What Caused the Crash? Let the Bickering Begin.

As the financial crisis of 2008–09 draws to a close, narratives of the meltdown are flooding bookstores, think tanks are cranking out white papers, and four different congressional committees are investigating what went wrong. Now that the debate over how to prevent the next collapse has begun, it might not be a bad idea to figure out how the last one happened. The only near-consensus is on the question of what triggered the not-quite-a-depression. In 2007 the housing bubble burst, leading to a high rate of defaults on subprime mortgages. Exposure to bad mortgages doomed Bear Stearns in March 2008 and then led to a banking crisis that fall. A global recession became inevitable once the government decided not to rescue Lehman Brothers. But right about here, agreement ends.

There are no strong candidates for what logicians call sufficient conditions—a single factor that would have caused the crisis in the absence of any others. There are, however, a number of plausible necessary conditions—factors without which the crisis would not have occurred. Most analysts find former Fed chairman Alan Greenspan at fault, for varying reasons. Conservatives tend to blame Greenspan for keeping interest rates too low between 2003 and 2005 as the real-estate bubble inflated, spurring a frenzy of irresponsible borrowing.

Liberal analysts are more likely to focus on the way that Greenspan's aversion to regulation turned innovative financial products into lethal weapons. In this view, the emergence of an unsupervised market for more and more exotic derivatives—credit default swaps (CDSs), collateralized debt obligations (CDOs), CDSs on CDOs—allowed heedless financial institutions to put the entire financial system at risk. Fed chairman Ben Bernanke also echoes this view, attributing the crisis to regulatory failure.

A bit further down on the list are factors that didn't cause the crisis but enabled it or made it worse than it might have been. These include global savings imbalances, which put upward pressure on asset prices and downward pressure on interest rates during the bubble years; misjudgments by the bond-rating agencies Moody's and Standard & Poor's about the safety of mortgage-backed securities; a lack of transparency about the risks borne by banks, which used off-balance-sheet entities to hide what they were doing; excessive reliance on mathematical models, which under-priced unpredictable forms of risk; and a flawed model of compensation that encouraged traders and executives at financial firms to take on excessive risk.

Other analysts look to the underlying mindset that encouraged the meltdown: shortsightedness, stupidity, and greed. But those are weak explanations, unless you think human nature changed in the final decades of the 20th century to make people greedier or more foolish. A subtler psychological argument is that investors fell prey to recurring delusions about risk and bubbles, which the economists Carmen Reinhart and Kenneth Rogoff describe in their book, ThisTime Is Different. In another new book, How Markets Fail, John Cassidy of The New Yorker focuses on the fallacies of free-market fundamentalism (Greenspan again). Still other writers, like Nobel Prize winner Joseph Stiglitz, in his new book, Freefall, point to the way globalization spread the toxicity from the U.S. mortgage market to the rest of the world. Not all such explanations fall according to ideological expectations. The conservative jurist Richard Posner argues in his book A Failure of Capitalismthat the free market itself is to blame for the recent troubles. Unfortunately, what these "root causes" explanations have in common is that they don't lend themselves to practical solutions.

I've left out some farther-fetched interpretations of the cause of the crisis. Libertarians and The Wall Street Journal editorial page continue to insist that government did it. In I.O.U., the only truly entertaining book I've read on the subject, the British writer John Lanchester theorizes that after the Cold War, capitalism could go wild because Western governments no longer had to worry about competing with communism. This is a fascinating idea, with no evidence to support it.

Historians are still debating what caused the Great Depression, so it's not likely this argument will be settled any time soon. But if we haven't at least learned that our financial markets need stronger regulatory supervision to prevent bad bets by big firms from going viral, we'll be back in the same place faster than you can say "30 times leverage."

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