Our economy is dead and we really need an autopsy to find out the causes. We know and I have pointed out on this blog for a long time causes for our downfall. It is often said we overspent, we bought houses we could not afford , WE DID IT TO OURSLEVES. Well now Joseph Stiglitz lays it out in “The Anatomy of a Murder”
A LIST OF THE GUILTY:
- Investment banks: they invented the packages that they knew would be lethal from the Gigo.
- Credit Rating Agencies: for rigging the credit rating as AAA when they knew they were junk.
- The Regulators: who looked the other way.
- The Mortgage Brokers : who sold the sold the mortgages to people they knew would end up in default.
- Every President from Bush to Regan (yes including Clinton) who pushed for deregulation and privatization of all business.
- The Same Presidents who jumped on the Free Market crapola that allowed (no forced ) our jobs to be outsourced.
- The Same Presidents: allowed the deregulation of market rules that had been put in place after the Great Depression to keep stuff like we see today made legal once again .(with the same result)
- The Economists that invented theories that made this bubble seem logical.
The Talking Heads: that spouted nonsense on the media outlets about how the old rules no longer applied ,that housing prices could only go up and that it was your money in the equity of your house and you should spend it now to buy the things you have always wanted but could not afford
THE BLAME GAME
To try to place degrees of blame on the above is a waste of time, they all are guilty. Some of crimes, some of deceit, some of greed, some of dishonesty . They all are in a chain of institutions guilty of fraud. Some try to make the case that they believed the crap they spouted, I think that is a naive thinking process. They knew exactly what they were doing and the design of the systems they were using prove that. The banks and mortgage brokers changed the rules for lending to enable more to get them. They knew that these new mortgages would explode at some point down the road, but they had no intention of owing them when they did. They sold these to mortgages to investment houses , who bundled them, sliced and diced them into untraceable chunks and sold them world wide knowing full well they would blow up in the future.
Every body in this chain probably knew better but bought this junk to add to their portfolio to gain a point or two in performance because everybody was doing it. It is really hard for me to believe that hot shot investment managers of large pension and investment firms bought this junk because they believed they were in fact AAA because the ratings companies said so. Did they stop at residential real estate, OH know they did commercial real estate , your credit cards and everything else they could bet on. Remember Enron , they sold contracts on future weather. Yeah, they went bust too.
Now we are at the beginning of the”Great Depression Two” which will be longer and worse than the first one. Remember just one thing from this rant if you remember nothing else. It’s an old investment axiom “IF IT SOUNDS TO GOOD TO BE TRUE, IT ISN’T”. Con men throughout history have counted on your greed to make their job easy.
Read the article below for a more detailed lay out of the blame.
Joseph E. Stiglitz
THE ANATOMY OF A MURDER:
WHO KILLED AMERICA’S ECONOMY?
ABSTRACT: The main cause of the crisis was the behavior of the banks—whose campaign
contributions ensured lax regulation. Conservative ideology, along with unrealistic
economic models of perfect information, perfect competition, and perfect markets, also
helped foster lax regulation. The banks misjudged risk, wildly overleveraged, and paid
their executives handsomely for being short-sighted, and lax regulation let them get away
with this—putting at risk the entire economy. The mortgage brokers neglected due
diligence, since they would not bear the risk of default once their mortgages had been
securitized and sold to others. Others can be blamed: the ratings agencies that judged
subprime securities as investment grade; the Fed, which contributed low interest rates;
the Bush administration, whose Iraq war and tax cuts for the rich made low interest rates
necessary. But low interest rates can be a boon; it was the financial institutions that
turned them into a bust.
Joseph E. Stiglitz, University Professor and Professor of Economics at Columbia
University, 814 Uris Hall, MC 3308, 420 West 118th Street, New York, NY 10027, a
2001 Nobel laureate in economics, is the author, inter alia, of The Roaring Nineties
(Norton, 2003).
Critical Review 21(2): ISSN 0891‐3811 print, 1933‐8007 online
c 2009 Critical Review Foundation DOI: 10.1080/08913810701461148
1
The search is on for whom to blame for the global economic crisis. It is not just a matter
of vindictiveness; it is important to know who or what caused the crisis if one is to figure
out how to prevent another, or perhaps even to fix this one.
The notion of causation is, however, complex. Presumably, it means something
like, “If only the guilty party taken another course of action, the crisis would not have
occurred.” But the consequences of one party changing its actions depend on the
behavior of others; presumably the actions of other parties, too, may have changed.
Consider a murder. We can identify who pulled the trigger. But somebody had to
sell that person the gun. Somebody may have paid the gunman. Somebody may have
provided inside information about the whereabouts of the victim. All of these people are
party to the crime. If the person who paid the gunman was determined to have his victim
shot, then even if the particular gunman who ended up pulling the trigger had refused the
job, the victim would have been shot: Someone else would have been found to pull the
trigger.
There are many parties to this crime—both people and institutions. Any
discussion of “who is to blame” conjures up names like Robert Rubin, co-conspirator in
deregulation and a senior official in one of the two financial institutions into which the
American government has poured the most money. Then there was Alan Greenspan, who
also pushed the deregulatory philosophy; who failed to use the regulatory authority that
he had; who encouraged homeowners to take out highly risky adjustable mortgages; and
2
who supported President Bush’s tax cut for the rich, 1 —making lower interest rates,
which fed the bubble, necessary to stimulate the economy. But if these people hadn’t
been there, others would have occupied their seats, arguably doing similar things. There
were others equally willing and able to perpetrate the crimes. Moreover, the fact that
similar problems arose in other countries—with different people playing the parts of the
protagonists—suggests that there were more fundamental economic forces at play.
The list of institutions that must assume considerable responsibility for the crisis
includes the investment banks and the investors; the credit rating agencies; the regulators,
including the SEC and the Federal Reserve; the mortgage brokers; and a string of
administrations, from Bush to Reagan, who pushed financial-sector deregulation. Some
of these institutions contributed to the crisis in multiple roles—most notably the Federal
Reserve, which failed in its role as regulator, but which also may have contributed to the
crisis by mishandling interest rates and credit availability. All of these—and some others
discussed below—share some culpability.
The Main Protagonists
1 Greenspan supported the 2001 tax cut even though he should have known that it would have led to the
deficits which previously he had treated as such an anathema. His argument that, unless we acted now, the
surpluses that were accumulating as a result of Clinton’s prudent fiscal policies would drain the economy
of all of its T-bills, which would make the conduct of monetary policy difficult, was one of the worst
arguments from a respected government official I have ever heard; presumably, if the contingency he
imagined—the wiping out of the national debt—was imminent, Congress had the tools and incentives with
which to correct the situation in short order.
3
But I would argue that blame should be centrally placed on the banks (and the financial
sector more broadly) and the investors.
The banks were supposed to be the experts in risk management. They not only
didn’t manage risk; they created it. They engaged in excessive leverage. At a 30-to-1
leverage ratio, a mere 3 percent change in asset values wipes out one’s net worth. (To
put matters in perspective, real-estate prices have fallen some 20 percent and, as of March
2009, are expected to fall another 10-15 percent, at least.) The banks adopted incentive
structures that were designed to induce short-sighted and excessively risky behavior. The
stock options that they used to pay some of their senior executives, moreover, provided
incentives for bad accounting, including incentives to engage in extensive off-balance-
sheet accounting.
The bankers seemingly didn’t understand the risks that were being created by
securitization—including those arising from information asymmetries: the originators of
the mortgages did not end up holding onto them, so the originators didn’t bear the
consequences of any failure at due diligence. The bankers also misestimated the extent
of correlation among default rates in different parts of the country—not realizing that a
rise in the interest rate or an increase in unemployment might have adverse effects in
many parts of the country, and the underestimated the risk of real-estate price declines.
Nor did the banks assess with any degree of accuracy the risks associated with some of
the new financial products, such as low- or no-documentation loans.
The only defense that the bankers have—and it’s admittedly a weak defense—is
that their investors made them do it. Their investors didn’t understand risk. They
4
confused high returns brought on by excessive leverage in an up market with “smart”
investment. Banks that didn’t engage in excessive leverage, and so had lower returns,
were “punished” by having their stock values beaten down. The reality, however, is that
the banks exploited this investor ignorance to push their stock prices up, getting higher
short-term returns at the expense of higher risk.
Accessories to the Crime
If the banks were the main perpetrators of the crime, they had many accomplices.
Rating agencies played a central role. They believed in financial alchemy, and
converted F-rated sub-prime mortgages into A-rated securities that were safe enough to
be held by pension funds. This was important, because it allowed a steady flow of cash
into the housing market, which in turn provided the fuel for the housing bubble. The
rating agencies’ behavior may have been affected by the perverse incentive of being paid
by those that they rated, but I suspect that even without these incentive problems, their
models would have been badly flawed. Competition, in this case, had a perverse effect:
it was a race to the bottom—a race to provide ratings that were most favorable to those
being rated.
Mortgage brokers played a key role: they were less interested in originating good
mortgages—after all, they didn’t hold the mortgages for long—than in originating many
mortgages. Some of the mortgage brokers were so enthusiastic that they invented new
forms of mortgages: the low- or no-documentation loans to which I referred earlier; these
5
were an invitation to deception, and came to be called liar loans. This was an
“innovation,” but there was a good reason that such innovations hadn’t occurred before.
Other new mortgage products—low- or no-amortization, variable-rate loans—
snared unwary borrowers. Home-equity loans, too, encouraged Americans to borrow
against the equity in their homes, increasing the (total) loan-to-value ratios and thereby
making the mortgages riskier.
The mortgage originators didn’t focus on risk, but rather on transactions costs.
But they weren’t trying to minimize transactions costs; they were trying to maximize
them—devising ways that they could increase them, and thereby their revenues. Short-
term loans that had to be refinanced—and left open the risk of not being able to be
refinanced—were particularly useful in this respect.
The transactions costs generated by writing mortgages provided a strong incentive
to prey on innocent and inexperience borrowers—for instance by encouraging more
short-term lending/borrowing, entailing repeated loan restructurings, which helped
generate high transactions costs.
The regulators, too were accomplices-in-crime. They should have recognized the
inherent risks in the new products; they should have done their own risk assessments,
rather than relying on self-regulation or on the credit-rating agencies. They should have
realized the risks associated with high leverage, with over-the-counter derivatives, and
especially the risks that were compounding as these were not netted out.
The regulators deceived themselves into thinking that if only they ensured that
each bank managed its own risk (which they had every incentive, presumably, to do),
6
then the system would work. Amazingly, they did not pay any attention to systemic risk,
though concerns about systemic risk constitute one of the primary rationales for
regulation in the first place. Even if every bank were, “on average,” sound, they could
act in a correlated way that generated risks to the economy as a whole.
In some cases, the regulators had a defense: they had no legal basis for acting,
even had they discovered something was wrong. They had not been given the power to
regulate derivatives. But that defense is somewhat disingenuous, because some of the
regulators—most notably Greenspan—had worked hard to make sure that appropriate
regulations were not adopted.
The repeal of the Glass-Steagall act played an especial role, not just because of
the conflicts of interest that it opened up (made so evident in the Enron and WorldCom
scandals), but also because it transmitted the risk-taking culture of investment banking to
commercial banks, which should have acted in a far more prudential manner.
It was not just financial regulation and regulators that were at fault. There should
have been tougher enforcement of anti-trust laws. Banks were allowed to grow to be too
big to fail—or too big to be managed. And such banks have perverse incentives. When
it’s heads I win, tails you lose, too-big-to-fail banks have incentives to engage in
excessive risk taking.
Corporate governance laws too are partly to blame. Regulators and investors
should have been aware of the risks that the peculiar incentive structures engendered.
These did not even serve shareholder interests well. In the aftermath of the Enron and
WorldCom scandals, there was much discussion of the need for reform, and the
7
Sarbanes-Oxley Act represented a beginning. But it didn’t attack perhaps the most
fundamental problem: stock options.
Bush’s and Clinton’s capital-gains tax cuts, in conjunction with deductibility of
interest, provided enhanced incentives for leverage—for homeowners to take out, for
instance, as large a mortgage as they could.
Credentialed Accomplices
There is one other set of accomplices—the economists who provided the arguments that
those in the financial markets found so convenient and self-serving. These economists
provided models—based on unrealistic assumptions of perfect information, perfect
competition, and perfect markets—in which regulation was unnecessary.
Modern economic theories, particularly those focusing on imperfect and
asymmetric information and on systematic irrationalities, especially with respect to risk
judgments, had explained how flawed those earlier “neoclassical” models were. They
had shown that those models were not robust—even slight deviations from the extreme
assumptions destroyed the conclusions. But these insights were simply ignored.
Some important strands in recent economic theory, moreover, encouraged central
bankers to focus solely on fighting inflation. They seemed to argue that low inflation was
necessary, and almost sufficient, for stable and robust growth. The result was that central
bankers (including the Fed) played little attention to the financial structure.
8
In short, many of the most popular micro-economic and macro-economic theories
aided and abetted regulators, investors, bankers, and policymakers—they provided the
“rationale” for their policies and actions. They made the bankers believe that in pursuing
their self-interest, they were, in fact, advancing the well-being of society; they made the
regulators believe that in pursuing their policies of benign neglect, they were allowing the
private sector to flourish, from which all would benefit.
Rebutting the Defense
Alan Greenspan (2009) has tried to shift the blame for low interest rates to China,
because of its high savings rate. Clearly, Greenspan’s defense is unpersuasive: The Fed
has enough control, at least in the short run, to have raised interest rates in spite of
China’s willingness to lend to America at a relatively low interest rate. Indeed, the Fed
did just that in the middle of the decade, which contributed—predictably—to the popping
of the housing bubble.
Low interest rates did feed the housing bubble. But that is not the necessary
consequence of low interest rates. Many countries yearn for low interest rates to help
finance needed investment. The funds could have been channeled into more productive
uses. Our financial markets failed to do that. Our regulatory authorities allowed the
financial markets (including the banks) to use the abundance of funds in ways that were
not socially productive. They allowed the low interest rates to feed a housing bubble.
They had the tools to stop this. They didn’t use the tools that they had.
9
If we are to blame low interest rates for “feeding” the frenzy, then we have to ask
what induced the Fed to pursue low interest rates. It did so, in part, to maintain the
strength of the economy, which was suffering from inadequate aggregate demand as a
result of the collapse of the tech bubble.
In that regard, Bush’s tax cut for the rich was perhaps pivotal. It was not designed
to stimulate the economy and did so only to a limited extent. His war in Iraq, too, played
an important role. In its aftermath, oil prices rose from $20 a barrel to $140 a barrel.
(We don’t have to parse out here what fraction of this increase is due to the war; but there
is little doubt that it played a role. See Stiglitz and Bilmes 2008.) Americans were now
spending hundreds of billions of dollars a year more to import oil. This was money not
available to be spent at home.
In the 1970s, when oil prices soared, most countries faced recessions because of
the transfer of purchasing power abroad to finance the purchase of oil. There was one
exception: Latin America, which used debt finance to continue its consumption
unabated. But its borrowing was unsustainable. Over the last decade, America took the
Latin route. To offset the negative effect of higher spending on oil, the Fed kept interest
rates lower than they otherwise would have been, and this fed the housing bubble more
than it otherwise would have. The American economy, like the Latin American
economies of the 70s, seemed to be doing well, because the housing bubble fed a
consumption boom, as household savings fell all the way down to zero.
Given the war and the consequent soaring oil prices and given Bush’s poorly
designed tax cuts, the burden of maintaining economic strength fell to the Fed. The Fed
10
could have exercised its authority as a regulator to do what it could do to direct the
resources into more productive uses. Here, the Fed and its chairman have a double
culpability. Not only did they fail in their regulatory role, they became cheerleaders for
the bubble that eventually consumed America. When asked about a possible bubble,
Greenspan suggested there was none—only a little froth. That was clearly wrong. The
Fed argued that you could not tell a bubble until after it broke. That, too, was not fully
correct. You can’t be sure there is a bubble until after it breaks, but one can make strong
probabilistic statements.
All policy is made in the context of uncertainty. House prices, especially at the
lower end, soared, yet the real incomes of most Americans stagnated: there was a clear
problem. And it was clear that the problem would get worse once interest rates rose.
Greenspan had encouraged people to take out variable-rate mortgages when interest rates
were at historically low levels. And he allowed them to borrow up to the hilt—assuming
interest rates would remain at the same low level. But because interest rates were so
low—real interest rates were negative— it was unreasonable to expect them to remain at
that level for long. And when they rose, it was clear that many Americans would be in
trouble—and so would the lenders who had lent to them.
Apologists for the Fed sometimes try to defend this irresponsible and short-
sighted policy by saying they had no choice: to raise interest rates would have killed the
bubble, but also killed the economy. But the Fed has more tools than just the interest
rate. There were, for instance, a number of regulatory actions that would have dampened
the bubble. It chose not to employ these tools. It could have reduced maximum loan-to-
value ratios as the likelihood of a bubble increased; it could have lowered the maximum
11
house payment-to-income ratios allowed. If it believed it did not have the requisite tools,
it could have gone to Congress and requested them.
This doesn’t provide a fully satisfactory counterfactual. True, perhaps the money
could have been deployed by financial markets in a more productive use, to support for
instance more innovation, or important projects in developing countries. But perhaps the
financial markets would have found another scam to support irresponsible borrowing—
for instance, a new credit-card boom.
Defending the Innocent
Just as all of the accomplices are not equally culpable, some suspects should be acquitted.
In the long list of possible culprits, there are two that many Republicans often
name. They find it difficult to accept that markets fail, that they should act in such an
irresponsible manner, that the wizards of finance didn’t understand risk, that capitalism
has serious flaws. It is government, they are sure, which is to blame.
I have suggested government is indeed to blame, but for doing too little. The
conservative critics believe, to the contrary, that government is to blame for doing too
much. They criticize the Community Reinvestment Act (CRA) requirements imposed on
banks, which required them to lend a certain fraction of their portfolio to underserved
minority communities. They also blame Fannie Mae and Freddie Mac, the peculiar
government-sponsored enterprises, which, though privatized in 1968, play a very large
role in mortgage markets. Fannie and Freddie were, according to the conservatives,
12
“under pressure” from Congress and the president to expand home ownership (President
Bush often talked about the “ownership society”).
This is clearly just an attempt to shift blame. A recent Fed study showed that the
default rate among CRA mortgagors is actually below average (Kroszner 2008). The
problems in America’s mortgage markets began with the subprime market, while Fannie
Mae and Freddie Mac primarily financed “conforming” (prime) mortgages.
It is America’s fully private financial markets that invented all the bad practices
that played a central role in this crisis. When government encouraged home ownership, it
meant permanent home ownership. It didn’t intend for people to buy homes beyond their
ability to afford them. That would generate ephemeral gains, and contribute to
impoverishment: the poor would lose their life savings as they lost their home.
There is always a home that is of an appropriate cost to an individual’s budget.
The irony is that because of the bubble, many of the impoverished wound up owning a
home no bigger than they would have if more prudent lending policies been enforced—
which would have dampened the bubble. To be sure, Fannie Mae and Freddie Mac did
get into the high risk high leverage “games” that were the fad in the private sector,
though rather late, and rather ineptly. Here, too, there was regulatory failure; the GSEs
have a special regulator which should have constrained them, but evidently, amidst the
deregulatory philosophy of the Bush Administration, did not. Once they entered the
game, they had an advantage, because they could borrow somewhat more cheaply
because of their (ambiguous at the time) government guarantee. They could arbitrage
13
that guarantee to generate bonuses comparable to those that they saw were being
“earned” by their counterparts in the fully private sector.
Politics and Economics
There is one more important culprit, which, in fact, has played a key behind-the-scenes
role in many various parts of this story: America’s political system, and especially its
dependence on campaign contributions. This allowed Wall Street to exercise the
enormous influence that it has had, to push for the stripping of regulations and to the
appointment of regulators who don’t believe in regulations—with the predictable and
predicted consequences (Stiglitz 2003) that we have seen. Even today, that influence is
playing a role in the design of effective means of addressing the financial crisis.
Any economy needs rules and referees. Our rules and referees were shaped by
special interests;ironically, it is not even clear whether those rules and referees served
those special interests well. It is clear that they did not serve the national interests well.
In the end, this is a crisis of our economic and political system. Each of the
players was, to a large extent, doing what they thought they should do. The bankers were
maximizing their incomes, given the rules of the game. The rules of the game said that
they should use their political influence to get regulations and regulators that allowed
them, and the corporations they headed, to walk away with as much money as they could.
The politicians responded to the rules of the game: they had to raise money to get
elected, and to do that, they had to please powerful and wealthy constituents. There were
economists who provided the politicians, the bankers, and the regulators with a
14
convenient ideology: according to this ideology, the policies and practices that they were
pursuing would supposedly benefit all.
There are those who now would like to reconstruct the system as it was prior to
2008. They will push for regulatory reform, but it will be more cosmetic than real.
Banks that are too big too fail will be allowed to continue little changed. There will be
“oversight,” whatever that means. But the banks will continue to be able to gamble, and
they will continue to be too big to fail. Accounting standards will be relaxed, to give
them greater leeway. Little will be done about incentive structures or even risky
practices. If so, then, another crisis is sure to follow.
REFERENCES
Greenspan, Alan. 2009. “The Fed Didn’t Cause the Housing Bubble.” The Wall Street
Journal, March 11.
Kroszner, Randall S. 2008. “The Community Reinvestment Act and the Recent
Mortgage Crisis.” Speech to the Confronting Concentrated Poverty Policy Forum,
Board of Governors of the Federal Reserve System, Washington, D.C. 3 December.
Stiglitz, Joseph E. 2003. The Roaring Nineties. New York: W.W. Norton.
Stiglitz, Joseph E., and Linda Bilmes. 2008. The Three Trillion Dollar War: The True
Costs of the Iraq Conflict. New York: W.W. Norton.
15
