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Who is to blame for the credit crisis?

October 14th, 2008 · 17 Comments

Politicians made a fine show of standing up to those fat cats and voted down TARP initially and reflected Main Street’s outrage that Wall Street is being bailed out through tax dollars. However, the credit crisis isn’t solely a made-in-Wall-Street phenomenon; there is enough blame to go around.

Government: Politicians couldn’t resist the opportunity to engage in grandstanding just weeks before an election but deserve plenty of blame for the credit crunch. Instead of voting for the regulation of credit default swap markets (which felled mighty AIG), Congress decided to prohibit any oversight of CDS and other derivative markets. In order to increase home ownership rates among minorities and low-income consumers, the Clinton administration pressured Fannie Mae to ease credit requirements on subprime loans purchased from banks.

Main Street: It is on Main Street that the toxic, subprime loans originated. Home owners were willing to borrow mind-boggling sums of money to finance their dreams of home ownership. Many homeowners surely realized that if they could barely afford the “teaser rates” on their subprime mortgage, they didn’t have a snowflake’s chance in hell of affording the regular payments. Still, they signed on

Investors: Who in their right mind would accept securities that paid slightly more interest than US treasuries because they are “AAA-rated”? Imagine if investors has instead sneered at these Wall Street geeks and their complex formulas and demanded higher rates to compensate for higher risk. It would have kept subprime a small part of the market.

Wall Street: The geniuses on Wall Street originated these loans, packaged them and sold it to investors around the globe for a nice fat fee. They also got stupid and drank their own Kool-Aid and kept some of these loans on their books. While Wall Street deserves its share of the blame, it is hardly the only guilty party here.

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17 responses so far ↓

  • 1 Four Pillars // Oct 14, 2008 at 9:44 pm

    It seems like just about everyone was involved one way or the other.

    I have every bit of confidence that the lessons learned in this mess will be written down in stone so they will never, ever be repeated again… :)

  • 2 Nurseb911 // Oct 14, 2008 at 10:08 pm

    I confess CC…it was me!!!

    I had Wall Street all doped up on cocktails of morphine, ativan, epinephrine, viagara (just for fun) and Mountain Dew to see what would happen when you stuck 42 accountants, 8 CEO’s, 24 engineers, 100 boxes of fig newtons and a donkey into a room together with Joan Rivers. (Can you imagine?!!)

    In order for them to escape they had to develop the most complicated, opaque, ridiculous investing schemes anyone had ever pondered.

    Then convince everyone that they were safer than bonds, paid double the interest and you could charge a commission of 500% divided by the square root of a shoe.

    Then we convinced the insurance guys stuck down in the basement to hire a pack of rabid monkeys to market this stuff around the world.

    It was brilliant – the monkeys couldn’t speak english or any other language so whenever someone asked questions about risk all the monkeys knew how to do was give a hi-five, pick their pockets and run out of the buildings.

    Yep…I lost a lot of good people in there :)

  • 3 Eric // Oct 15, 2008 at 7:46 am

    There’s a nice little write up about regulation on the big picture blog: http://bigpicture.typepad.com/comments/2008/10/regulate-or-not.html#more

  • 4 Rob // Oct 15, 2008 at 8:32 am

    Amen CC

  • 5 Dividend Growth Investor // Oct 15, 2008 at 9:41 am

    I would blame it on GREED, which cannot be legislated away.

    As my man Buffett used to say, never invest in something that you don’t understand..

  • 6 Steve // Oct 15, 2008 at 9:48 am

    This problem is structural in nature and a “big picture” analysis of the problem is still generally lacking in the media. This problem is not the fault of Wall Street, they can claim to be fool victims just as the rest of us can. They were given access to cheap cheap money for far too long, as were consumers. Corporate profits have been driven by easy money, not real improvements in production from efficiency or design. Easy money is drying up, corporate profits will generally fall except for those companies who can produce more with less (a good thing for standard of living).

    In regards to moving away from stocks and into bonds; stocks in general will perform poorly for quite a while now as companies will have to compete more for profits (again, a good thing). Individuals WITH savings will enjoy a higher return on them then they have in years.

  • 7 Curt // Oct 15, 2008 at 10:45 am

    Primarily the government; just like every other nation that has suffered from hyperinflation when their government spent them into oblivion.

    Sure you could argue, like Allan Greenspan tries to, that Wall Street is to blame because they repackaged worthless mortgages and sold them as triple-A investment grade bonds or you could argue that Freddie Mac and Fanny May encouraged the housing bubble by providing banks an easy way to lower their lending standards and given just about anyone a mortgage. Or you could argue that people who bought a mortgage with false income statements or no income statements are to blame.

    But, in the end – None of this would have been possible without the government attempt to plan the economy through the lowering of interest rates by the Federal Reserve and the government supported mortgage entities of Freddie Mac and Fanny Mae.

    The entire financial meltdown and ensuing recession that we are headed into is a grand failure of the government’s efforts to plan the economy, rather than allowing market forces of capitalism to run the economy.

  • 8 Canadian Capitalist // Oct 15, 2008 at 11:41 am

    Mike: There will be another insanity pretty soon. In only eight years, we’ve seen dot com stocks, income trusts and the credit crunch. It’s a safe bet that there will be more and soon.

    Brad: Funny but that pretty much sums up Wall Street’s conduct.

    Eric: That’s a great article — unregulated derivative markets look excessively stupid in retrospect.

    Curt: Low interest rates are hardly to blame here — inflation is low and it figures that interest rates would be low as well. Look at long-term interest rates that are mostly set by market forces, which have remained low.

  • 9 Al // Oct 15, 2008 at 12:24 pm

    CC,

    I’ve got to disagree with your response to Curt with regards to interest rates. Banks have been setting their prime rate based upon changes by the various CBs. And of course, the CBs have been keeping rates low.

    The reason this matters is because it has led to horrible missallocation of resources. Companies that shouldn’t exist surving on cheap loans. People buying furniture and electronic gadgets on credit. Higher rates would have helped prevent this (would you buy a $1000 couch on credit if it cost you 8% per year?)

  • 10 Steve // Oct 15, 2008 at 12:58 pm

    I agree with Al and Curt. This problem was predicted by some as early as 2002. Inflation was low, but that was skewed by an artificially cheap Yuan. Access to money was too cheap, and GDP was expanded by wasting it via houses and consumer spending that no one needed. Look at US consumer spending that was -1..0% in 2006. Interest rates are going to have to rise at some point, to the detriment of corporate profits and easy economic growth, but in the long term it’s necessary medicine after years of poor economic policy.

  • 11 tmoneybags // Oct 15, 2008 at 1:36 pm

    pretty good video from 60 minutes about the credit default swap “shadow market” estimated at $60 trillion:

    http://www.cbsnews.com/video/watch/?id=4502673n

  • 12 Forone // Oct 15, 2008 at 7:03 pm

    Don’t blame the US retail homebuyers: first, they were given assurances that in a couple of years they could re-fi in the unfailingly rising market and square all accounts on their more valuable home, but second, and even more importantly, because of the “NINJA” no down loan terms they had no skinny in the game – as soon as the market price sank below the value of the mortgage and showed no signs of recovery soon, they walked away sadder maybe, but not any poorer. The fault is the breakdown, created by securitization, of the traditional direct first-level lender-borrower relationship that is still dominant in Canada.

  • 13 Steve Heath // Oct 15, 2008 at 7:48 pm

    A second problem with low interest rates is that between progressive taxes and inflation there’s huge disincentives to saving.

    If you work and your employment income pushes your savings up into a higher bracket, no matter how low your interest goes, you still lose up to 50% of it, which can push your returns below inflation. This, of course, forced savers to move into the stock market to find returns that at least equalled inflation, causing bubbles there.

    Even if you put it into your RRSP, saving it as fixed income would only yield you, lately, 1-1.5% over what the government claimed inflation is, but many people argue is an artificially low figure based on some CPI shell games, such as declaring ground beef an equivalent substitute for steak, so again, if you want to get ahead for retirement, you’re looking for higher returns.

    Lower interest rates pumped the market and pushed everyone to spend, and the only long term solution at this point is a period of higher interest rates after the crisis to allow families to build up their savings again in a safer environment than the market.

  • 14 Weekly Roundup: Secret 5 Year Wedding Anniversary Weekend at Clever Dude Personal Finance & Money // Oct 17, 2008 at 11:57 am

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  • 15 Scotty // Oct 19, 2008 at 11:45 pm

    How about aggressive sales agents who pushed homeowners to remortage their homes for a nice commission and then these assets are then packaged for wall street. Where these sales agents benefiting themselves or looking after the interests of the homeowner??

    What about the rating agencys who given these subprime assets AA standards ? Like Standard & Poors..it seems that these rating agencies are also the blame for this mess. These rating agencies have analysts that are suppose to check the credit worthiness of companies, bonds and other investment assets. Average investors use these reports to help make an inform decision what to invest in. For example, If X company bonds are rated a C+ rating and Y company has been rated an AAA+ rating then which company would that Average investor would buy? So how come the gov’t has not prosecuted these rating agencies for not providing accurate ratings like they did with accounting firms in the late 90’s.

    How about mortage interest deductibility ? it has a role in this subprime mess. If one can deduct mortage interest payments off income tax then their is no incentive for the homeowner to own that home. The only people who benefit for mortage interest deductability are the banks. Banks in the US are basically Pimps and homeowners are the junkies. So if Bank can then ask client X to trade up from their home which these homeowners can afford to a higher valued home (after all the mortage interest can be deducted from income taxes). US bank had no real interest of protecting the homeowner ability to pay /credit wothiness (and bank future balance sheet) US banks only cared about their short term profits and the revenues that was generated from those interest payments with those new higher value homes . In essence US banks did not care about risk assesment of pushing this policy and their own future existence like Washington Mutual ,Wachovia etc. So when a homeowner loses a job, the homeowner is now in a difficult situation in paying for these homes (though interest payments and mortage itself) they could not afford to buy . So the Homeowner has the following options : 1) default 2) rearrange their house loan or 3) Bank foreclose

    1)So perhaps the Banks have been too greedy ?
    2) Homeowners buying big homes they couldn’t afford to buy (at the beheast of aggressive Bank home mortage representatives and Real Estate agents ) and
    3) Gov’t idiotic policy of mortage interest deductability policy which gives the incentive not to own ones home. If u own a house then the person can’t deduct from his/her home on income tax the interest payments so its better for the owner just deduct the interest payments thereby reducing ones taxes then homeownership. Of coz , the Banks make large amounts of monies/revenues from these transactions and its these Banks and executives from these Banks which contribute to political parties and politicians. Politicians are then beholding to these contributors and make laws to the satisfaction of these individuals and corporations.

  • 16 Money, Stock and Finance » Blog Archive » Comment on Who is To Blame For the Credit Crisis? By Scotty // Oct 20, 2008 at 2:51 am

    [...] In essence US banks did not care about risk assesment of pushing this policy and their own future existence like Washington Mutual , Wachovia etc. So when a homeowner loses a job, the homeowner is now in a difficult situation in paying …[Continue Reading] [...]

  • 17 Linkstuff For A Big Bad Bear Market // Oct 24, 2008 at 4:59 am

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