Dean Baker: Recession not caused by a financial crisis

Dean Baker, the earliest economist to publicly warn about a housing bubble, argues that the recession was directly caused by the decline of the housing bubble, not by the financial crisis:

Politicians and the media continue to refer to the economic downturn as being the result of a financial crisis. This is wrong. We have 15 million people out of work because the housing bubble that drove the economy since the last recession finally burst. The financial crisis may have been good entertainment for those who like to see huge banks collapse, but it was a sidebar. The real story was the rise and demise of the housing bubble.

Those who claim that the real problem was the financial system and its faulty regulation can be disproved with a single word: Spain.

Spain is noteworthy because it now has an unemployment rate of more than 19%, the highest rate in any of the wealthy countries. Spain did not have a financial crisis. In fact, its well-regulated financial system is often held up as model for the United States.

Spain did have a horrific housing bubble. ... When the housing wealth created by the bubble disappeared people naturally cut back their consumption. ...

This is why Spain's economy is in a severe slump right now. Note that just about all analysts agree, Spain's financial system was well regulated and it had none of the loony loans and outright corruption that pervades Wall Street and the US financial system. Yet, it is suffering from this economic downturn even more than the United States.

The moral of this story is that the problem is not first and foremost a financial crisis. ... The economy's real problem is simply the loss of demand created by collapse of the bubble. ...

We do need financial reform. We have an incredibly wasteful and reckless financial industry. But bad financial regulation by itself did not give us 10% unemployment, nor would good regulation have been sufficient to prevent it. Just ask the workers in Spain.

So, while apparently 71% of Bubble Meter readers blame banks for the U.S. housing bubble (see polls in the sidebar), Dean Baker seems to argue that Spain disproves them.

I still put most of the blame on human psychology. When asset prices are going up, people jump on the bandwagon, which pushes prices up even more. When the bubble finally bursts, people deny personal responsibility by making scapegoats out of people they resent (i.e. those who are "big", rich, powerful, or foreign).