Another Inconvenient Truth

It has been the conventional wisdom that the big banks were at the heart of 2008 financial crisis that resulted in the “Great Recession”. Those on the inside of the industry have known for years that this was not the case but just try to convince someone in the press or government. They have been fanning these populist flames for eight years. Now there finally seems to be a little daylight being shed on the real story and it involves a larger cast of characters including the U.S. government. What is also interesting is that these similar views are bi-partisan.

First, there is Paul Krugman in his recent column on Bernie Sanders (“Sanders Over The Edge”, The New York Times, 4/8/16). Paul represents the liberal side in terms of his political perspective but here is what he had to say about the 2008 crisis:

“The easy slogan here is “Break up the big banks.” It’s obvious why this slogan is appealing from a political point of view: Wall Street supplies an excellent cast of villains. But were big banks really at the heart of the financial crisis, and would breaking them up protect us from future crises? Many analysts concluded years ago that the answers to both questions were no. Predatory lending was largely carried out by smaller, non-Wall Street institutions like Countrywide Financial; the crisis itself was centered not on big banks but on “shadow banks” like Lehman Brothers that weren’t necessarily that big. And the financial reform that President Obama signed in 2010 made a real effort to address these problems. It could and should be made stronger, but pounding the table about big banks misses the point.”

From the conservative side we have Phil Gramm and Michael Solon weighing in (“The Great Recession Blame Game”, The Wall Street Journal, 4/15/16). The column is basically aimed at Obama and the dismantling of Dodd Frank but their comments on the roots of the crisis are worth noting. First the authors take issue with the myth of the over-leveraged state of the major banks that has been cited as one of the causes of the crisis:

“Virtually all of the undercapitalization, overleveraging and “reckless risks” flowed from government policies and institutions. Federal regulators followed international banking standards that treated most subprime-mortgage-backed securities as low-risk, with lower capital requirements that gave banks the incentive to hold them. Government quotas forced Fannie Mae and Freddie Mac to hold ever larger volumes of subprime mortgages, and politicians rolled the dice by letting them operate with a leverage ratio of 75 to one—compared with Lehman’s leverage ratio of 29 to one.”

Gramm and Solon go on to call out the regulators role in the crisis and their misguided response:

“Regulators also eroded the safety of the financial system by pressuring banks to make subprime loans in order to increase homeownership. After eight years of vilification and government extortion of bank assets, often for carrying out government mandates, it is increasingly clear that banks were more scapegoats than villains in the subprime crisis… The subprime crisis was largely the product of government policy to promote housing ownership and regulators who chose to promote that social policy over their traditional mission of guaranteeing safety and soundness.”

These government policies led to these toxic mortgages getting fed into the banks’ securitization machine and the rest was history.

In the end though we should be less concerned with setting the record straight than taking away one central truth about the financial crisis of 2008: The government caused the crisis and has never been held accountable. The regulations they have put in place to respond to this crisis of their own making may be the catalyst for the next major financial crisis. As I have noted in previous posts the unintended consequences of the post-crisis regulations could make the next financial crisis even worse. There needs to be real bi-partisan discussion about the impact of these regulations. Along with this dialogue there must be a willingness to examine, change and potentially discard those rules that are creating more risk than they are mitigating. Without this we may bear out the famous saying: “He who does not learn from history is destined to repeat it.”

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