Common Rationale for the Crisis

The rationale for the financial crisis presented to the public by a news culture that all too often publishes (uncritically) government sponsored sound bites, suggested that the crisis was attributable to a set of conditions no one could be held accountable for because ‘everyone’ was responsible.

1. * The alleged - but not illegal - ‘cronyism’ of the Bush administration prevented state governments from enforcing state banking law which would have curtailed national bank mortgage practices now recognized to be heavily laced with ‘fraud’8 and seen to be the primary enabler of toxic subprime loans. The failures at Fannie Mae were charged to Clinton administration ‘cronyism.’ Cronyism has been tolerated by the Congress, courts and the voting public for decades.

2. *

Lax monetary policy managed by Wall Street insiders at the Treasury and Federal Reserve continually and excessively fed a mortgage market with low interest rates with the ‘policy goal’ of providing all Americans with a home while fostering economic growth. Additionally, sale of subprime mortgages was unofficially encouraged by Alan Greenspan according to some:

Greenspan gave a wink and a nod in favor of adjustable rate mortgages precisely at the time subprime growth was growing rapidly. He denies now that he was indicating these instruments were appropriate for most borrowers, but Dean Baker of Beat the Press begs to differ: The [Washington Post] article cites Greenspan’s denial that he had encouraged people to take-out nontraditional mortgages. The immediate point at issue was that Greenspan had suggested in early 2004 that homebuyers often wasted money by taking out fixed rate mortgages.9

The truth is that Greenspan explicitly encouraged the expansion of the subprime market.

“With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. The widespread adoption of these models has reduced the costs of evaluating the creditworthiness of borrowers, and in competitive markets cost reductions tend to be passed through to borrowers. Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending…”10

3. *

Lax regulatory oversight of the retail mortgage companies, the agencies securitizing the mortgages, the insurance companies providing insurance for the hedges on interest rates, and the investment companies using these mortgaged backed securities for more sophisticated investment products, was the norm.

“Changes in the lending business and financial markets have moved large swaths of subprime lending from traditional banks to companies outside the jurisdiction of federal banking regulators. In 2005, 52% of subprime mortgages were originated by companies with no federal supervision, primarily mortgage brokers and stand-alone finance companies. Another 25% were made by

finance companies that are units of bank-holding companies and thus indirectly supervised by the Federal Reserve; and 23% by regulated banks and thrifts 11

Regulation also failed to keep pace. At the Securities and Exchange Commission (“SEC”), the Office of Risk management had been reduced to an office of one by February of this year. From 2005, the number of SEC enforcement division personnel was cut by 146 from 1338 to 1192 in 2007. In 2004, the SEC reduced the capital requirements for the largest Wall Street investment banks. The SEC was given insufficient oversight authority over the credit rating agencies when Congress adopted the Credit Rating Agencies Reform Act of 2006. And as Chairman Cox has recently and correctly testified, Congress also failed to give the SEC adequate supervisory powers over Wall Street Investment Bank Holding companies with the passage of the Gramm Leach Bliley Act. Congress also has failed to regulate the credit and other derivative instruments which in some instances are “Toxic Waste” to the financial system.

Meanwhile, the Federal Reserve and banking regulators examinations failed to identify and rectify unsound lending and banking practices at institutions such as IndyMac, Washington Mutual (“WaMu”), Countrywide, and Citigroup. Often these practices developed as lenders sold loans they had originated, or were able to protect against credit risks through credit derivatives, thereby eliminating any “skin in the game.” As these unsound practices grew, the regulators also failed to ensure there was adequate capital in financial institutions that had taken on and retained excessive risks.12

In the medical industry, this laxness is referred to as malpractice.

4. *

The decline in national economic productivity starting in 2003-2004 resulted in homeowners not being able to increase personal earnings in a manner required by their debt obligations, thus requiring them to default.

5. * Political contributions13 and sweetheart loans14 to federal agency administrators and Congressmen ‘may’ have resulted in a lack of oversight. Proposed legislation by Senate Banking Committee Chairman Richard Shelby (R-Ala.) in 2003 for regulation and control of Fannie Mae and Freddie Mac in the wake of their accounting scandals was defeated when Fannie Mae committed to Congress to invest heavily in subprime mortgages. The deal between Fannie Mae and Congress allowed regulators to turn a blind eye. In truth, the proposed reorganization was lacking any teeth to begin with: “I don’t see much other than a shell game going on here, moving something from one agency to another….”(Representative Melvin L. Watt, Democrat of North Carolina), and should have been viewed solely as an attempt to allow the President to control Fannie Mae and Freddie Mac rather than Congress.15

6. * Greed and self interest, re-enforced by a culture that legitimizes and rewards the same, caused hundreds of thousands of home buyers, mortgage companies, bankers, investors, regulators and lawmakers to fib, lie, commit fraud and act irresponsibly. Punishment for misrepresentation and fraud over the years had never exceeded the benefits, and most executives responsible for the previous two decades of crises landed comfortably after all was said and done.16 Millions of investors benefited when their retirement and savings funds grew rapidly from the profits of the highly profitable, securitized subprime loans.17 (Rest assured these investors were required by the funds to identify the level of risk they were willing to take with their funds, and as a result have no ethical basis for crying ‘foul!’.) Everyone (in the top 10% of the economy) gained from this culture, and turned a blind eye.

7. *

A culture of excessive corporate risk taking was reinforced by setting precedents for a “too-big-to-fail” mentality. The history of Federal interventions and bailouts goes back to the Savings and Loan bailout (1989), the $20 Billion Mexican bailout (1994-95), the Long Term Capital Management Crisis (1998), 18 the $18.5 Billion for the Asian financial crisis of 199819, the $30 Billion Brazilian Bailout20, a Plunge Protection Team to support intervention in the case of a national crisis,21 and the ‘implicit’ bailout of Fannie Mae and Freddie Mac if needed.

8. *

The behaviors that transformed the crisis from potential to acute (Bear Sterns and Lehman Brothers) may have been the Wall Street trader practice of practice of ‘naked short selling’ rather than the weakened security portfolios.

Most of these conditions and explanations seem fairly conventional, and casual observers concluded the ‘market, political and social forces and human nature’ were at the core of this crisis – and ‘no one person or group’ could conceivably be held responsible. All activities, however ethical or not, were viewed as legal in the eyes of the regulators and courts.

On the other hand, the subprime mortgage market had been around for decades, operating well within the controls of the financial system. The market had, to a certain degree, regulated fraud by exposing fraudulent operations and punishing those who took excessive risk. The appropriate questions should be: what was the root cause of the meltdown, what happened to allow the entire industry to spin out of control, and was it allowed to spin out of control on purpose?