"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."
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.