Reality vs. Rhetoric: What REALLY Caused the Financial Meltdown?

The leading Republican candidates for president are spending a lot of time talking about the economy, both the state it is currently in and the causes of the 2009 financial meltdown.  My questions are, how much is rhetoric and how much is fact?  These are important things to answer.  It stands to reason that solving the financial mess we are in starts with understanding the mistakes that were made that led to it.  Both of the front runners for the GOP presidential nomination have embraced a version of events that just doesn’t stand up.  In fact, the chairman of the Federal Reserve, a plethora of economists and even three of the four Republicans on the government commission to investigate the meltdown disagree with them.

Both former House Speaker Newt Gingrich and former Massachusetts Governor Mitt Romney say that the real estate crash that almost brought down the whole banking system was primarily caused by government housing policy.  They like to blame Fannie Mae and Freddie Mac, and they also lay blame at the doorstep of the Community Reinvestment Act of 1977.  They like to say that the government FORCED banks into making risky loans to people who could not afford them.  The danger is “big government” the battle cry goes, trying to legislate prosperity.

“The reason we have the housing crises we have is that the federal government played too heavy a role in our markets,”Romney said in a November 9th Republican debate. “The federal government came in with Fannie Mae and Freddie Mac, and Barney Frank and Chris Dodd  told banks they had to give loans to people who couldn’t afford to pay them back.”  Gingrich has even gone so far as to suggest that Frank and Dodd should be jailed for their role in regulating Fannie Mae and Freddie Mac, but this was before it came to light that Gingrich himself had recieved somewhere between $1.6 and $1.8 million “consulting” Freddie Mac.

So let’s start with the government forcing banks to make subprime loans to people who couldn’t afford them. The Community Reinvestment Act of 1977 was enacted to combat “red-lining” by lenders that often refused to serve low-income borrowers. Under the law, government regulators evaluate banks’ provision of credit and use their performance in approving mergers.  In other words, lenders were being strongly discouraged from showing discrimination against low-income borrowers and financing the purchase of properties designated to be in low-income areas.  At the bubble’s peak in 2005-2006, only 6 percent of all subprime loans involved lenders or borrowers governed by the law, according to Federal Reserve data. “The available evidence seems to run counter to the contention that the Community Reinvestment Act contributed in any substantive way to the current mortgage crisis,” Fed economists Neil Bhutta and Glenn Canner wrote in 2009.  But the facts haven’t stopped the popular misconception that those awful poor people trying to live beyond their means were the cause of the crisis.

Another pillar in the GOP attempt to absolve Wall Street of blame in the crisis has been to point to a 1995 push by President Bill Clinton to expand home ownership by lowering mortgage-underwriting standards. They say it encouraged private lenders to make ever-riskier loans.  The story goes that Fannie Mae and Freddie Mac lowered their standards so drastically private lenders were forced into lowering theirs even further to be able to compete.

That just doesn’t wash for a number of reasons.  First of all, and most obviously, this doesn’t explain why the housing collapse was not just an American affair.  Niether the Community Reinvestment Act nor the lowering of Freddie Mac and Fannie Mae’s lending standards accounts for why house prices in the U.K., Ireland, Spain and France doubled earlier this decade and almost doubled in Australia. All have suffered steep losses since then, with Ireland’s home prices dropping 38 percent by December 2010 from the 2006 peak. Our laws and institutions have no impact on the housing markets in other countries.  Private lenders, however, do.

Secondly, Fannie and Freddie have nothing to do with commercial real estate, where prices rose by 91% in the seven years leading up to October of 2008.  This is an area of the real estate market that is solely serviced by private lenders.  To blame the collapse of commercial real estate prices on Fannie and Freddie is simply a work of fiction. “Commercial real estate seems to have been in a bigger bubble than residential real estate, and there was absolutely no intentional government policy to encourage commercial real estate,” said Douglas Elliott, a former managing director at JP Morgan Chase & Co.

Thirdly, losses on subprime mortgage-backed securities didn’t start shaking financial institutions until 2007, three decades after the CRA was introduced and 15 years after affordable housing goals were established for Fannie Mae and Freddie Mac.

Another myth that needs dispelling is that the subprime loans were primarily given to poor people who should of known they couldn’t pay back the loans.  On the contrary, according to the Government Accountability Office (GAO) of the nation’s 55 million outstanding mortgages in 2008 only 4.59 million of those were subprime loans.  Furthermore, Randall Kroszner, who was then a Federal Reserve governor, said in a 2008 speech that 60 percent of all subprime loans were extended to middle- or higher-income borrowers in middle- or high-income neighborhoods. Another 20 percent were given to low-income borrowers by nonbank lenders that weren’t subject to the anti-discrimination law.   It is also important to note that t the bubble’s peak in 2005-06, only 6 percent of all subprime loans involved lenders or borrowers governed by the Community Reinvestment Act of 1977, according to Federal Reserve data.

So what did cause the crisis?  The Financial Crisis Inquiry Commission, established by Congress in 2009, concluded that “collapsing mortgage-lending standards and the mortgage securitization pipeline” were among several contributors. Other analysts say the lure of profits, not government encouragement, prompted companies to get into subprime. From 2001 to 2005, private lenders’ share of mortgage-backed security issuance rose to 55.2 percent of the market from 19.7 percent.  “The private sector led the way; there’s no question about it,” says Kathleen Engel, author of “The Subprime Virus” and a professor at Suffolk University Law School.

So those are the facts. Not just my facts, but the opinion of most serious economists and policy analysts.  The Republican candidates are in the minority, among serious people, in their belief that “big government” caused the financial crisis.  But that doesn’t stop them, or Fox News, from pushing this propagandized falsehood.  In fact, according to many national polls, they seem to have convinced the majority of Americans that government is to blame.  One is left to wonder how on earth they can possibly solve a crisis they have so profoundly misunderstood.

The important thing is that WE, the people know the truth.  The crisis was caused by the lure of big profits, both in the lending and the securitizing of the debt, by the big banks and other private financial lenders.  And it doesn’t just stop with housing.  They have also securitized sovereign debt and credit card debt, and it’s just a matter of time before these financial time bombs go off.  If you don’t believe me, just take a look at what is going on in Greece. And Spain. And Italy. And Ireland. And Portugal.  It’s just a matter of time.

To date, nothing significant has been done to stop these private players from pursuing their endlessly reckless quest to find new ways to squeeze profit from the people. So it really is just a matter of time before it happens all over again.  We can’t get serious until we get real.

Write if you hear something good.

One thought on “Reality vs. Rhetoric: What REALLY Caused the Financial Meltdown?

  1. See, now why isn’t this information just, flat out, EVERYWHERE?! Here you have it, complete, concise, and with supporting documents. I would just like to thank you for adding another rational voice to the ‘blogoshpere’ that is rapidly becoming the ‘new’ news. However frustrating and discouraging the media has become, I see some light at the end of the tunnel with places like yours. So, do you think it is just a matter of time before the ‘masses’ discover that your ilk have become the real journalists and television news becomes back to back TMZ episodes?

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