The President, Congress, and the Financial Crisis: Ideology and Moral Hazard in Economic Governance

The worldwide financial meltdown of 2008-09 caught economists and policy makers by surprise, including the U.S. president and his chief economic advisors. While the Council of Economic Advisers (CEA), the U.S. Treasury Department, and the Federal Reserve (or Fed) expected a downward market correction from the dramatic boom in housing prices and homeownership, none of these economic agencies predicted the near collapse of the financial structure in the United States and its global economic repercussions. In his testimony before the House Committee on Government Oversight and Reform in 2008, Alan Greenspan, former Fed chairman, was asked by Committee Chairman Henry Waxman, "In other words, you found that your view of the world, your ideology, was not right, it was not working." Greenspan responded, "Absolutely ... that's precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well" (U.S. Congress 2008a, 2008b). During the early months of the crisis, senior federal government policy makers, including the president, the secretary of the U.S. Treasury, and members of the president's economic team, as well as academic economists, shared these sentiments. How was it possible that senior economic officials in the president's administration and prior administrations did not see this crisis developing or pursue policies to avert it? The basic argument of the article is that the system for governing the market--the institutions, rules, regulations, and personnel practices that shape the way the market operates--is central to understanding the development of and failure to anticipate the financial crisis. In developing this argument, the article focuses on the role of the president in interactions with the Congress, economic advisors, and the independent regulatory agencies. Over the course of three decades leading up to the financial crisis, the give and take of macroeconomic ideas representing different economic interests and professional views converged into a common set of policy preferences and ideology across political parties, the houses of Congress, the president, and professional experts. Reinforcing this development was a powerful political moral hazard a condition in which public officials and private interests had strong incentives to take actions mutually beneficial to them but adverse to the overall economy and the interests of the general public--that led to a decline in institutional checks and balances in economic regulation. The system of economic governance thus failed to function as envisioned, and thereby, contributed to the crisis. These developments occurred during a time of significant economic change and financial innovation, making it difficult for the president and Congress, regulators, and private corporate directors to foresee the degree of risk building in the system. In this sense, the crisis represented a perfect storm in which financial innovations, a common set of policy preferences and ideology, and weakened check and balance governance converged to help bring the country to the brink of financial meltdown. In general, governance consists of the institutions and decision processes that determine how society makes choices. It includes the Constitution, the basic structure of the legislature, the presidency, and the courts, as well as legislative procedures, legal rules, and administrative practices. In the private sector, it includes the basic legal framework for private organizations, corporate policies and practices, and boards of directors. In the United States, the Constitution established a "check and balance" system as the basic structure of governance for the society and economy. Consequently, the U.S. Constitution prescribes an independent judiciary, separate houses of Congress elected in different ways and for different terms, and a separately elected chief executive as president. …