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.