One year later, full examination of crisis lacking

A YEAR AFTER the financial equivalent of Hurricane Katrina struck, damaging the world's economies, devastating the major capital markets and demolishing major financial institutions, it is worthwhile to examine what action has been taken to prevent a similar disaster. Although the world's major stock markets have recovered perhaps two-thirds of their losses, most world economies are still mired in recessions triggered by the disaster, and governments mostly have applied bandages to stanch the economic bleeding. In the United States, government action to revise regulation to prevent a recurrence of such a crisis remains largely stalled by the debates over the Obama administration's push for health care reform and environmental regulation. Some of the conditions that led to the financial meltdown have been cured by the disaster. Others will require changes in government policies. The primary cause of the meltdown was the bursting of the housing bubble, which was produced by the Federal Reserve's easy-money policy and the United States' huge trade deficit. That led to enormous inflows of recycled dollars from China and the oil-exporting countries. Although the housing bubble shows no sign of being reinflated, the Fed has continued to follow easy monetary policies for the past year to stave off an even more devastating recession, perhaps a depression, and the U.S. trade deficit remains huge. The excess money has to flow somewhere, and the fear is that it will trigger serious inflation when the economy begins to recover. The low U.S. savings rate, which contributed to the economic problems, is being fixed. The housing bubble helped drive up consumer debt and push the national savings rate to nearly zero by encouraging homeowners to look upon their increasing home equity as savings. Consumers borrowed against that equity, and consequently, savings fell, and debt increased. Household debt grew from $7.4 trillion at yearend 2000 to $14.5 trillion in midyear 2008, 134% of disposable personal income. That has been reversed, with consumers now pushing the national savings rate to above 5% of household income. This eventually should help make the country less dependent on foreign capital inflows to finance the government's borrowing — if the growth in government spending slows. The securitization of mortgages, particularly subprime mortgages, and other forms of debt such as credit card receivables and auto loans, also contributed to the crisis as low-grade mortgages and receivables were bundled into apparently triple-A-rated securities. At least for now, the crisis has halted these securitization practices as regulators pay closer attention to them and buyers remain wary. In fact, the collapse of the market for such securities has greatly damaged the so-called shadow banking system and hampered the economic recovery. Academics and investment bankers are conducting autopsies to determine where the flaws in the models and assumptions on which the pricing and ratings of these securities lay. No doubt, better models and more accurately priced securities will result when the market recovers. Many government policies contributed to the bubble and the ultimate crash. The policy of pushing banks, and Fannie Mae and Freddie Mac, to help more poor workers become homeowners contributed to both the rise in home prices and the issuance of large numbers of subprime mortgages. The easing of leverage limits for investment banks contributed to the failure of The Bear Stearns Cos. Inc. and Lehman Brothers Holdings Inc., and the near collapse of others. -Neither of these has been addressed, nor have many other regulatory -failures. Regulators remain largely ignorant regarding what to do about credit default swaps and other exotic instruments. So a year after the crisis, a certain amount of healing has oc-curred, but Congress has been distracted from closely studying the causes and regulatory failures, and using the results of the study to develop sound reforms. If the appropriate committees in the House of Representatives and Senate produce reform legislation before the end of the year as they promise, it will be without the kind of intensive examination that is called for. The chances of Congress' getting the answers wrong therefore will be high.