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Behavioral Economics and the Credit-Crisis Novel
Following the collapse of the dot-com economy in the early years of the twentyfirst century, private investment in US assets began wane. Fearful of recession, the US Federal Reserve reduced interest rates, lowering the cost of borrowing to banks and, by extension, consumers. Credit became cheaper than ever. Spurred on by high demand, housing prices rose an astonishing 68 percent. By early 2007, however, investors were beginning to recognize the profoundly high risk inherent in securitized debt. As interest rates began to tick up and housing prices began to fall, a wave of bankruptcies hit the subprime mortgage-lending sector first, then highly leveraged investment banks like Bear Stearns. From July 2007 to March 2008, investment banks and brokerages lost $175 billion of capital. In the fall of 2008, global financial services firm Lehman Brothers filed for the largest bankruptcy in US history; American Insurance Group (AIG), which had insured high-risk MBSs, and wealth-management firm Merrill Lynch were “saved” by being sold for pennies on the dollar. Although the world’s central banks pumped immense amounts of liquidity into the global financial system—$150 billion in stimulus from the United States alone and $200 billion from international central banks—banks were unwilling to lend to one another, paralyzing credit markets across the United States and around the world. Between 2007 and 2008 nearly a hundred mortgage lenders failed. In October 2008, as the head of the IMF declared the global economy “on the brink” of total meltdown, many countries were forced to close markets or halt trading lest the wave of failures lead panicked depositors to run on their banks.1 In the immediate aftermath of this crisis, it seemed a matter of great urgency to decide who was responsible for the crash. In early 2009, Time magazine ran a poll identifying the “Top 25 People to Blame for the Financial Crisis.” The list was noteworthy for its emphasis on individuals. There were no institutions on this list—no AIG, no Lehman Brothers, no Securities and Exchange 21
