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5 lessons of the Great Recession

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The housing market became a realm of now-familiar abuses: Low "teaser" interest rates that would jump sharply after a few years. Loans with no down payment. Mortgages with "negative amortization," in which the balance due on the home would rise over time rather than fall, allowing borrowers to pay less in early years. It all seemed OK because home prices were going to keep rising inexorably.

Fueling this excess at the consumer level was excess in high finance. Home loans were packaged into securities that investors snapped up for their seemingly safe returns – with blithe approval from rating firms like Moody's and Standard & Poor's.

All the while, economists marveled at the moderate but sustained growth of the economy, a seemingly golden era of stability. A period of intense financial innovation was perceived as more than just an economic boon. It represented the next phase of evolution for a capitalist society – a sort of postindustrial Shangri-La.

"We grew up believing that finance was the next level of capitalism," Mohamed El-Erian, who heads the investment firm PIMCO, said at a recent panel discussion in Washington. The idea was that "somehow you go through agriculture and manufacturing, and then you go into services, and then if you're really lucky, you get to finance."

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.

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."

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