Ten years ago, Neil Fligstein, an economic sociologist at the University of California, Berkeley, wrote a review essay in Contemporary Sociology (2011) with the title “The Banks Did It.” Today, some six coauthored academic articles later on various aspects of the role of banks and mortgage finance in the financial crisis, Fligstein is out with the present volume. What's new? For readers not widely read on the financial crisis and unfamiliar with the author's work, quite a lot; for others, much less.
Fligstein argues that despite the many publications on the financial crisis of 2007–2008, no one has yet zoomed in on the role of banks in mortgage finance. The book's main contribution is to examine in great detail the historical underpinnings of the U.S. financial system and its inner workings in the years up to 2008. Fligstein demonstrates how the urge to make money out of mortgage finance led banks to assume more and more risk and to engage in fraudulent behavior.
The crisis, Fligstein writes, grew out of a business model based on vertically integrated banks where origination, securitization, selling, and holding of mortgages and various derivatives became the dominant (and a wonderfully profitable) activity. As profit opportunities from conventional mortgages declined, banks took on unconventional, or subprime, mortgages that became ever more risky despite AAA ratings. The underlying driver of this system was deregulation brought about by a shift from relationship banking to transaction and fee-based banking set in motion by financial disintermediation, the stagflation crisis of the 1970s, and the savings and loan crisis of the 1980s.
As the business model of banks came to be based on mortgages, the funding of these ever more doubtful assets shifted toward the interbank market, increasing both the interconnectedness and fragility of the system. Fligstein stresses that it was a system in which the government laid out the rules—under the influence of lobbying, of course. Hence, the title of the final chapter: “The Banks Did It (With the Help of the Government!).”
It was the U.S. government under President Johnson that enabled securitization of mortgages in the first place and set Fannie Mae and Freddie Mac, so-called government-sponsored enterprises (GSEs), en route to becoming part of the mortgage supply chain. Despite many claims to the contrary, however, the GSEs were not responsible for the financial crisis. Until 2005, they were restricted by regulation to less risky conventional mortgages. At that time private banks had already dominated and engaged in subprime lending and securitization for some years.
Why did the banks go on like this? Why did they not see the crisis coming? According to Fligstein, “the natural tendency to think that the worse could not happen took over. Everyone thought they would hunker down and be the last firm standing” (p. 169). Apart from the statement by then Citi CEO Chuck Prince that as long as the music plays you've got to get up and dance, it's not clear what the evidence is for this claim. How can we understand why firms like Goldman Sachs, J.P. Morgan Chase, and Wells Fargo avoided the same destiny as the book's four case firms, Citigroup, Washington Mutual, Bear Stearns, and Countrywide Financial? It seems to me to be a rather simplified “greed explanation,” which does not allow for a better understanding of the crisis as a complex phenomenon. It is hard to believe that they saw the crisis coming but just could not help themselves. So, what future did these bankers imagine and what cultural frame did they see their world through?
Still, many banks, including international ones such as Deutsche Bank, UBS, and RBS, did go on to the bitter end. With reference to Hyman (not Herman, as he is called in the book) Minsky, Fligstein argues that only regulators could have stopped them. As we know, they did not, and in chapter 8 Fligstein explains why. Apart from being subject to lobbyism and cognitive capture, the Fed did not see the crisis coming because its policymakers saw the economy through a macroeconomic frame that created blind spots and did not allow for a close relationship between finance and the so-called real economy.
This makes sense, but is it not conceivable, then, that bankers too saw the world through a frame or narrative that made them believe that this time was different? In the final chapter Fligstein calls it “sobering” how difficult it was for policymakers to foresee the crisis ex ante, but the bankers are not viewed in this light. Arguably, “new era” thinking is a key part of Minsky's work but not of Fligstein's framework. In The Bankers Did It, bankers just counted their money as they went down the slippery slope to disaster like a herd destined for self-destruction. Fligstein uses the term “making sense” numerous times throughout the book but doesn't think in terms of Karl Weick's sensemaking approach until chapter 8 on why the Fed did not see the crisis coming.
I think the book would have gained from a more consistent overall framework apart from what is briefly described in general terms (see p. 4) but did not much use after that. I am also not convinced that the book's overall thesis about the role of the banks and mortgage finance is quite as novel as the author suggests. Apart from details and nuances (some of them important), the conclusion that the “proximate cause” of the banks’ problems was the short-term funding of their mortgage-backed securities (MBSs) and collateralized debt obligation (CDOs), while “the real cause of their eventual demise was their dependence on profits based on the vertically integrated business model,” will not come as a big surprise to informed readers (p. 171).
The book's dependence on the author's articles may explain to some extent the lack of a consistent framework and the repetition. It does not explain the omission of contributions by economic and business historians including, but not limited to, Mark Rose's Market Rules: Bankers, Presidents, and the Origins of the Great Recession (2019) and Adam Tooze's Crashed: How a Decade of Financial Crises Changed the World (2018). The book suffers from some typos and errors, but more confusing is the shifting meanings of concepts such as “shadow banking” and “capital” throughout.
The Banks Did It does a good job of explaining the development of U.S. banks’ mortgage-based business model and how it shaped the foundations of the crisis. It is less successful as an explanation of the financial crisis at a more general level. Trends such as financialization and the political economy of neoliberalism, shareholder value model, and a general belief in efficient markets and competition is only discussed briefly in the final chapter. Arguably, such cultural and societal factors were important in shaping the Great Financial Crisis and its international character.
At the end of the day, Fligstein has written an important book that makes clear the significance of understanding the importance of banks’ vertically integrated mortgage-based business model to the financial crisis. It suffers from its own blind spots, however, and downplays or omits the role that other important factors played in bringing about the worst financial crisis in generations.
