Personally, I’ve grown weary of the blame game for the causes of the US financial crisis of 2008. Some place the blame entirely on the private sector. Others place the blame entirely on the government. The pattern I’ve noticed is that one’s political orientation tends to determine who blames whom. In other words, if you’re left-leaning or Democrat, you’re more likely to blame the private sector and if you’re right-leaning or Republican, you’re more likely to blame the government.
The blame game is ridiculous and it misses the whole point because the debate is inherently flawed. It’s not an either/or proposition because both the public and private sectors deserve blame (if I had to make the choice between the two, I’d blame the government more than the private sector, but I don’t have to). So, both sides are actually right, however they still don’t tell the complete story. Consider your mind blown.
I’m not denying the private sector had major responsibility here. We know they relaxed their 3C’s of credit (collateral, character, and capacity) and thereby relaxed their historically-effective lending standards. We know they overleveraged. We know they bundled derivatives and other creative products that were dysfunctional from the start, be it due to the actual design of the product or its constituents. We know the ratings agencies were asleep at the wheel and managers failed to do their own due diligence. I’ve written about all of this before, so I’m not going into much more detail here.
I want to take some time to look at the government’s role in the crisis because, in order for the private sector to do what it did, it had to be allowed, maybe even encouraged, to do so by the government. At a minimum, the private sector needed the government to look the other way, and at worst, it needed the government to actively encourage and facilitate such activity. Note that these topics could easily be whole posts in and of themselves.
The natural counter is that the private sector bought the government. Even if true, it doesn’t change the fact that it’s the government’s collective job (as legislators, regulators, judges, etc.) is to be the ‘adult in the room’ and remain vigilant against danger. The government is not supposed to be an enabler, facilitator, and/or cheerleader here. It is the government’s job to look out for the well-being of the nation at large. In this sense, the government deserves blame and failed to do its job. We can’t absolve the government from responsibility by saying they were bought out.
So, what did the government do to deserve its share of blame? The repeal of Glass-Steagall is really what set this in motion because it broke down the divide between commercial and investment banks. A commercial bank is where you and I go for a mortgage or car loan or a checking/savings account while an investment bank is where a company goes to sell bonds or stock to the market. Glass-Steagall was passed during the Great Depression by FDR to separate commercial and investment bank activity and it was a good thing to have in place. It’s one of the few things FDR actually did right in the New Deal, but I digress.
There were also various other lapses in regulatory judgment. These include the Securities Exchange Commission (SEC) allowing the big five investment banks (Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Stearns) to expand their leverage to very high levels, which I’ve discussed previously. We’re talking 30-1 or worse in some cases. There was also the unwillingness to regulate derivatives and various non-bank lending institutions, of course. Additionally, there were breakdowns regarding interstate banking restrictions.
The government not only did its part to undo key regulations like Glass-Steagall and turn a blind eye on derivatives and non-bank lenders as discussed above, but the government also encouraged the reckless behavior. It was very clear that the government wanted to see the homeowner percentage elevated from its historical norm. Various statements and reports from Fannie Mae, Freddie Mac, Congress, and the White House (under both Clinton and Bush Jr.) show this pattern.
Clinton wouldn’t have expanded Jimmy Carter’s Community Reinvestment Act (CRA) if the goal wasn’t to break down barriers to home ownership, for example. We can’t fully ignore the CRA’s role in the crisis because, even though some are quick and correct to point out that the non-bank lenders were often not subject to the CRA, many of the banks that ended up with the non-bank loans were subject to the CRA. It was at the bank’s discretion whether or not it wanted to try to treat the non-bank loans as CRA loans, thus creating an incentive for the non-CRA lenders to ensure their loans could be counted under the CRA.
And, with that, we come to the Federal Reserve. In the early 2000’s, the Fed cut their rates to a then-historic low of 1%. They left them there for a while, and in hindsight, we see they left them there too long. Alan Greenspan’s Fed also was very hands-off about regulating, figuring the self-interest of the market was enough to police itself. The most dangerous thing the Greenspan Fed did, however, was create an expectation of bailout in the event things went bad. Easy Al was willing to step up during several incidents, such as the Long Term Capital Management debacle and emerging market bubble of the late 1990’s or the post-tech bubble era of the early 2000’s. This is known as the Greenspan put (simply, puts are options contracts that can be bought as a hedge against a decline in value or a play on the asset declining in value). More recently, Big Ben Bernanke has continued this trend, as we saw in 2008 and with the recent coordinated global intervention for Europe. It’s now known as the Bernanke put.
Basically, the Fed’s low interest rate and easy money policies caused asset bubbles, and then the Fed used those same tools to address the aftermath of said bubbles, thereby creating a new bubble somewhere else. Furthermore, they’ve created a culture that expects to be bailed out if things go awry. If bad actors aren’t allowed to fail, it’s not really capitalism. This is where ‘capitalism on the way up and socialism on the way down’ comes from because they keep the profits as they rally, but they look for a bailout from the government as we plunge.
Again, I’m not absolving the private sector of responsibility because it definitely did its part. All I’m saying is we can’t absolve the government, either. Sure, we can quibble over which side was more at fault (and we probably will for years to come), but this either/or framework for discussion has done a tremendous disservice to America in terms of our ability to understand and address the crisis. Oddly enough, the conflict also protects both the government and private sector from meaningful reform efforts.
As I said above, this doesn’t tell the entire story because it’s not just about blaming the government and private sector. I’ll go into this in greater detail in future posts about the rest of the story, including cultural/psychological aspects that enabled the crises and a simple takedown of the common argument that because the crisis was global, it has to be mainly the private sector’s fault.
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