So why didn’t people see it coming? Part of it was hubris: “Serious economists were arguing that financial innovations like derivatives … had made crises a thing of the past.” (How serious were these economists, actually?) And the reality was that financial innovation made things worse, not better: Most of “the leverage in U.S. finance” — debt that was vulnerable to panic — had moved to “shadow banks” that, unlike conventional banks, were largely unregulated and lacked a financial safety net.

Image

Also, as they say, “it’s hard to fix something before it breaks.” As long as the housing bubble was still inflating, defaults were few and everything seemed sound. A few Cassandras warned about the risks, but like the original Cassandra, they went unheeded. And BGP, to their credit, acknowledge their own failures to recognize the danger, including Bernanke’s notorious declaration that problems in subprime lending were “contained.”

Then it all fell apart. Most of the book is concerned with the increasingly desperate efforts of BGP and other officials to prop up financial dominoes before they could topple and collapse the whole system. It’s an intricate story, one whose details probably seem a lot more interesting to those who were involved than they will to a broader readership. And I don’t think there are any shocking new revelations.

There is, however, a unifying theme to all that complexity: Containing this crisis was so hard precisely because of all that financial innovation. Conventional banks are both overseen and guaranteed by the Federal Deposit Insurance Corporation, which has the power “to wind down insolvent banks in an orderly fashion while standing behind their obligations.” But “the federal government had no orderly resolution regime for nonbanks.”

So BGP and company had to engage in frantic innovation. For example, the Fed funneled money through conventional banks into the hands of nonbanks, in effect lending to institutions they weren’t really supposed to support. This exposed the Fed to new risks; Paulson effectively indemnified the Fed against those risks, apparently without real legal authority to do so. At another point, when a run on money-market funds — which would have been a complete catastrophe — seemed imminent, Paulson guaranteed those funds using money legally earmarked for a completely different purpose, defending the dollar’s foreign exchange value.

Sometimes all these efforts fell short. In a section that will no doubt cause a lot of controversy, BGP argue that there was nothing they could legally have done to prevent the bankruptcy of Lehman Brothers, the event that nearly broke the world. Was this true? I’m not enough of a lawyer to tell.

Still, by the late spring of 2009 the storm seemed to have passed. Recovery was slow, but at this point we are back to an economy with low unemployment and seemingly stable financial markets.