Through The Flaw

The "flaw" that this documentary is named after draws from the now-famous statement made before Congress by Alan Greenspan in October 2008. The Reagan-appointed chairman of the Federal Reserve Bank had his hands on the levers of US economic power throughout the 1990s and early 2000s. His interest rate policies were widely implicated in the asset price bubble leading up to the credit crunch of 2008.

Greenspan was a disciple of the objectivist philosopher and novelist Ayn Rand, and during his time as a young man in her inner circle he absorbed the notion that the decisions of individuals should not be swayed by consideration of the interests of others. Much later, when he took control of the US economy, Greenspan was able to put this philosophy into practice. Markets, Greenspan thought, should be left to get on with it. Asset prices, when they rise too high, are automatically brought lower by individuals cashing in by selling. Conversely when asset prices go too low, investors spot a bargain, buy, and prices head back up again.

Government interference in this process, Greenspan’s philosophy said, could only warp prices and hence create distortions that would cloud the efficient operation of markets, damage economic progress and depress wealth creation. The events of 2008 shattered this view. In a striking scene in which Greenspan addresses a congressional panel, the film shows the moment when he admitted that he was wrong after all. Markets do not always work—no matter what Eugene Fama’s Efficient Markets Hypothesis had apparently shown. "I have found a flaw in the model that defines how the world works," Greenspan announced; "I was shocked.''

The US housing market is at the centre of the film's narrative. It was here that the bubble which led to the crash grew. A host of talking heads is drafted in to narrate the story: economists such as Joseph Stiglitz and Robert Shiller crop us, as does Jim O’Neill, the former chief economist at Goldman Sachs and now the chairman of Goldman Sachs Asset Management. Mortgage salesmen, a former bond trader and indebted mortgage borrowers also appear, and together they provide a broad collection of perspectives.

The film’s conclusion is perhaps not the one that might be expected. Credit-driven asset price bubbles, the film shows, have the effect of channelling money from the bottom of society to the top, and during the credit bubble of the 2000s, this process was the most pronounced that it has been in US history. The results of this transfer are staggering. A statistic cited in the film says that 15,000 American citizens own $700bn of assets—an amount equivalent to half the GDP of Brazil.

The reason that credit booms trigger this surge of money into the hands of higher wage earners is that they tend to be involved in financial activity. So when the credit markets begin to heat up, they tend to earn the benefits of the lending splurge. The money they make is used to buy assets and in the run up to the crash of 2008, those assets were houses. Their house purchases had the effect of dragging upwards overall prices for the entire housing market. This had a knock-on effect all the way down to lower income home-buyers, who had to borrow in order to buy. In this way, credit-fuelled asset price bubbles result in more money being made at the top and more money being borrowed at the bottom. The result is an expanding wealth gap, which in the US is now the worst it has been since the 1920s.

No solution is proposed for this inequality. The film does not set out regulatory ideas or legislative recommendations; which is surprising, considering the brainpower that the producers managed to assemble on camera. To hear Shiller or Stiglitz on the need to reform markets in over-the-counter derivatives, on the oversights of the Commodity Futures Trading Act and the need for proper consumer financial protection would have enhanced the film’s impact no end. As it is, the way ahead is not considered, and the film feels incomplete because of it.

Another concern is that the film manages to construct a narrative where the banks are shunted to one side and take a secondary role in the retelling of the crisis. The relationship between borrower and lender is shown as the real culprit. For this reason, the banks’ originate and distribute model is only touched on in passing, and the vast engine of credit default swaps and collateralised debt obligations is overlooked.

This examination of the relationship between borrower and lender gives a sense of earthiness that is absent from other analyses of the crash. The Flaw displays a high level of sophistication in explaining why the markets collapsed as they did, unlike, for instance, Michael Moore's Capitalism: A Love Story. But can a documentary film of the credit crunch of 2008 really go 89 minutes without asking how we can ensure the banks don’t do it all over again?

James Elwes is the deputy editor of Prospect