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  • What Didn't Cause the Financial Crisis

    For the next few days, weeks and probably years, we’re going to hear a lot about what caused the financial crisis and led to a $700 bailout. And we’ve already heard presidential nominees, Members of Congress and political analysts blame free markets and deregulatory policies over the past 8 years. Using free markets and deregulation as scapegoats couldn’t be farther from the truth. Let’s see why.

    Here’s Sebastian Mallaby’s take:

    Financiers did create those piles of debt, and they certainly deserve some blame for today’s crisis. But was the financiers’ miscalculation caused by deregulation? Not really.

    The key financiers in this game were not the mortgage lenders, the ratings agencies or the investment banks that created those now infamous mortgage securities. In different ways, these players were all peddling financial snake oil, but as Columbia University’s Charles Calomiris observes, there will always be snake-oil salesmen. Rather, the key financiers were the ones who bought the toxic mortgage products. If they hadn’t been willing to buy snake oil, nobody would have been peddling it.

    Who were the purchasers? They were by no means unregulated. U.S. investment banks, regulated by the Securities and Exchange Commission, bought piles of toxic waste. U.S. commercial banks, regulated by several agencies, including the Fed, also devoured large quantities. European banks, which faced a different and supposedly more up-to-date supervisory scheme, turn out to have been just as rash.

    By contrast, lightly regulated hedge funds resisted buying toxic waste for the most part – though they are now vulnerable to the broader credit crunch because they operate with borrowed money.

    If that doesn’t convince you that deregulation is the wrong scapegoat, consider this: The appetite for toxic mortgages was fueled by Fannie Mae and Freddie Mac, the super-regulated housing finance companies. Mr. Calomiris calculates that Fannie and Freddie bought more than a third of the $3 trillion in junk mortgages created during the bubble and that they did so because heavy government oversight obliged them to push money toward marginal home purchasers.

    There’s a vigorous argument about whether Mr. Calomiris’ number is too high. But everyone concedes that Fannie and Freddie poured fuel on the fire to the tune of hundreds of billions of dollars. “

    Here’s George Mason economist Walter Williams:

    The financial collapse of Fannie Mae and Freddie Mac is not a failure of the free market because lending institutions in a free market would not have taken on the high-risk loans. They were forced to by the heavy hand of government.”

    Here’s our own distinguished fellow, former Congressman Ernest Istook:

    Greed was indeed a problem, but not just on Wall Street and in the mortgage industry. It also motivated buyers who thought they could get something for nothing. Don’t omit the political greed, although politicians want to mask this by holding hearings about the faults of others but not of themselves. Thanks to politics, our government was not only an enabler, but actually required lenders to issue something-for-nothing loans.

    As noted by George Mason University economics professor Russell Roberts, “For 1996, HUD [Department of Housing and Urban Development] required that 12 percent of all mortgage purchases by Fannie and Freddie be ‘special affordable’ loans, typically to borrowers with income less than 60 percent of their area’s median income. That number was increased to 20 percent in 2000 and 22 percent in 2005. The 2008 goal was to be 28 percent.”

    The left’s affordable-housing agenda created not just incentives but actual mandates for bad behavior, especially with their political allies running those GSEs. Public outrage stopped the Clintons from taking over health care. But their HUD stealthily sowed the seeds of today’s financial mess.

    Government regulation cannot now be the all-purpose answer when it was the source of the problem.”

    If you still need convincing, read our Senior Research Fellow in Regulatory Policy, James Gattuso’s “Red Tape Rising: Regulatory Trends in the Bush Years” that shows the regulatory burdens have increased in the years since George W. Bush assumed the presidency.

    Going back to Mallaby, he properly warns us by saying:

    [B]laming deregulation for the financial mess is misguided. It is dangerous, too, because one of the big challenges for the next president will be to defend markets against the inevitable backlash that follows this crisis.”

    Posted in Economics [slideshow_deploy]

    10 Responses to What Didn't Cause the Financial Crisis

    1. Stefcho, UK says:

      This explains it all…


      Take the time to watch, then you decide.

    2. Pingback: topwebbusinesses » Blog Archive » What Didn’t Cause the Financial Crisis

    3. Rob says:

      As noted by George Mason University economics professor Russell Roberts, “For 1996, HUD [Department of Housing and Urban Development] required that 12 percent of all mortgage purchases by Fannie and Freddie be ’special affordable’ loans, typically to borrowers with income less than 60 percent of their area’s median income.

    4. Eileen Berger says:

      Will someone fill in McCain! He has no clue how to debate this issue in an informed, clear way.

    5. DenverDiva says:

      Let's not forget who went to the banks then directly to Freddie and Fannie with the intimidation to make those loans to borrowers with income less than 50% of the necessary income to pay the loans Yes, your very own Barry Obama and Bill Ayers when both working together at ACORN – that was 15 years ago when Barack was an adult…he knew exactly what was going on and what he was doing…Now he wants to act as though he can fix this financial issues…Do not Trust that…do not trust him.

    6. Mrs. Betty B. Staffo says:

      Wonderful article. Thanks. I'm so depressed to face the fact of the greed of companies, Senators, Representatives, etc. The American people depend on these people to do the right thing. But, I believe , the further the American people move from belief in God and our constitution, the more of this sort of horrible bank failings, etc., will happen. What's happened to honesty, doing the right thing, caring about what happens to buyers, families and children? This affects us all so severely. It just reminds me how important it is to elect people who tell the truth and have a record of honesty and doing the right thing. I will admit it's getting harder & harder to find these people. But I have faith. So…………………

    7. Steve Hudson says:

      Like Eileen Berger who posted 'McCain doesn't have a clue how to debate this stuff', I watched the last debates of both the Senator and the Governor in a stupor. It is clear the operatives running the show are naive and this seems evidenced by the average age of those appearing on the media to represent the campaign.

    8. Will, New York says:

      Respectfully, I'd point out that when Sebastian Mallaby chooses to focus his blame on 1/3 of the source of the junk mortgage business i.e. Fannie and Freddie, he is ignoring the larger 2/3 of the problem which was the securitization market outside of those institutions. Wouldn't it be fair to say that a larger share of the blame and scrutiny should go to 2/3 of the whole problem?

      There is a lot I don't know about this crisis, but it seems to me that this was a failure of the free market where investors saw nothing much else to invest in, and thought that these MBS's and CDO's seemed like a good scam that was insulated from risk so long as we could keep this bubble going. The fact that this crisis was mostly external to Fannie and Freddie suggests to me that fault does not lie with liberal programs to provide housing, but with a free market looking for a reliable percentage.

    9. Danny Grimes says:

      Dear Heritage Foundation: Apparently the financiers did cause this Crime. And it is criminal when iteffects innocent people. Why Would anyone send a whole country into deeper debt- unless they had a reason for doing it. They cannot explain it away, and they want more, and more money to cover the The mistake they made. Not me ,and not you. Where is the real accountability? Where are the law makers that would protect the individuals that never will recover, and are fed hopes that are heeped up high, that will melt into nothingness, and that is what We will get, and every body else.

    10. Steve Hudson says:

      Any time a mandate or set of rules is created – in this particular, make and administer less than creditworthy or credit-prudent loans, but also generally, with tax policies, congressional ethics or perhaps more familiar to us all in dieting – "it's the weekend; I'll make it up during the week", there will naturally be analysis of how to apply, adhere and let's face it, best take advantage of the playing rules. The all-important interpretation.

      To some, advantage will come by way of openly cheating, but others, and we depend in particular on our financial advisors to do this, will through ingenuity and enterprise find the opportunities available by playing within the system. This participation is the greed everyone wants to identify presently. Is it wrong? Hmm, is it wrong when HR Block saves you $1000 on your taxes you didn't know about?

      Selling something for nothing – mortgages, credit default swaps, whatever; and banking on sunshine tomorrow because it shone today, are both gambling. And gambling and it's inherent reliance on a good roll is what got us into this mess and was universally shared by politicians, by speculative builders, by fund managers, by foreign countries and local bankers alike – the experts that we the public rely on. Well, caveat emptor! Little guy. Any craps player will tell you, "you can't make a living betting the field".

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