Some people don’t like the concept of blame.? They view it as useless because it wastes time in looking for a solution.? I will tell you differently.? Blame is useful because it identifies offenders, which is the first step in eliminating the problem.? The trouble is that few have the stomach to get rid of the offenders.
So, as I traveled home from prayer meeting with my children last night, we listened to a radio show discussing the current credit crisis.? This was a good discussion, unlike many that I hear.? But the discussion (on NPR) eventually focused on “who should we blame?”? Okay, here is my incomplete version of who we should blame:
1) The Federal Reserve, especially Alan Greenspan.? For the past 20 years, we couldn’t let the economy have a severe, much less a moderate recession.? Rates were reduced before significant pain was felt by those who had borrowed too much.? The 1% Fed funds rate in 2003 was the pinnacle of that effort.? It created the ultimate bubble; there is nothing left to reflate in 2008 from easy monetary policy.
2) Congress and the Presidency — they encouraged undue leverage in a variety of ways:
a) Fannie, Freddie, the FHLB, and more: Everyone has gotta live in a single family home.? Gotta do that.? Thomas Jefferson’s ideal was that we should encumber future generations so that marginal buyers could live in houses beyond their means.? They compromised lending standards more and more, along with private lenders as the boom went on.
b) The SEC: in a fiat currency world, controlling the currency means controlling leverage of financial institutions.? The SEC waived leverage restrictions on the investment banks in 2004, leading to a boom, and a bust. Big bust.? Ginormous bust — how many large standalone investment banks are left?
c) Particularly the Democrats in Congress defended the GSEs as their own pet project.? I am not bashing the CRA here; I am bashing the goal of having everyone live in a house beyond their means.
d) We offered a tax deduction on mortgage interest, and a limited exemption on capital gains from selling a home.? There is no good reason for these measures.
e) And, the Republicans in Congress who favored deregulation in areas for which it was foolish to deregulate.? Much as I favor deregulation, you can’t do it if you have fiat money (unbacked paper money).? In that case you must restrain the growth of credit.
f) The Bush Jr. Administration — they did not enforce regulations over financial institutions the way that the law would demand on a fair reading.? Again, I’m not crazy about regulation, but unless you have a gold standard, or something like it, you have to regulate the issuance of credit.
g) Their unfunded programs with promises to the future; the states and Federal Government always promise today, and don’t fund it.? Hucksters.
3) Lenders steered borrowers to bad loans.? There was often implicit fraud, and in some cases, fraud.? The lenders paid their staff to do it.
4) Borrowers were lazy and greedy.? What? You’re going to enter into a transaction many times your income or net worth, and you haven’t engaged helpers or friends to advise you?? Regardless of the housing price mania, you should have gone slower, and done more homework.? Caveat emptor — you neglected that.
5) Appraisers were slaves of the lenders who wanted to originate and sell.
6) Those that originated MBS did not check the creditworthiness adequately.? They just sold it away.? Investment banks did not care where a profit was coming from in the short run.
7) Servicers did not demand a high price for their services, making it hard for them to service anything but solvent borrowers.
8) Realtors steered people into buying more than they could rationally afford; I’m not saying they did that on purpose, but their nature was to sell to get the highest commissions.
9) Mortgage insurers and financial guarantee insurers — because of the laxness of accounting rules, they were able to offer guarantees significantly in excess of what they could pay in the deepest crisis.
10) Hedge funds, investment banks and their investors — they demanded returns that were higher than what was sustainable.? They entered into businesses that would not survive difficult times.
11) Regulators let themselves be compromised by those following the profit motive.? Many hoped to make money after joining private industry later.
12) America.? We let ourselves become short-term as a culture, encouraging short-term prosperity, regardless of the cost.
13) Neomercantilists — they lent us money, because they wanted they export sectors to grow for political reasons.? This made our interest rates too low, encouraging overinvestment and overconsumption.
14) Average people who voted in Congress, and demanded perpetual prosperity — face it, we elect those that govern us, and there is the tendency in America to love the representative that brings home the pork, while hating Congress as a whole.? Also, we need to bear with recessions, and let them do their work, and not force our government to deal with them.
15) Auditors that did a cursory job auditing financial entities.? As the boom went on, standards got lower.
16) Academics who encouraged a naive view of diversification, and their followers who believe in uncorrelated returns.? In a bad economy, everything is correlated, and your statistics from a good economy don’t matter.
17) Pension and other funds that believed the academics.? It is amazing what institutional investors will fund, given the mistaken idea that correlation coefficients are stable.? Capitalistic economies are unstable by nature!? Why should we expect certain strategies to workallo the time?
18) Governmental entities that happily expanded government programs as the boom went on.? Now they are talking about increased taxes, rather than eliminating programs that are of marginal value to society.? Governments should not rely on increased taxes from capital gains, or real estate tax assessments.
19) Those that twitted “doom-and-gloomers,” and investors who only cared if markets went up.? It is hard to write about what could go wrong in the markets.? Many call you a wet blanket, spoiling their fun, and alleging that you are a short, or some sort of misanthrope.? The system is biased in favor of happy talk.? Just watch CNBC.
20) Me, and others who warned about the current crisis. Perhaps we weren’t clear enough.? Maybe our financial interests made us look like we were talking our books.? I know that I spent a lot of time on these issues, but in the short run, I was still an investor, trying to make money in the markets, hoping that what I feared would not occur.? Now I am getting my just desserts.
This is an incomplete list.? I invite you to add others to the list in your comments.
Rating agencies didn’t make the list? I would have put them in the top 10.
I can’t add to the list, but I was amused that when you typed 8) on your list, your software picked it up as an emoticon (which looks like a smiling real estate agent in sunglasses!)
Looks like I made the same mistake. It should read “on line number 8 of your list…”
Mr. Merkel:
I have one more to add – the Office of the Comptroller of the Currency. Not only did they fail to regulate the national banks, they also stone-walled State and local governments from bringing suit (claiming jurisdiction, but never following up on claims).
Rating agencies and the OCC — oversights both. They are on the list should I do version 2.
Oh, don’t forget the carry traders who have now gotten carried out on their shields. Too many players trying to clip uncertain interest spreads, from hedge funds to Japanese housewives…
You did not explicitly mention flippers, and they played a huge part in this mess. Folks with 2, 3, 4 or more mortgages, obtained with no money down and no docs in order to capitalize on forever-rising home prices. When prices finally stopped going up, people got caught with their pants down and nothing but their &^$^ in their hand.
No single snowflake believes that HE is responsible for the avalance.
Yeah, toss in the flippers…
0. Short term Greed
I’d include the entire field of quantitative risk management. The analyses are reasonable tools when used properly, but rating agencies, investment banks and hedge funds used the analysis to justify excessive leverage, not test it.
Throw in the quants, bigtime — particularly the ones doing CDOs. Greed, yes, covered in many of the points.
I like your list. The Fed and the fiat money system are proverbial root of all evil. When you have a single monopolistic provider of legal currency, and especially when that currency is not backed by anything of intrinsic value, the laws of nature ensure that at some point you will be up shit creek without a paddle. The least we can do is find a way to eliminate fiat money (then perhaps we could do away with all those regulations?).
Though you refer to them in a couple of cases, the simple buyside must take more blame–as I keep saying, if they didn’t buy this crap it wouldn’t get sold.
BTW, I had Jeremy Siegel in business school as a macroeconomics professor. “Stocks for the Long Run” is an embarrassment. All the people who said “stay in the market”, “don’t time the market” etc. etc. are culpable.
David, note my response to your Big Picture post about the Jamaican Central Bank–
I agree it is phony, but still better advice than anything Greenspan or Bernanke has ever offered to us!
TGIF
Do you think it is a mistake for the Feds to have nationalized the investment banks and caused stockholders in these banks to lose their investment? Isn’t this was precipitated the loss of trust, i.e. who would want to put money in an investment bank that is slightly unstable if next week the gov’t takes it over and causes all stockholders to tank? There must have been some more rational actions the Fed chairman could have done. Also have you ever heard of a Tres Sec being so proactive?? signed email name: bulababy
Can you expand a little bit on #16 please? What is an intelligent view of diversification?
A. A running imbalance of fear and greed. Too little fear and too much greed yields a bubble. Too little greed and too much fear yields a collapse.
B. Market and mortgage rules that don’t allow for personal realities. We are all “competing” for things in our finite lives. So NOT taking the big mortgage, or NOT seeking the high return, in effect lost ground in one way or another – socially, or personally, if not financially.
Put another way – some part of market behavoir is set by the environment. No snowflake believes it’s responsible for the avalance, but if there’s a lot of snow on a hillside, there will likely be an avalance regardless of what any snowflakes do.
Which again implies that reasonable regulation, more transparency and accountability, and the occasional recession for house cleaning, are required….
I will put RATING AGENCIES at the very top.
They caused instability on the way up and they cause instability on the way down.
Remember not long ago, Moody’s tried to rate all Icelandic banks Aaa. Only the outrage from the investor community stopped them.
Please, don’t forget the tax havens – home of hedge funds and money laundring – without which none of this would have happened !
Hi David, I commented a few days ago on “a new speed record” post. Maybe you didn’t want to reply, but I thought there was a good chance you didn’t see it due to the small post. My questions are the same, but with the Fed’s balance sheet declining now with bad quality assets, the inflation potential I fear looks more real. Of course, the dollar is really gaining, which is a baffling thing…
Why would more markets seek out our t-notes, despite the declining quality of our debt? All year I’ve been hearing in my head “S&P lowers its credit rating on US debt.” Que financial Armageddon?
How about the Prime Brokerage business model followed by most banks and investment banks which allowed their speculative clients to go “nuclear” in any marketplace as long as they had a credit facility and a cell phone. A $10 million hedge fund run out of a basement in Westchester County NY or Orange County CA could control $1 Billion worth of goodies in many cases. Yikes !!
Another keeper, Dojo. If I do version 3, I will add that on.
Regulators let themselves be compromised by those following the profit motive. Many hoped to make money after joining private industry later.
The bank regulators at the FDIC. It was their JOB to maintain oversight of the banking industry. Every regulator who allowed the banks they were monitoring to giving liar loans, or pick a rate loans, or zero down payment loans, and didn’t call a halt, should be fired for malfeasance. The regulators who had oversight of Washington Mutual and Indy Mac should be fired. And their BOSSES should be fired. Right up to Shiela Blair.
That brings the blame total up to 30, dlr.