Today’s political meltdown looks a lot like the 2008 financial crisis

Is America’s political system facing a meltdown? Dire symptoms of a breakdown are evident.  

The public is irreparably divided on virtually every issue, large or small and vital or trivial. Neither political party is able or willing to compromise on solutions. And the political discourse is as nasty and vicious as it has ever been, demoting truth and fact to non-relevance.

The most dangerous symptom, unprecedented in American history, is that both parties regard the other as “threats to democracy.” 

President Joe Biden argues that the threat of this era is between democracy and autocracy. Abroad, China, Russia, North Korea and Iran are principal forces of autocracy. At home and if elected, former President Donald Trump would end democracy as we know it and become a “dictator.”

Trump calls Biden “the worst president” in American history. Trump has accused Biden of weaponizing the Justice Department against him. Initially vowing “retribution” and “revenge” by bringing a successful administration, Trump has reversed course. Revenge will be against the political opposition. And one think tank and one former aide have produced a blueprint for “revolutionizing” the Constitution.

This concurrent attack on democracy is eerily similar to what almost brought the financial system to ruin in 2008. Both parties are assuming a ruinous outcome. But what happens when assumptions go awry?  

Past crises were caused by assumptions that housing prices would rise and mortgages could be securitized and turned into safe financial instruments on which huge amounts of money could be made based on monthly payments and cash flows. This led to credit default swaps and collateralized debt obligations. 

Investopedia defines a credit default swap as “a financial derivative that allows an investor to swap or offset their credit risk with that of another investor,” through an arrangement where “the buyer pays an ongoing premium similar to the payments on an insurance policy. In exchange, the seller agrees to pay the security’s value and interest payments if a default occurs.”

Tick, tick, tick.

It defines a collateralized debt obligation as “a complex structured finance product that is backed by a pool of loans and other assets and sold to institutional investors.” It’s a “derivative,” meaning “its value is derived from another underlying asset,” and “these assets become the collateral if the loan defaults.”

In 2006 and 2007, with low interest rates,  the appeal of owning not just a residence but multiple properties became very attractive. Agents, mortgage companies and banks began granting loans with little oversight.

Mortgages from AAA to subprime were turned into credit default swaps and collateralized debt obligations. Risk was eliminated by combining the AAA mortgages. Bets were made on these instruments. A further assumption was assuming that prices would rise. And worse, bets were made on other bets.

The process became the financial equivalent of a nuclear reaction. So-called NINJA loans — meaning no income, job or assets were required to obtain them  — became common. Too many unqualified loans were made to people who could not afford to make them. Rating agencies such as Standard and Poor’s and Fitch continued to back these instruments. Money was being made hand over fist until the music stopped.

Defaults on payments began to rise. These escalated to a crisis. The banking system was about to crumble as loans could not be paid and credit default swaps and collateralized debt obligations became financial weapons of mass destruction as defaults dramatically rose.  

Fortunately, the Federal Reserve intervened with huge amounts of capital. Among the victims, the veritable Lehman Brothers and Bear Stearns banks collapsed. It could have been worse. But despite the cheating and illegal activities, only one banker went to jail.

In politics, there is no Federal Reserve Bank to intervene to save the system. As both parties declare democracy is at risk, the system’s legitimacy will erode just as NINJA loans and defaults helped create the financial crisis. And the equivalent of credit default swaps and collateralized debt obligations are today’s social media and the willingness of both parties to use all means, fair or foul, to attack and defeat the other.

What can be done?  It may well be that the political system is more resilient and stronger and its endangerment may have been exaggerated. Checks and balances could limit what either party can or will do if their candidate wins.

But suppose, like the financial crisis, those assumptions are incorrect.  Then what?

Harlan Ullman Ph.D. is a senior advisor at the Atlantic Council and the prime author of the “shock and awe” military doctrine. His 12th book, “The Fifth Horseman and the New MAD:  How Massive Attacks of Disruption Became the Looming Existential Danger to a Divided Nation and the World at Large,” is available on Amazon. He can be reached on Twitter @harlankullman.