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5 lessons of the Great Recession

Five years after the worst crisis since the 1930s, America has devised safeguards and changed the rules of Wall Street. But could the country really avoid another financial collapse?

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Post-crisis, Mr. El-Erian says the more appropriate mentality for his industry is a humbler one, getting back to its basic role of simply serving businesses and consumers.

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Still, the question looms: Why did so many people miss the danger building in the housing market?

"Ever since World War II, due to all of the government policies promoting homeownership, we've never had a major nationwide decline in housing prices," says Mr. Paulson. "If investors own a pool of diversified mortgages, the biggest risk was that they would get their money back too soon if interest rates dropped and homeowners prepaid their mortgages."

As a nation "we were addicted to debt and consumer debt," he says in a telephone interview from his Chicago-based foundation, The Paulson Institute. "Many Americans were using their homes almost like an ATM."

When the housing crash came, it affected communities from the Nevada desert to the sandy beaches of Florida. Stockton, Calif., saw home prices plunge by two-thirds and its city government go bankrupt. But the effects of the bust extended beyond housing, affecting everything from exports to consumer spending.

Since then, safeguards have been put in place, particularly when it comes to mortgages. A Consumer Financial Protection Bureau, created by the Dodd-Frank Act, has issued rules to avoid a repeat of bubble-era lending atrocities. So-called qualified home loans (most mortgages) can no longer have negative amortization, an "interest only" payment plan, or a repayment term longer than 30 years. Lenders have to judge whether the borrower can repay, with payments that don't exceed 43 percent of income. Down payments still aren't required, but they have come back into vogue.

Beyond mortgages, the Dodd-Frank law also aims to constrain the broader risk of financial excess. It calls for tracking "derivatives" (complex financial contracts) and hedge funds. It doesn't regulate banker compensation, but it does require that shareholders have a "say on pay." And the Federal Reserve is nudging the financial sector toward pay incentives that reduce risk-taking.

While all this promises to result in a safer financial system, no one is expecting sudden perfection in the banking industry. Some of the reforms, after all, are akin to fighting "the last war" rather than preparing for the next one. Lobbying by industry and by fair-lending advocacy groups eliminated other potential reforms. Then there is the hard truth of history. "As long as we've had markets and banks, we've had financial crises," says Paulson.

That doesn't mean the efforts to prevent another calamity are hopeless. Rather, in Paulson's view, it means regulators should strive to "address problems before excesses create major speculative bubbles, and [should] have the tools and political will to act with force to minimize the impact of any crisis."

2. THE ONLY WAY TO STEM A PANIC IS WITH ACRONYMS.

For all its complexity, the financial crisis was, at root, a run on banks. The core challenge wasn't simply that the housing market had collapsed. It was the way the collapse triggered wider doubts about the safety of many large financial firms – and finally caused important pipelines of credit to freeze altogether.

In this case, the "run on the bank" wasn't by mom and pop depositors. It was a run largely by financial firms on one another as they backed away from short-term loans that had flowed easily before 2007.

The problem was a basic one. In good times, banks thrive by loaning money long term, at a relatively high interest rate, using short-term funds that they borrow at a lower rate. But in hard times, their short-term funds can disappear if investors or depositors have reason to worry about the bank's solvency.

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