Wall Street turned a few million home-loans into what Warren Buffet called "economic weapons of mass destruction," cratered the global economy and then, when the bubble burst, turned around and insisted on a massive bailout courtesy of the American tax-payer.snip
That rightly infuriated most Americans, but it has nonetheless become something of an article of faith among conservatives that Wall Street bears little blame for the Great Recession. The dominant narrative on the right today is that "big government" is ultimately responsible for the crash. In the words of one of Andrew Breitbart's bloggers, Democratic lawmakers like Barney Frank and Chris Dodd “brought down the banking industry by forcing banks to give loans to people who couldn’t afford them.”
That such a ludicrous claim could gain such wide traction is a testament to the intellectual debasement of modern conservative discourse. No bank was ever “forced” – or coerced or incentivized by the government in any way – to make a bad loan.
But the claim falls apart even before one digs into the particulars, for the simple reason that people's mortgages didn't bring down the banking system in the first place.
The entire subprime mortgage market was worth only $1.4 trillion in the fall of 2007, and that includes loans that were up-to-date. As former Goldman Sachs trader Nomi Prins noted in her book, It Takes a Pillage: Behind the Bailouts, Bonuses, and Backroom Deals from Washington to Wall Street, the federal government could have bought up every single residential mortgage in the country – good, bad and in between – and it would have cost a trillion less than the bailouts.
Short of that, notes Prins, if the crisis were really about people buying McMansions that they couldn't afford, “we could have solved it much more cheaply in a couple of days in late 2008, by simply providing borrowers with additional capital to reduce their loan principals. It would have cost about 3 percent of what the entire bailout wound up costing, with comparatively similar risk.”
What brought down the global economy was as much as $140 trillion worth of financial gimmickery built on top of the mortgage industry. It was the alphabet soup of the credit meltdown – the CDOs, default swaps and other derivitaves that made less than a trillion dollars of foreclosed loans into an economic weapon of mass destruction that would cost the American economy alone $14 trillion in lost wealth.
A fair criticism of the government's role is that it didn't “meddle” in the free market sufficiently to protect borrowers, investors and the public – that $140 trillion house of cards was built in an environment created by decades of deregulation. But that situation is also the fault of Wall Street rather than an indication of the perfidy of "big government." It was bought at great cost by the banking lobby (and as powerful chairs of congressional banking committees, the right's bogeymen, Barney Frank and Chris Dodd, are two of the financial industry's top recipients).
The reality is that no bank has ever been “forced to comply with government mandates about mortgage lending” – it's a bald-faced lie.snip
There are no “government mandates,” and there never were. In order to qualify for government-backed deposit insurance—a benefit that banks aren’t forced to accept but enjoy having—the Community Reinvestment Act – and similar measures designed to prevent discrimination in lending (to qualified individuals) – only encourage banks to lend in all of the areas where they do business. And Section 802 (b) of the Act stresses that all loans must be “consistent with safe and sound operations”—it’s the opposite of requiring that lenders write risky mortgages.
There are no penalties for noncompliance with CRA guidelines. The only “stick” hanging over banks that fail to meet those standards is that their refusal might be taken into account by regulators when they want to open new branches or merge with other financial institutions. What’s more, there are no defined standards for CRA compliance, and within the banking community, the loose guidelines are considered to be somewhat of a joke.
As Sheila Blair, the chairwoman of the FDIC, asked in a December 2008 speech, “Where in the CRA does it say: make loans to people who can’t afford to repay? Nowhere! And the fact is, the lending practices that are causing problems today were driven by a desire for market share and revenue growth...pure and simple.”
The most important point here is that the bankers knew they were playing with fire. The Los Angeles Times reported, “Before Washington Mutual collapsed in the largest bank failure in U.S. history, its executives knowingly created a ‘mortgage time bomb’ by making subprime loans they knew were likely to go bad and then packaging them into risky securities.”
According to the Wall Street Journal, U.S. prosecutors are, as of this writing, investigating whether Morgan Stanley misled investors about mortgage-derivatives deals it helped design and sometimes bet against.” And the Securities and Exchange Commission charged Goldman Sachs with “defrauding investors by misstating and omitting key facts about a financial product tied to subprime mortgages as the U.S. housing market was beginning to falter.”
They needed some help laundering the risk out of those shaky loans, and they got it. According to a Senate investigation concluded earlier this year S&P and Moody's, the two dominant ratings agencies, “issued the AAA ratings that made ... mortgage backed securities ... seem like safe investments, helped build an active market for those securities, and then, beginning in July 2007, downgraded the vast majority of those AAA ratings to junk status.” And when they did so, it “precipitated the collapse of the [mortgage-backed securities] markets and, perhaps more than any other single event, triggered the financial crisis (PDF)."
According to the Senate investigation, in the years leading up to crash, “warnings about the massive problems in the mortgage industry” — including internal warnings from their own analysts — had been ignored because of “the inherent conflict of interest arising from the system used to pay for credit ratings.” The big “rating agencies were paid by the Wall Street firms” that were making a fortune selling that glossed-up garbage to credulous investors. This, again, was Wall Street's doing rather than a result of some public policy passed by Congress.
This isn't about ideology; it's about pushing back on some notably dangerous historical revisionism. Because there is one thing that’s as sure as death and taxes: Big Finance’s lobbyists will continue to resist calls to re-regulate the financial sector. And absent effective regulation of the financial markets, we can expect to continue to suffer through an endless series of booms and busts, while the fat cats of Wall Street continue to get fatter.