1.WHAT'S A NICE ECONOMY LIKE YOU DOING IN A PLACE LIKE THIS?

Did anyone get the license plate of that truck?

That's how many Americans felt after our financial system spun out of control and ran over all of us—almost literally—in 2008. The U.S. economy was crawling along that summer, with employment drifting down, spending weakening, and the financial markets suffering through a gut-wrenching series of ups and downs—mostly downs. The economy was hardly in great shape but neither was it a disaster area. It wasn't even clear that we were headed for a recession, never mind the worst recession since the 1930s. Then came the failure of Lehman Brothers, the now-notorious Wall Street investment bank, on September 15, 2008, and everything fell apart. Yes, the license plate of that truck read: L-E-H-M-A-N .

Most Americans were innocent bystanders who didn't know where the truck came from, why it was driven so recklessly, or why the financial traffic cops didn't protect us better. As time went by, shell shock gave way to anger, and with good reason. A host of financial manipulations that ordinary people did not understand, and in which they played no part, cost millions of them their livelihoods and their homes, bankrupted many businesses, destroyed trillions of dollars' of wealth, brought the once-mighty U.S. economy to its knees, and left all levels of government gasping for tax revenue. If people felt as though they were mugged, it's because they were.

The financial “accidents” that took place between the summer of 2007 and the spring of 2009 had severe consequences, which Americans experienced firsthand. But most citizens are baffled, and many are extremely displeased, by what their government did in response to the crisis. They question the justice of the seemingly large costs taxpayers had to bear, and they wonder why so many reckless truck drivers are still on the road, prospering while other Americans suffer. Perhaps most of all, they are anxious about what the future may bring. As late as the 2012 election, a strong majority of Americans were telling pollsters that the country was still “on the wrong track” or “heading in the wrong direction.” No wonder we heard populist political thunder from both the Right (the Tea Party movement) and the Left (the Occupy movement).

The United States recently completed the quadrennial spectacle we call a presidential election with a plainly angry electorate. While President Obama won reelection, no one yet knows what the 2012 election will bring in its wake. But we do know that the last chapters of the story that began in 2007 are yet to be written. So let's start by looking back. What hit us—and why?

Historical perspective accrues only with the passage of time, and we are still living through the aftermath of the frightening financial crisis and the Great Recession that followed closely on its heels. But enough time has now elapsed, and enough dust has now settled, that some preliminary judgments can be made. Consider this book a second draft of history. There will doubtless be thirds and fourths.

It is vital that we reach some preliminary verdicts relatively quickly because Americans' well-justified anger is affecting—some would say, poisoning—our political discourse. This book concentrates on the what and especially the why of the financial crisis and its aftermath. It's a long and complicated story, but some understanding is essential for the better functioning of our democracy. So before getting enmeshed in the details, here is a very brief history of the financial crisis, the Great Recession, and the U.S. government's responses to each. It will take only four paragraphs. The fourth may surprise you.

The U.S. financial system, which had grown far too complex and far too fragile for its own good—and had far too little regulation for the public good—experienced a perfect storm during the years 2007–2009. Things started unraveling when the much-chronicled housing bubble burst, but the ensuing implosion of what I call the “bond bubble” was probably larger and more devastating. The stock market also collapsed under the strain, turning many 401(k)s into—in the dark humor of the day—“201(k)s.” When America's financial structure crumbled, the damage proved to be not only deep but wide. Ruin spread to every part of the bloated financial sector. Few institutions or markets were spared, and the worst-affected ones either perished (as in the case of Lehman Brothers) or went on life support (as in the case of Citigroup). We came perilously close to what Federal Reserve Chairman Ben Bernanke called “a global financial meltdown.”

Some people think of the financial markets as a kind of glorified casino with little relevance to the real economy—where the jobs, factories, and shops are. But that's wrong. Finance is more like the circulatory system of the economic body. And if the blood stops flowing . . . well, you don't want to think about it. All modern economies rely on a variety of credit-granting mechanisms to circulate nutrients to the rest of the system, and the U.S. economy is more credit-dependent and “financialized” than most. So when the once-copious flows of credit diminished to mere trickles, the economy nearly experienced cardiac arrest. What had been far too much liquidity and credit during the boom years quickly turned into vastly too little . The abrupt drying-up of credit, from both banks and the so-called shadow banking system, coupled with the massive destruction of wealth in the forms of houses, stocks, and securities, produced what you might expect: less credit, less buying, and a whopping recession.

The U.S. government mobilized enormous resources to alleviate the financial distress and, more important, to fight the recession. Congress expanded the social safety net and enacted large-scale fiscal stimulus programs. The Federal Reserve dropped interest rates to the floor, created incredible amounts of liquidity, and expanded its own balance sheet by making loans, purchasing assets, and issuing guarantees the likes of which it had never done before. Many of the Fed's actions were previously unimaginable. I remember coming into class one morning in September 2008, scratching my head in disbelief and saying, “Last night the Federal Reserve, which has never regulated an insurance company, nationalized one!” The company was the infamous AIG.

Now the surprise: It worked! Not perfectly, of course. But for the most part, the financial system healed faster than most observers expected. (Remember, healing in this context does not mean returning to the status quo ante. We don't want to do that.) And the economy's contraction, though deep and horribly costly, turned out to be both less severe and shorter than many people had feared. Only the homebuilding sector, a small share of our economy, experienced anything close to Great Depression 2.0. For the rest, unemployment never quite reached 1983 levels, never mind 1933 levels. That doesn't mean everything was hunky-dory by, say, 2012. Far from it. But the worst, most assuredly, did not happen.

So that's my capsule history, and it suggests a modestly happy ending—or at least a sigh of relief. That said, we are grading on a pretty lenient curve when the good news is that the United States avoided a complete meltdown of its allegedly best-in-class financial system and a second Great Depression. In truth, U.S. macroeconomic performance since the fall of 2008 doesn't merit even the proverbial gentleman's C. It has been the worst in post–World War II American history. Give it an F instead.

Congress rewrote the rulebook of finance in 2010, trying to ensure that nothing like this will ever happen again. But the financial reforms are so new—most not yet even in effect—that no one knows how the redesigned regulatory system will work in practice, especially once it comes under stress. And bank lobbyists are fighting the reforms tooth and nail. To turn Rahm Emanuel's famous principle into a question: Did we waste this crisis or use it as a catalyst for much-needed change? Only time will tell.

Another aspect of the crisis motivates this book: Even today, despite numerous works on the crisis—some of them excellent—most Americans remain perplexed by what hit them. They have only a limited understanding of what the U.S. government did, or failed to do, on their behalf—and, more important, why . They also harbor several major misconceptions. In consequence, the Tea Party movement erupted in 2009, voters “threw the rascals out” in the elections of 2010, Occupy Wall Street exploded in 2011, economic issues were central to the hotly contested election in 2012, and trust in government is still scraping all-time lows.

This, too, is understandable. As I watched the financial crisis, the recession, and the policy responses to each of them unfold in real time, one of my biggest frustrations was how little explanation the American people ever heard from their leaders, whether in or out of government. Sadly, that remains true right up to the present day. We won't restore trust in government until Americans better understand what happened to them and what was done to help.

The president of the United States possesses the biggest megaphone in the world. But President George W. Bush virtually dropped out of sight during the waning months of his administration. Can you remember even a single Bush speech on the nation's developing economic crisis? President Barack Obama has been vastly more visible, activist, and eloquent than his predecessor. Yet even he has rarely taken the time to give a speech of explanation—far less time than the American people need and deserve. The two secretaries of the Treasury during the crisis period, Henry Paulson and Timothy Geithner, have between them barely given a single coherent speech explaining what happened and—perhaps more important—why they did what they did. Federal Reserve Chairman Ben Bernanke has done more explaining, and done it better. But his audience is specialized and limited, and he tries to stick to the Fed's knitting, not the administration's.

So most of the job of explaining has been outsourced by default to the private sector. Even there, however, the supply has been inadequate. For example, while our financial industry is allegedly teeming with brilliant people who understand all this stuff, hardly any industry leaders have stepped up to explain what happened, much less to apologize—probably on advice of counsel. Journalists, academics, and the like have, of course, penned hundreds of articles and op-eds on the origins of the crisis and the responses to it—including a few by yours truly. But mass media outlets require such brevity that anything remotely resembling a comprehensive explanation of something as complex as the financial crisis is out of the question. Twelve seconds of TV time constitutes a journalistic essay.

While this book tells the story in what I hope is an intelligible manner, its more important goal is to provide a conceptual framework through which both the salient facts and the litany of policy responses can be understood . More concretely, I want to provide answers to the following three critical questions:

How Did We Ever Get into Such a Mess?

The objective here is not to affix blame, though some of that will inevitably (and deservedly) be done, but rather to highlight and analyze the many mistakes that were made so we don't repeat them again.

What Was Done to Mitigate the Problems and Ameliorate the Damages—and Why?

Were the policy responses—some of which were hastily designed—sensible, coherent, and well justified? Again, my purpose is not so much to second-guess the decision makers and grade their performances as to learn from their experiences, so we're better prepared the next time around. My big worry is that the policy responses of 2008–2009 are now held in such ill repute that politics will stand in the way the next time a financial crisis hits.

Did We “Waste” the Financial Crisis of 2007–2009—in Emanuel's Sense—or Did We Put It to Good Use?

Specifically, were the financial reforms enacted in 2010 well or poorly designed to create a sturdier financial structure? What did they leave out? Has the financial industry cleaned up its act? Perhaps most important, what comes next?

A well-known series of TV commercials brags that “what happens in Vegas stays in Vegas.” But the calamities that befell the financial markets in 2007–2009 did not stay there. They soon had profound ill effects on the real economy—the places where Americans live and work, where nonfinancial companies make profits or losses, and where standards of living rise or fall. Indeed, with many Americans desperate to find work or struggling to make ends meet, we are still living with many of those effects.

The links from financial ruin to recession and unemployment are not hard to fathom. As credit becomes more expensive and, in worst cases, unavailable, businesses lose the ability to finance everyday needs—like meeting payroll, buying materials, and investing in equipment. In industries whose customers rely heavily on credit—such as for buying houses or automobiles—firms also find their sales dwindling. With sales down and costs of credit up, businesses have no choice but to scale back operations. Output falls, which means more layoffs and less hiring. And that, in turn, spells less income for consumers and therefore reduced sales at other firms. The process feeds on itself, and we get a recession. All this happened with a vengeance in 2008–2009, bringing untold misery to millions.

The two panels of figure 1.1 offer two versions of one part of this sad story: the sharp rise in joblessness in the United States that started early in 2008. The left panel displays the behavior of the national unemployment rate since 2003. Its steep ascent from the early months of 2008 to late 2009 depicts a national tragedy. As this book went to press, the unemployment rate still stood at 7.9 percent. Unemployment had been at 7.8 percent or higher for 46 consecutive months.

SOURCE: Bureau of Labor Statistics

The right panel puts the recent stretch of miserably high unemployment into historical perspective by tracking the unemployment rate for almost thirty years. During the quarter century from February 1984 through January 2009, Americans never witnessed an unemployment rate as high as 8 percent for even a single month . An entire generation entered the labor force and worked for decades without ever experiencing an unemployment rate as high as the lowest rate we had from February 2009 through August 2012. The graph shows that even unemployment rates above 7 percent were rare during this twenty-five-year period. One has to go back to the spring of 1993, when today's thirty-seven-year-olds were graduating from high school, to find the previous instance. In fact, as recently as the summer of 2007, the unemployment rate was barely above 4.5 percent—a low rate we had come to think of as normal. Then came the Great Recession.

According to the U.S. Bureau of Labor Statistics, payrolls began contracting modestly in February 2008 and then with increasing ferocity after Lehman Brothers crashed and burned in September 2008. Job losses averaged a mere 46,000 per month over the first quarter of 2008, but a frightening 651,000 per month over the last quarter, and a horrific 780,000 per month over the first quarter of 2009. The labor-market pain was agonizingly deep and dismayingly long. Total employment peaked in January 2008 and then fell for a shocking twenty-five consecutive months—the longest such losing streak since the 1930s.

The total job loss was just under 8.8 million jobs, over a period during which our economy should have added perhaps 3.1 million jobs just to accommodate normal labor-force growth. So in that highly relevant sense, the cumulative jobs deficit was around 12 million by February 2010—nearly the population of Pennsylvania. Millions of families were thrown into privation and despair; many remain there. And the jobs deficit rose even higher in 2010 and 2011 as the anemic pace of job creation fell short of the roughly 125,000 jobs per month needed just to mark time with a growing population.

Figure 1.2 shows that employment crashed in 2008 and 2009, and then barely crept back up in 2010 and 2011. By August 2012 total employment was back to only about May 2005 levels. That's zero net job growth over a period of more than seven years! The dearth of jobs is both a human and an economic tragedy that has had serious consequences already and will continue to have them for years to come.

SOURCE: Bureau of Labor Statistics

It gets worse. Short spells of unemployment may not be terribly problematic; some are even welcome as people move or change jobs. But long spells of joblessness are devastating. Research shows that when displaced workers find new jobs, they are typically at much lower wages and that students graduating into a high-unemployment economy are burdened by a wage disadvantage that lasts for at least a decade or two.

Long-lasting unemployment is not a traditional part of the American story. In an average month during the years of 1948 to 2007, fewer than 13 percent of the unemployed were jobless for more than six months—the so-called long-term unemployed (see figure 1.3 ). By April 2010 this indicator of extreme labor-market stress had reached an astonishing peak above 45 percent, and it's only slightly lower today. Figure 1.3 shows that we have literally never seen a labor market this bad in the postwar era—not by a mile.

SOURCE: Bureau of Labor Statistics

Jobs are something tangible. Real (that is, inflation-adjusted) gross domestic product (GDP) is, on the other hand, an abstract concept created to measure the overall size of the economy and to monitor its growth. It's our most widely used economic scoreboard. By common definition, a recession is a time when real GDP declines for two or more consecutive quarters. Fortunately, that doesn't happen often. Quarterly GDP statistics date back to 1947, and during the sixty-one years from then until the start of the Great Recession, real GDP declined for two consecutive quarters only nine times. It declined for three consecutive quarters only twice, and it never fell for four consecutive quarters. Then came 2008–2009.

Real GDP declined in five of the six quarters that made up 2008 and the first half of 2009, including a losing streak of four straight. Whether one counts the five quarters out of six or the four in a row, that decline was the worst performance since the 1930s. The bottom literally fell out during the winter of 2008–2009, which is when the phrase “Great Depression 2.0” crept into the lexicon. All told, real GDP fell 4.7 percent. Since trend growth would have been at least 3.5 percent over that period, we probably lost over 8 percent of GDP, relative to trend. That's the equivalent of every American losing 8 percent of his or her income, or, more realistically, 10 percent of the population losing 80 percent. As Frank Sinatra might have said, it was a very bad year.

The recession of 2007–2009 is without peer in the pantheon of postwar U.S. recessions. Only the steep contractions of 1973–1975 and 1980–1982 even hold a candle, and each in its day was called “the Great Recession.” All in all, it is hard to escape the conclusion that the 2008–2009 period was the worst by far in seventy years, both in terms of job loss and GDP decline.

There's more. Steep declines in GDP are normally followed by strong growth spurts as the economy makes up for lost ground. For example, our economy grew 6.2 percent and 5.6 percent in the years immediately following the previous two Great Recessions. By this additional criterion—the speed of recovery—the 2007–2009 recession stands out on the downside, too. Given such a deep recession, we should have grown by somewhere near 7 percent in the following year; instead, we managed just 2.5 percent. We got a double whammy: a sharp recession followed by a weak recovery. No wonder most Americans think the recession never ended.

Things were not always so. The main story of the U.S. economy in the decades leading up to the crisis was one of growth and job creation, not of decline and job loss. Calling the years since 2008 “the new normal” represents defeatism that no one—not economists, politicians, or the public—should accept.

Look back at the first graph of this chapter, figure 1.1 . The peak unemployment rate after the previous recession was only 6.3 percent, a rate we would stand up and cheer for today. And after hitting that peak in June 2003, unemployment fell steadily through late 2006, bottoming out at 4.4 percent. Net job gains during that three-plus-year period amounted to about 6 million jobs—nearly 2 million per year. So American workers benefited from a tight labor market for a protracted period. That's the sort of environment we want.

The job market was even better during the late years of the Clinton boom. Although the U.S. economy was believed to be at full employment by 1995, it surprised us and proceeded to create about 2.8 million net new jobs in 1996, 3.4 million in 1997, another 3 million in 1998, and 3.2 million more in 1999. The unemployment rate even touched 3.9 percent for a few months in 2000. Those were the days. With jobs plentiful and employers competing actively for scarce labor resources, it was said in 1999 that if you had a pulse, you could get a job. And if you didn't, some employer would help you get one!

I recount these two happy episodes not so much to make us feel ashamed of our sorry recent performance as to make two points. The first is that it is unduly pessimistic to declare either that the American economy can't sustain job growth of 3 million a year over multiple years, or that we'll never get back to, say, 5 percent unemployment. Nonsense. Been there, done that. In fact, done both several times. So perish the thought—and I do mean perish it . Such job growth and unemployment targets are not the stuff of gauzy dreams. They are things we have achieved in the recent past.

Which is the second point. The years 2000 and 2007, especially the latter, are not ancient history. Ask yourself what could possibly have changed so fundamentally about the U.S. labor market in six years to consign us to permanently higher unemployment? My answer is straightforward: nothing. There is not a single reason to believe that we cannot get back to within shouting distance of 5 percent unemployment again. But it will take some time; after all, we are digging out of a pretty deep hole. For reference, after the unemployment rate peaked at 10.8 percent at the end of 1982, about four years of strong growth took unemployment back down into the sixes again, and about another year brought it down into the fives. Something like that should be our target now: say, a five-year march back to 5 percent unemployment. “Five in five” makes a nice slogan. Unfortunately, we're off to a slow start.

Given what happened afterward, it is worth noting that, contrary to myth, the growth spurt that started petering out in 2005 was not powered mainly by building more houses. In fact, business investment grew at essentially the same rate as housing. In terms of share in overall GDP, homebuilding rose from 4.5 percent in 2000 to just over 6 percent in 2005. That extra 1.5 percentage points of GDP, spread out over five years, added just 0.3 percent per year to the overall GDP growth rate. Not much.

But inside the small housing sector it was a very big deal. American builders started 1.6 million new homes in 2000 but 2.1 million in 2005. That's a half million more new dwellings per year—too many, in retrospect. When homebuilding peaked in the second half of 2005, few people viewed that development with alarm. GDP was, after all, still moving up modestly: Growth averaged 2.4 percent over the second half of 2005 and the two full years of 2006 and 2007. Yes, the house-price bubble had burst and the housing sector had cratered. But maybe that was just a return to normalcy.

The economy looked to be in decent shape on the eve of the Great Recession. The unemployment rate was under 5 percent, where it had been for about two years. GDP was growing close to its assumed trend rate. Outside of housing, the seas did not look particularly stormy. But there were hints of trouble: House prices were falling, the homebuilding industry was dying, and employment growth was meager over the last half of 2007. In addition, both American businesses and American households had saddled themselves with huge debts. If the economy tanked, these debts would be hard to repay.

Then came the slide.

As everybody knows, the collapse of homebuilding led the way. Residential construction, which is normally about 4 percent of GDP, soared to as high as 6.3 percent of GDP in 2005:4—and then started falling. According to myth, the story was simple: The house-price bubble burst and new home construction came tumbling after. But that's not actually the way it happened. In fact, spending on residential construction started to decline well before house prices topped out.

Sounds surprising but it's true. The data on housing show clearly that homebuilding peaked in 2005. Home prices tell a messier story, however: They peaked either in 2006 or in 2007, depending on what measure you use. Two major competing indexes of national average house prices are shown in figure 1.4 . The upper line plots a celebrated index devised by Karl “Chip” Case of Wellesley and Robert Shiller of Yale, and now maintained commercially by Standard & Poor's. The lower line plots an index maintained by the government—specifically, by the Federal Housing Finance Agency (FHFA), which is the regulator of Fannie Mae and Freddie Mac. You can see that they tell rather different stories.

According to the Case-Shiller index, home prices peaked in May 2006, but the FHFA index dates the peak a year later. That's a pretty big difference. ^[1] By either measure, however, the house-price bubble burst long after new home construction went into decline. So the oft-repeated story that falling prices killed homebuilding isn't right.

A simpler explanation is that homeownership simply reached an unnatural high of 69 percent of all American housing units in 2004 and 2005—up from 64 percent just a decade earlier. Just as not everyone likes vanilla ice cream, not every American wants to (or should) own a home. For some people, renting is the better option—especially when home prices soar relative to rents. But whatever the reason, the data show a remarkable decline in spending on new homes, which kept on falling for an amazing three and a half years, eventually dropping to less than half its peak value. The housing sector didn't just experience a recession; it had a depression.

But the housing collapse alone could never have caused a recession as large as the one we experienced. Both the magnitudes and the timing are off. Housing typically accounts for only about 4 percent of the economy. So the stunning collapse of homebuilding was not nearly big enough to cause a serious recession. Furthermore, the U.S. economy did not slip into a recession until the final month of 2007, according to official dating, and I will argue shortly that the recession didn't really begin in earnest until September 2008. Thus two to three years passed between the start of the decline in housing and the serious decline in the overall economy. During 2006 and 2007, real GDP rose at about a 2.3 percent annual rate, and the unemployment rate barely budged, despite an imploding housing sector. Macroeconomists call that steady trend growth. Others call it boring. But it wasn't a recession.

Things deteriorated in the winter of 2007–2008, however. Payrolls started to decline in February 2008, beginning what would ultimately become the horrific twenty-five-month job-losing streak mentioned earlier. The unemployment rate ticked up in November 2007, beginning a long ascent that would eventually take it to a dizzying high of 10 percent in October 2009. GDP tells a different story. It decreased only slightly, on net, over the last quarter of 2007 and the first half of 2008. The U.S. economy was staggering but had not yet fallen to its knees.

When an economy is inching along, with employment drifting down, spending weakening, and its financial system reeling from a gut-wrenching year of ups and downs, that economy is in a weak position to withstand any adverse shock. And we got a whopper on September 15, 2008, when Lehman Brothers filed for bankruptcy. Immediately thereafter, the whole U.S. economy fell off the table. Look at figure 1.5 . Lehman's bankruptcy came late in the third quarter of 2008. In that quarter, real GDP fell at a 3.7 percent annual rate. Then it dropped at a frightening 8.9 percent rate in the fourth quarter, and then at a rapid 5.3 percent rate in 2009:1. The graph gives the unmistakable visual impression of something sliding downhill fast—right after the truck hit us.

Job losses, which had averaged “only” 152,000 per month over the first eight months of 2008, leaped to 596,000 jobs per month over the last four, and then to 780,000 a month over the first three months of 2009. Figure 1.6 , which depicts these numbers, looks downright scary—and it felt so at the time.

As jobs declined, the unemployment rate, which was just 6.2 percent in September 2008, soared. It was a miserable time for American workers. It is only a slight exaggeration to say that everything fell apart after Lehman Day. That is why, unlike the official arbiters at the NBER, I date the start of the recession to a precise day: September 15, 2008. It was one of those rare cases in which we know exactly what hit us: Lehman Brothers failed, kicking off a virulent financial crisis.

If you were watching data such as these in real time, the U.S. economy might have appeared to be falling into an abyss—Great Depression 2.0, if you will—from Lehman Day until sometime in February or March 2009, when the collapse hit bottom. Figures 1.7 and 1.8 extend the awful data shown in figures 1.5 and 1.6 beyond the first quarter of 2009, to see what happened next. Here you see that it was literally true—as some people were ridiculed for saying at the time—that things started getting worse at a slower rate. GDP stopped dropping and jobs were still falling, but at a slower pace. That was progress!

The visual impression left by these two figures, and many others I could show, reinforce the case that the darkest days came in February and March of 2009. ( Welcome to Washington, President Obama! ) After that the U.S. economy entered the “getting worse at a slower rate” phase, and some glimmers of light began to show. Beginning in 2009:3 for GDP but only in March 2010 for employment, the uphill climb began in earnest. Unfortunately, once an economy has fallen into such a deep hole, climbing out takes quite awhile. As this book went to press, we were still climbing far too slowly.

Did the years 2008 and 2009 really constitute America's worst macroeconomic performance since the Great Depression, as is frequently claimed? Well, that depends on what you mean by “since the Great Depression.” The Great Contraction began in August 1929 and ended in March 1933. It was vastly longer and incomparably deeper than what we have suffered through recently. Thank goodness for that.

But what is often forgotten is that after the U.S. economy hit bottom in March 1933, the climb out of its superdeep hole was very rapid. Try guessing the average annual real GDP growth rate from 1933 to 1937. You're probably too low. The astonishing answer is 9.5 percent, which sounds like China today. This “boom,” of course, started from a shockingly low base, and there was misery throughout.

The robust expansion of the mid-1930s came to an abrupt halt in May 1937—due to mistakes by policy makers, by the way—and “the recession within the Depression” followed. Although the 1937–1938 recession seemed like peanuts compared with the Great Contraction of 1929–1933, it was pretty violent by modern standards. So standing as America's worst recession since 1937–1938, as 2007–2009 does, is a pretty high dishonor.

What sent the U.S. economic juggernaut into a tailspin in 2008? The short answer: the financial crisis. It's now time to find out how. What made the music stop?

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[1] The two indexes differ in many ways. The FHFA index is limited to mortgages that qualify for securitization by Fannie Mae and Freddie Mac. These restrictions chop off both extremes of the housing market—the high end , where so-called jumbo mortgages are too large for Fannie and Freddie to handle, and the low end , which is where most of the subprime mortgages were. Since we know from other data sources that low-end house prices inflated more than middle- and high-end prices during the bubble, the FHFA index may understate the boom and bust. But the Case-Shiller index puts too much weight on twenty major urban areas, on the East and West Coasts in particular, where home prices are more volatile. So it seems at least arguable that Case-Shiller overstates the bubble. MW7n5oloRDT4RulK2gVxcS3LE0U/SzCejqaN945k1vQSPiu5q0cIopco3PKFkGnJ