How Wall Street's Inside Job Sank the Economy
Policy + Politics

How Wall Street's Inside Job Sank the Economy

Every good story needs a villain, and Inside Job is a good story. The coldly furious Charles Ferguson documentary — the most serious cinematic chronicle the 2008 financial crisis — has no shortage of recognizable bad guys, and it makes the most of them. Under Ferguson’s editing, Goldman Sachs’ Lloyd Blankfein, the Clinton and Obama Administrations’ Larry Summers, and former Treasury Secretary Hank Paulson, among others, end up looking not just evil, but guilty as hell. In archived footage, they evade, equivocate, patronize, bluster and squirm while 15 million Americans still look for work, millions of homes are foreclosed and trillions of dollars of savings are vaporized. By the end of Inside Job, you are outraged and want every one of those villains thrown in jail. And if there’s anything wrong with this film, it’s that. 

The intellectual battle to explain the financial crisis has two camps. One is the “Black Swans,” who regard the crisis as an unforeseeable, low-probability event in which many strands came together in a kind of perfect financial storm. Ferguson falls in the other camp, which blames what economists call the “agency problem”: The people we entrusted to run our banks and manage our economy had incentives to act in their own interests, not ours, and they did so with lusty enthusiasm. One of Ferguson’s protagonists is Raghuram Rajan, former chief economist of the IMF, who presented a paper in 2005 warning that deregulation and runaway pay were pushing banks to take potentially suicidal risks. Rajan was mocked and then ignored.

Responsible regulators, in Ferguson’s view, should have prevented the crisis, but they had long since been bought off. The co-optation started at the top: Presidential administrations of both parties dating back to Reagan’s were stacked with bankers and supporters of deregulation, from Merrill Lynch’s Don Regan (Treasury secretary for Reagan) to Citigroup’s Robert Rubin (Clinton’s) , Goldman’s Paulson (Bush II), and Harvard’s Summers (Obama).

Frederic Mishkin, a former Fed president who was paid $124,000
for a study of Iceland’s financial system, fumbles to explain
the change on his CV from “Financial Stability in Iceland” 
to “Financial Instability.” “A typo,” he finally offers.

Meanwhile, academic economists lent their intellectual imprimatur to deregulation — or as  Inside Job contends, sold their imprimatur for Wall Street money. Ferguson devotes a lot of energy to this contention, in the movie and in subsequent interviews. One reason is that economists were the only antagonists naïve (or smug) enough to agree to be interviewed on camera. Clearly caught off guard by Ferguson’s hostile questions, they are the unwitting stars of some of the film’s best moments.

In one interview, Glenn Hubbard, dean of Columbia Business School and chairman of George W. Bush’s Council of Economic Advisers, huffily tells Ferguson that he won’t disclose whether he was paid to co-write a positive analysis of derivatives just before the crash. In another, Frederic Mishkin, a former Fed president and current Columbia University economist who was paid $124,000 for an upbeat study of Iceland’s doomed financial system, fumbles to explain why the name of the study mysteriously changed on his CV from “Financial Stability in Iceland”  to “Financial Instability.” “A typo,” he finally offers.

Once you stop shaking your head, though, you have to wonder what exactly the two professors did that was so shocking. Tim Taylor, an economist at MacAlester College and editor of the Journal of Economic Perspectives, points out that economists have long hired themselves out as expert witnesses in civil trials and as consultants in mergers and acquisitions. “The practice has been around for years, decades even,” he says. “I don’t think it is any worse than it always was.”

Yes, Hubbard was spectacularly wrong about derivatives and Mishkin about Iceland, but so were a lot of people at that time. It’s not clear anything more sinister is at work than sloppiness, a lack of transparency and ideological blindness. In a 2009 New York Times Magazine cover story, “How Could Economists Get it So Wrong,” Paul Krugman considers the possibility that the economics profession was corrupted by money in the years before the crisis. But he concludes economists’ real failure in the crisis was a kind of mass delusion that held that markets are always right and regulations are always wrong: 

“But while sabbaticals at the Hoover Institution and job opportunities on Wall Street are nothing to sneeze at, the central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.”

It’s harder to make a similarly extenuating case for Wall Street and the Street’s cronies in Washington. Real street-level fraud took place in mortgage lending. Wall Street firms encouraged it and sold securities made with fraudulent mortgages while secretly unloading the same securities from their own portfolios. They misled regulators about the level of risk they were taking. Their access to power in Washington allowed them to get away relatively unscathed in the crash, and they’ve since awarded themselves record bonuses while the rest of the country struggles.

Outrage is the most satisfying response, and Ferguson pours it on. Yet, as with the economists, he might have spent more time pointing out how banal and bumbling Wall Street was, too. Few on Wall Street understood the complex securities they had created. For every John Paulson — the hedge fund manager who made billions betting against mortgages — there was a Howie Hubler, the Morgan Stanley trader who reportedly cost the firm $9 billion in the credit collapse. The only problem from a filmmaker’s point of view is, it’s harder to get really outraged about Howie Hublers.

Yes, the criminals who committed fraud should be brought to justice. The executives who lied to shareholders should go to jail. The corrupting pay packets of Wall Street should be reined in by shareholders (why they aren’t is a mystery). Most of all, the idea that markets don’t need oversight should be consigned to the ash heap of history. There were plenty of villains in the crisis, but it’s too simple to say that it was bad people who brought us to the edge of the abyss. It was a bad idea.

Related Links:
'Inside Job' Director Charles Ferguson, Taking Wall Street Firmly to Task (NPR)
Why Economists Failed to Predict the Financial Crisis (Knowledge@Wharton)
Who to Blame for the Financial Crisis (US News)