honorentheos wrote:I really enjoyed the book
All the Devils are Here that talks about the crash and it's causes. The authors chose the title because just about everyone has some fault in the crash.
While I agree that wall street types bear the greater fault, it's also true that the reason they made the highly risky loans was in part because they actually didn't think there was a risk: the government was going to bail them out no matter what happened. Fanny/Freddie represented a false safety net. True libertarian proponents of free markets point to the depth of the crash as an example of misguided market interference because, they argue, if it wasn't for the belief in this safety net the number of high risk loans would have been limited to the high risk taking segment of the financial industry rather than becoming the norm. I'd say rightly so, since the regulatory side of the interference equation was almost completely lacking.
That said, even with all of the pro-housing market manipulation, the financial sector is wholely responsible for the invention and destructive effectives of credit default swaps and other synthetics. An example of the financials playing with a toy chemistry set thinking they are too smart to be wrong while trying to make lead into gold...and blowing up the building.
Anyway, here's
a good article on the government's part in causing the crisis.
It’s true that I’m being more than a little simplistic in assigning
all of the blame to the free markets—the government plays a role. And understating my feelings as much as possible, I’m not a fan of George W. Bush, so throwing him and his administration under the bus is tempting.
But the fact remains that if you understand all of the moving pieces, you can build a model that captures most everything that was going on:
Demand: There was a huge demand for mortgages. Several factors contributed to that—the idea that homes were a good investment, tax breaks on mortgage interest, cable TV shows that showed people making money flipping houses, low interest rates, etc.
The only major piece of the demand for mortgages that the government is responsible for is the home mortgage deduction. The Federal Reserve didn’t cause there to be low long-term interest rates. The market determines those. To be fair, the Fed is responsible for low short-term interest rates, which made adjustable-rate mortgages appealing.
Supply: There was a
huge supply of money that people wanted to invest in long-term investments—the supply was much bigger than the demand. It was this huge supply that drove down the long-term interest rates and actually funded the mortgages. The money was supplied by rich savers having a lot of money they wanted to save. This supply made it to the market because investment banks claimed they could turn crappy mortgages into good ones through the magic of securitization. The private organizations that rate bonds believed the investment banks, and the investment community believed the banks. It’s true that Fannie Mae and Freddie Mac played the game with the investment banks. And the investors made choices between buying AAA bonds from Lehman Brothers that yielded 4.5%, or AAA bonds from Fannie Mae that yielded 4.25%. These rates were determined by the markets, and the differences--25 basis points in this example—is how much the market valued the implicit guarantee that if needed, the government would bail out Fannie Mae.
Once this model is correctly set up, you can play around with it and see what would happen if you change things. You quickly discover that the crisis was actually quite robust. If the Fed would have raised short-term interest rates, more unqualified people would have taken out fixed long-term rates rather than ARMs. If Fannie Mae would have held tight underwriting standards, the spread between Fannie bonds and Investment Bank bonds would have risen, and more money would have flowed through the investment banks. But with all of those changes, the crisis still happens—it just changes what financial institution is holding the mortgage when it went bad.
The only change that seriously take the steam out of the whole mess is to change the perceptions of the “sophisticated” free-market purchasers of mortgage-backed securities and their belief about the viability of the “credit enhancements” that investment bankers put into the securities they were peddling. Because of that, they must receive the bulk of the blame.