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KEITH HENNESSEY, DOUGLAS HOLTZ-EAKIN, AND BILL THOMAS 

STAGES OF THE CRISIS
As of December , the United States is still in an economic slump caused by a fi-
nancial crisis that first manifested itself in August  and ended in early . The
primary features of that financial crisis were a financial shock in September  and
a concomitant financial panic. The financial shock and panic triggered a severe con-
traction in lending and hiring beginning in the fourth quarter of .
Some observers describe recent economic history as a recession that began in
December  and continued until June , and from which we are only now be-
ginning to recover. While this definition of the recession is technically accurate, it ob-
scures a more important chronology that connects financial market developments
with the broader economy. We describe recent U.S. macroeconomic history in five
stages:

• A series of foreshocks beginning in August , followed by an economic
slowdown and then a mild recession through August , as liquidity prob-
lems emerged and three large U.S. financial institutions failed;
• A severe financial shock in September , in which ten large financial institu-
tions failed, nearly failed, or changed their institutional structure; triggering
• A financial panic and the beginning of a large contraction in the real economy
in the last few months of ; followed by
• The end of the financial shock, panic, and rescue at the beginning of ;
followed by
• A continued and deepening contraction in the real economy and the beginning
of the financial recovery and rebuilding period.

As of December , the United States is still in the last stage. The financial sys-
tem is still recovering and being restructured, and the U.S. economy struggles to re-
turn to sustained strong growth. The remainder of our comments focuses on the
financial crisis in the first three stages by examining its ten essential causes.

THE TEN ESSENTIAL CAUSES
OF THE FINANCIAL AND ECONOMIC CRISIS
The following ten causes, global and domestic, are essential to explaining the finan-
cial and economic crisis.

I. Credit bubble. Starting in the late s, China, other large developing
countries, and the big oil-producing nations built up large capital surpluses.
They loaned these savings to the United States and Europe, causing interest
rates to fall. Credit spreads narrowed, meaning that the cost of borrowing to
finance risky investments declined. A credit bubble formed in the United
States and Europe, the most notable manifestation of which was increased