Financial Crisis: Who’s to Blame?
Think of the current market and economic turmoil as a disaster by committee, with blunders by government officials, Wall Street pros, and regular Americans alike
U.S. Treasury Secretary Henry Paulson, Federal Reserve Board Chairman Ben Bernanke, Chairman of the Securities and Exchange Commission Christopher Cox, and Director of the Federal Housing Finance Agency James Lockhart III
Tune in to Anderson Cooper on CNN and watch as he counts down the “10 Most Wanted Culprits of the Collapse.” Pick up the New York Post and read about FBI investigations of top financial firms under the headline “Fraud Street.” With a bewildering and frightening financial crisis in full swing, the new national pastime is finding someone to blame.
As markets crash and retirement dreams fade away, media and the public are full of outrage at everyone from mortgage brokers and Wall Street CEOs to real estate investors to experts who failed to predict the crisis was coming. Congress hauls the most prominent executives before tough committee hearings, while political candidates blame each other. Pundits proffer lists of the mustache-twirling villains who caused the whole thing.
An Epic Whodunit
Investigators will undoubtedly uncover fraud, cheating, and other criminal behavior. But for now, there is no shortage of players who stand accused of having a hand in the crisis. It just depends on where you think the landslide began or who gave it the biggest push.
If you blame loosened financial regulations, maybe former Sen. Phil Gramm (R-Tex.) or Securities & Exchange Commission Chairman Christopher Cox are your men.
Think that a political push to boost homeownership handed too many people mortgages they couldn’t afford? Why not single out Franklin Raines, former CEO of Fannie Mae?
Maybe you think the whole housing bubble could have been avoided with an interest rate increase (Alan Greenspan, step right up). Or, that folks should never have signed up for no-doc, interest-only loans, no matter how many silhouettes danced across their computer screen in a Web ad. In that case, the villain may be no further than your bathroom mirror.
(For a walk through some of those people who are blamed for having a hand in the meltdown, go to our slide show.)
“Whole System” at Fault
Of course, all of these people had something else in mind other than wrecking the U.S. economy. Some of them were making lots and lots of money—for themselves, of course, but also for their investors. Others truly believed in the virtue of freeing the marketplace’s animal spirits from the cold hand of government regulation. And how many people were arguing against the virtues of homeownership?
Just the fact that one can assemble such a long list of possible villains gives a hint as to how many institutions, officials, and regular Americans made mistakes. “It’s so difficult to pinpoint one person or two people,” says Georgetown University finance professor Reena Aggarwal. “It really was the whole system.”
Even Presidential candidates eager for votes have acknowledged there’s no easy scapegoat. “Part of the reason this crisis occurred is that everyone was living beyond their means—from Wall Street to Washington to even some on Main Street,” Senator Barack Obama (D-Ill.) said on Oct. 13.
Indeed, it was a series of bad ideas, surprising linkages, and all-too-predictable blunders that came together to send the U.S. financial system, and then the entire world economy, into a serious credit crunch and global stock panic. That’s not to
A Sign: Soaring Home Price-to-Income Ratio
First, there was a bubble in the U.S. housing market as home prices hit unsustainable levels. We should have recognized a bubble when we saw it: Just a few years before, another market bubble collapsed—in technology stocks. And all the signs were there in housing.
If you ever drove through row after row of new tract homes sprouting from the California desert and wondered, “How can all these people afford $500,000 houses?” the answer was, they couldn’t. For the two decades until 2001, the national median home price went up and down, but it remained between 2.9 and 3.1 times the median household income, according to the Harvard Joint Center for Housing Studies. By 2004, however, the ratio of home prices to income hit 4.0, and by 2006 the ratio was 4.6. Or consider this statistic: in 2006, at the height of the bubble, more than four in every 10 California households owning a home spent 30% or more of their incomes on housing.
“As a system, we were pressing beyond what the economics were suggesting people could afford,” says Michael Strauss, chief economist at Commonfund. Nonetheless, nearly everyone in the system had a “false sense of security that housing prices would always go up.”
That included home buyers and real estate and mortgage professionals.
Another Sign: The Securitization Monster
But what turned a nasty housing downturn into an extinction-level event for the whole economy was a Wall Street innovation called securitization.
With interest rates low, investors around the world were eager for places to put their money that offered substantial returns. While the federal funds rate was at 6.5% for much of 2000, by the end of 2001 Federal Reserve Chairman Greenspan had lowered the rate to below 2%. It remained there until late 2004. In 2003, the yield on the one-year Treasury bill dipped well below 2%, its lowest level in the past 40 years. Securitization, and the new investment products it could spawn, seemed to be the answer for a Wall Street seeking a bigger payoff.
Through securitization, Wall Street firms would buy up mortgages, bundle them together, and sell them off to investors. These mortgage-backed securities were highly complex and hard to price accurately. But selling them offered returns for financial firms far above those of safer investments. And with home prices continuing to rise, many, including ratings agencies, assumed that assets backed by U.S. mortgages were safe.
“The development of the securitization pipeline [meant] there was a lot of pressure to create the loans,” says University of Kansas finance professor George Bittlingmayer. Mortgages were given to buyers with low credit scores—so-called subprime borrowers—and other high-risk borrowers, with little concern that they wouldn’t be able to pay the loans off. The easy money, in turn, contributed to an “upward spiral” of home prices, Bittlingmayer says—”until the bubble collapsed.”
Most of the mortgage brokers who originated these loans weren’t “bad people,” Bittlingmayer adds. “They were doing what the system was asking them to do.”
Wall Street was eager to buy up, bundle, and securitize the mortgages. Washington, in turn, had urged the mortgage industry to give more loans to low-income home buyers. During the Clinton and Bush Administrations, “there was a push to try to put homes within reach of everyone,” says Larry Tabb, founder and chief executive of the TABB Group, a capital markets research and advisory firm.
Original article: Financial Crisis: Who’s to Blame? From businessweek
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[...] Credit crunches like the current one (except milder) contributed to all three of the last recessions. In 1980, the Carter Administration tried to cool off the economy with government-imposed credit controls and succeeded all too well, contributing to the sharpest quarterly downturn in real GDP growth in the past 50 years, a nearly 8% annualized decline, says JPMorgan Chase economist Robert Mellman. JPMorgan predicts the current squeeze will cause GDP to decline at an annual rate of 2% this quarter and the next, though the bank expects a healthy recovery in the back half of 2009. SLOWING AND TIGHTENING [...]