean exactly what I say—that the actions of many, if not most, of the large American financial firms (and of the many ...