‘The Financial Crisis Was the Result of Government Housing Policy’
The American Enterprise Institute’s Peter Wallison on how government, not greed, was the essential ingredient in the 2008 meltdown.
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Wallison: I will dispute the idea that we had to bail out Wall Street for this reason. The government bailed out Wall Street on the theory that all of these firms were interconnected. That’s the term you used, and that’s in fact the term that was used initially in the Bear Stearns bailout that occurred in March 2008. OK, well, what does that mean? What it means, according to the government, is that if one of these large companies fails, it drags down others. That is, if Bear Stearns failed, then what it owed to all the others would cause all the others to fail, or many others to fail. So they bailed out Bear Stearns. But when we came to Lehman Brothers, they reversed their policy and didn’t bail [them] out.
What do we learn from Lehman Brothers? Yes, there was chaos after Lehman Brothers failed, no question about it. No one is denying that. But did any other company fail as the result of Lehman Brothers being unable to meet its obligations? The answer to that question is no, with the exception of one instance, and that is a money market mutual fund by the name of the Primary Reserve Fund. Primary Reserve Fund held on to some Lehman Brothers paper which it probably would have sold much earlier but for the fact that it believed the government was going to bail out Lehman Brothers the way it bailed out Bear Stearns, and [that] therefore the Primary Reserve Fund would not suffer any losses on this Lehman debt. That was the only example.
Every other institution that got into any kind of trouble—and we can talk about Wachovia, Citi, WaMu, even Merrill Lynch and Goldman Sachs, Morgan Stanley, and AIG—all of those institutions, which have been the ones that have been somehow aided by the government or had to be acquired by a healthier institution, all of those were not affected in any way by Lehman Brothers.
(Interview continues below video.)
reason: Even by the turmoil that the Lehman Brothers collapse caused to the financial markets? Lehman went into bankruptcy in the middle of September 2008. By the time that the bailout was passed and initiated in October, Wachovia, Washington Mutual, and other institutions had already started to fail.
Wallison: Yes, there was chaos. Investors ran from all of these large financial institutions. That is what happened. As a result they hoarded cash because they wanted to be very sure they had the cash when their depositors or other investors came for it. And that’s what the financial crisis was: You couldn’t get financing…for anything, because these large financial institutions were hoarding cash. But was that caused by Lehman being unable to pay its debt? No, that was caused by what I call, and what scholars have always called, a “common shock.”
The reason that it is different from interconnection is that a common shock refers to a case in which a very widespread asset of some kind—and in this case we’re talking about mortgage-backed securities backed by these low-quality or subprime mortgages—suddenly plunges in value. And when it does, it causes all other financial institutions that are holding these instruments, these assets, to look weaker. Their capital goes down and their liquidity goes down because they can no longer use these mortgage-backed securities for financing purposes—that is, for liquidity purposes. It was the common shock that caused all of them to look very, very weak, and when Lehman failed, then people panicked because all of these other institutions had looked very weak.
So if we had avoided the common shock, the interconnections would have meant nothing. In other words, if Lehman had failed in an economy in which people were not worried about all the other financial institutions because of the common shock, it would have had no effect whatsoever.
You had pointed correctly to what actually did happen, but that was because all of these institutions had been weakened well in advance by the decline in the value of mortgages. Interconnection is an excuse that the government used, was picked up happily, readily, avidly by the media, and broadcast as the reason. But when we look at Lehman Brothers and what happened after Lehman Brothers, we can see that nothing that Lehman Brothers did by failing (except for the Primary Reserve Fund) had any significant effect on all of these other firms, such as AIG, Citi, and so forth.
reason: We’re three years past the heart of the financial crisis and Congress has put in place the Dodd-Frank Act, signed by President Obama in 2010, as a way to keep the financial crisis from happening again. Are we headed in the right or wrong direction in terms of financial services regulation?
Wallison: Let’s talk first about the Dodd-Frank Act, because this is the perfect example of how a false narrative that misinterprets what happened in the financial crisis can result in bad legislation.
It seemed to me that the purpose of the Financial Crisis Inquiry Commission was to do an honest job of looking at what really happened in the financial crisis, and if they’d done an honest job, we would have had a different answer to what happened in the financial crisis. They didn’t. They essentially followed the left’s analysis of what happened, which is lack of regulation, predatory lending, greed on Wall Street. So if that is in fact the cause of the financial crisis—Congress decided that before the FCIC even reported, so they went right ahead and legislated anyway—but if that was really the cause of the financial crisis, then of course you’d have the Dodd-Frank Act, which imposes huge regulation on the financial system. If the financial system wasn’t sufficiently regulated, then you want to regulate them more. That, however, is wrong.
From my perspective, what really happened was a result of government housing policy causing, enabling, a lot of people to get mortgages who otherwise couldn’t get these mortgages. And then they couldn’t sustain the mortgages when the bubble that was growing stopped growing. And as a result, we had the financial crisis.
reason: Is there anything in Dodd-Frank that is causing separate, perverse impacts on the U.S. economy today?
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Anyone mind if I pimp the usual blog post here?
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No, you've been beating the drum on the issue long enough that you can be excused a victory dance when a post like this comes along.
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I put the blame on the ugly mixing of private and public that seems so popular in today’s economy. Fannie and Freddie were created by government but they were also listed on the New York Stock exchange. What was it, a government entity to create a public good or a private entity to provide a private good?
What we need is a wall of separation between public and private
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Fannie Mae was a government entity created so that politicians could make money. They did so by buying Fannie stock, then giving them preferred financing from the Fed, and watching Fannie take over the mortgage securitization market, and their stock go up.
They also got lots of money from Goldman Sachs who helped Fannie repackage and sell the mortgage backed securities. Obama being the biggest recipient of cash from them.
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You mean giving a loan to people whocan't pay them back causes problems?Everyone knew you could borrow 105% of a house and the equity would grow,like magic,and you could borrow against that alsso.Down payments and paying of you princple is for chumps
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Yes, this explanation is 100% political. An attempt to exonerate Republicans of blame and lay it at the feet of the people who, according to them, are responsible for all social ills: poor black people.
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Tony......you never give up do you?
get a clue.
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Toni, you give douches a bad name.
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Fuck you, you race mongering asshole.
$
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Fuck you. You probably buy into the Republican spin while claiming to be a free thinking nonpartisan.
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There are vastly more poor white people in this country than poor blacks, just by shear numbers. So no asshole, if any group of people could be "blamed" for our social ills (which I don't think anyone can really do since people aren't a homogenous glop) it would be poor and lower middle class whites.
Stick that in your pipe and smoke it.
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Heerpity Derp-derp-derp. And now back to your regularly scheduled program.
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About the time I think the liberal vomit has scalded Tony's throat he arrives to dispel that rumor and further expose himself as a slow thinker.
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I agree that government intervention in the market is the major cause of the crisis. But it is the private sector who is giving money and 'encouragement' to both parties to support this and other government interference with a market. And that money encouragement is driven by greed with lack of concern for the future effects. So the crisis was caused by government intervention which was supported by greedy private market companies, like home builders and realtors. Until we get rid of the crony capitalism it is impossible to say the cause is only one.
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By that logic, the voters are the ones that are truly responsible for every ill the government has brought against us, including the recession. Which I guess is true.
The only way to stop businesses and individuals from seeking gov help against competition is to take away the gov's power to do so.
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No individual or corporation (i.e. the "private sector") can force government to interfere in the market to benefit the individual or corporation. Only politicians can do it. Yet you blame the private sector. First you paint a broad brush regarding "encouragement" given to politicians to intervene in the market. How do you distinguish contributions to politicians for:
1) rent-seeking
2) avoiding legislation that hurts the bottom line (additional regulations to adhere to regardless if customers want it)
3) avoiding legislation that benefits one's competitors, but not your business
4) seeking benefits available to other companies/industries (if we support dairy farmers, why not "fill in the blank")Not all contributions are from rent-seekers. I don't fault contributions for reasons 2 and 3.
It's not money and "private sector" greed that corrupts the free market, it's political greed corrupting the free market (creating a politically controlled market instead), by politicians who've shown they'll give government favors for big bribes (I mean campaign cash).
The best regulator of business, is the free market. The worst regulator is the government.
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Shouldn't it be easy then to prove all this with numbers and not just rhetoric about the policies?
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For sure. Buy what was the impetus for the government policy? Government had to implement easy credit policies because of rising inequality. Lower middle class American families would not have been able to afford a house otherwise because of stagnant wages. While the rich and corporations benefited from lower taxes, the middle class were left behind. Their disposable income also declined. The easy credit policy was needed to placate this large constituency. It was good politics, but bad economics. So yes government policy led to the crisis, but it was income inequality and the stagnant purchasing power of many Americans that was the impetus behind it.
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I disagree with Mr. Wallison's premise that government was the driving influence in the events of 2008. Government served as a complicit operative of the perpetrators, but not in the way described by Mr. Wallison, the FCIC majority, or Dr. Fukuyama.
The events of 2008 were orchestrated financial fraud of gargantuan proportions. Federal regulators aided the fraud. The SEC repealed the "up-tick" rule, e.g., while knowing violation of that rule at the heart of the Crash of 2000-2002. The SEC also adopted a "Madoff exception" rule, permitting naked short selling (electronic counterfeiting) of shares to drive down share prices. A secret report (now de-classified) obtained by the Pentagon in 2009 supports my conclusion.
Recent private research found more than half of all sub-prime mortgage-backed securities in the markets in 2006-2007 were designed-to-explode synthetic derivatives. Creators of these IED securities profited by buying credit default swaps (bets against the MBS), and by naked short selling the shares of financial firms who were so ill-advised as to buy the fraudulent MBS.
This is not the entire story, but space is limited. My point is orthodox views simply do not get close to the real story of what is being done to this country - an estimated $13 trillion looted from investor capital in 2008 alone, per the Pentagon report.
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The nexus and source of all the financial and economic problems in America is the Federal Reserve System, period. Fiat money and the coercive, arbitrary manipulation of interest rates are at the heart of all of it.
But yes, the government was all over this thing from top to bottom. In addition to the Fed, we had the government underwriting shit mortgage credit, I don't think the "bailouts" were even bailouts at all, since all that debt was underwritten by the government anyway.
In 2004 I was an intern with the "housing finance agency" in the downtown of my state capital. My job was to write commitment letters for the public housing project finance applications that were submitted through our agency. 99.9% of the letters I wrote were approvals; I think I wrote three denials in the year I was there. These applications were from a gaggle of penniless "community investment trusts" and private developers, and I saw numbers from $250,000 to $25M. I wrote letters all day long, every day.