ROOT CAUSES OF THE FINANCIAL CRISIS OF 2008

Economics Without The B.S.**: ROOT CAUSES OF THE FINANCIAL CRISIS OF 2008

[**  Double entendre intended.]

[Written in 2011]

ROOT CAUSES OF THE FINANCIAL CRISIS OF 2008

AND IT’S CONSEQUENCES

          If you are a small business in Topeka, Kansas and you cannot get a business loan today that you could have secured a few years ago…Why?  Why!  Because there was a great cash flow during the bailout of the financial industry that went from the rest of the nation to the New York City metropolitan area, where the financial industry is centered.

Recent commentary by some on the causes of the financial crisis is a mix of superfluous, disjointed peripheral issues and fails to get at the root causes and central issue concerning a well functioning democratic society dependent on a vibrant economic system.

          Some want to blame Fannie Mae and Freddie Mac; but, as the FCIC Report and Congressional testimony has indicated, they only contributed to the problem, they did not cause  the problem.  They do not originate any mortgages.  Their buying activity fueled the flames of the brew of toxic mortgages; but, they were late to the feast.  Testimony by Angelo Mozilo of Countywide, their biggest customer for selling mortgages to them, revealed that he told them they were “irrelevant” after they lost 40% of their market to Wall Street firms.

          They also blame community banks coming under the influence of the Community Reinvestment Act (CRA).  But as the FCIC Report indicates (and the FDIC) community banks contributed less toxic mortgages than other sub-prime lenders not subject to the CRA – Countrywide, Washington Mutual, and Citibank to name a few.

          Some blame too much Government regulation of the financial industry, which clearly defies the facts.  From the 1980’s and 1990’s the Glass-Steagull Act which separated commercial banking from investment banking in the 1930’s was continually weakened and ultimately got Citigroup mixed up in the toxic brew of this crisis.  In addition, the failure to let Brooksley  Born’s Commodity Futures Trading Commission regulate OTC (Over-The-Counter) derivatives meant that this market activity would remain opaque and in the dark  rather than transparent and in the open market.

          As the FCIC Report details – both the majority and the minority view – you had a toxic brew of financial products created by Wall Street firms that encouraged the lowering of underwriting standards not just for the making of mortgages but also the securitization of packaged mortgages, coupled with a failure of governance by rating agencies and an assortment of governmental regulators, resulting in a business model that could not sustain itself.  Not to mention a compensation system along the way for all participants which encouraged this societally destructive behavior.  When Lehman Brothers collapsed, following earlier bankruptcies of sub-prime lenders, the collapse of Bear Sterns, followed by the take-over of Fannie Mae and Freddie Mac, the “Crisis” began because of the liquidity squeeze from over-priced assets and over-leveraged financing resulting in a contraction to the world economy not seen since the 1930’s.  As the minority report noted, the liquidity freeze had international repercussions in Europe although they did not have the toxic mortgages and poor underwriting standards found in the U.S.; but, still got caught in the mire because of overly optimistic lending practices that led to a highly speculative market which could no longer be supported in the liquidity freeze.

          The problem, as the FCIC Report addresses, is that we have allowed these enterprises to become too big and too connected so that they represent a systemic risk if they fail.  It should not be left to governmental regulators to provide a safety guarantee from financial failure.  The moral hazard argument would suggest otherwise.  Instead of letting these business ventures fail, we (the Public) have had to transfer trillions of dollars from public resources to the financial industry in order to provide some form of stability to our way of life.  These contractions in our economy with the resultant take-over of failing firms by bailed-out healthier firms evolves into a concentration within the industry and a concentration of wealth and political influence which becomes entrenched and less subject to the transformation needed in a vibrant, democratic society.  This undermines our democratic, middle-class values.  What is regrettable is that several years later, even after Dodd-Frank, we still have the same financial system and we are back to business as usual.

P.S.  Those of us who are not professionals when studying just what is going on are left to wonder about the recent events in the world, especially in the Arab revolt of the masses, if there is not some connection between their plight – perhaps living in the margins of society – and the cash squeeze caused by the global effects of the financial crisis.