July 13 (Bloomberg) -- As should be abundantly clear by now to anyone who has taken the time to study things carefully, there were many factors that contributed to the calamitous financial crisis of the last three years.
In this disastrous bouillabaisse, one could find the following ingredients:
-- Financial innovation, which took the idea of securitizing cash-flow streams to excess.
-- Wrong-headed incentives, which rewarded Wall Street bankers and traders for taking risks with other people’s money while somehow absolving them of accountability.
-- The misguided monetary policy of Alan Greenspan’s Federal Reserve, which lowered interest rates dramatically after the Sept. 11 attacks, leaving investors with little choice but to take bigger and bigger risks in order to find meaningful yields. (This is happening again, by the way.)
-- Regulators who failed to regulate or caved into the desires of those it regulated. (See particularly the Securities and Exchange Commission under Christopher Cox)
-- The ratings services, which were paid by Wall Street to slap AAA credit ratings on securities that were anything but.
-- And politicians who did everything they could to encourage homeownership -- thinking it was an important part of the American Dream -- which led thousands of people who would otherwise be renters to take out mortgages they could not afford.
These squirrelly mortgages, of course, were packaged into securities by Wall Street, stamped AAA by the conflicted rating services and sold all over the world to investors hungry for yield. When homeowners could no longer make payments on their mortgages, and when those mortgages could no longer be refinanced because home prices were no longer increasing, the whole stew became a toxic mess.
Alan Schwartz, the chief executive officer of Bear Stearns for the three months leading up to its sudden collapse in March 2008, had a front-row seat for the crisis and understands well the multiple strands of its DNA. “These things do occur with some regularity,” he explained in a quote I put on the final page of my book about the collapse of Bear Stearns. “And we haven’t ever figured out how to stop the next one from happening. I’m sure we’ll figure out how to prevent something like this from happening again. Wall Street is always good at fighting the last war. But these things happen and they’re big, and when they happen everybody tries to look at what happened in the previous six months to find someone or something to blame it on. But, in truth, it was a team effort. … Government. Rating agencies. Wall Street. Commercial banks. Regulators. Investors. Everybody.”
A Strong Report
After its creation in May 2009, the Financial Crisis Inquiry Commission studied thoroughly the causes of the crisis, interviewed more than 700 witnesses and held 19 public hearings. Its nearly 600-page report, released in January, analyzed many of the same threads that Schwartz described as being among the chief culprits of the problem and came to the accurate conclusion that the crisis was man-made and entirely preventable.
“The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire,” the report stated. “The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand, and manage evolving risks within a system essential to the well-being of the American public. Theirs was a big miss, not a stumble. While the business cycle cannot be repealed, a crisis of this magnitude need not have occurred. To paraphrase Shakespeare, the fault lies not in the stars, but in us.”
Placing the Blame
The FCIC’s report put the majority of the blame squarely where it belonged: On the shoulders of the Wall Street executives who led their companies straight into the financial abyss. Rather than finding themselves in jail or in bankruptcy court, you can find them in Sun Valley, Martha’s Vineyard and the Hamptons, living very well indeed off the hundreds of millions of dollars in compensation they Hoovered up during their years of mismanagement at the top.
The report’s gutsy and accurate conclusion was not the unanimous view of the commission. Rather, it was endorsed by only six of the 10 commissioners, all Democrats. The four dissenters, who were Republicans, made their views known in two separate reports, which had some good points but went too easy on Wall Street’s behavior.
Now the author of one of those dissenting reports -- Peter Wallison, a senior fellow at the conservative American Enterprise Institute -- appears to be on some kind of crazy crusade to rewrite history. He is intent on deflecting any blame away from Wall Street and its unhealthy incentive system and toward the much-maligned government-sponsored entities, Fannie Mae and Freddie Mac.
“Far from being a marginal player, Fannie Mae was the source of the decline in mortgage underwriting standards that eventually brought down the financial system,” Wallison wrote in a Wall Street Journal column published yesterday. “It led rather than followed Wall Street into risky lending.”
Sure, Fannie and Freddie -- and their political cronies in Congress and the White House -- had a meaningful role in the origins and the exacerbation of the crisis, as is well documented in “Reckless Endangerment,” a new book by Gretchen Morgenson of the New York Times and Joshua Rosner, a Wall Street analyst. But to pretend that Fannie and Freddie are the sole culprits is a terrible distortion of the truth of what actually occurred.
A Myopic View
What’s worse, Wallison bolsters his myopic view by insisting that “Reckless Endangerment” supports his argument, when by the authors’ own account their book was meant not to be a comprehensive accounting of the origins of the crisis, but an investigation into a somewhat overlooked one.
Wallison now accuses the FCIC of having a partisan agenda. “The commission majority’s false narrative,” he wrote, “buttresses the notion that more regulation of banks and other private-sector financial institutions could have prevented the financial crisis -- and might be necessary to prevent another one.” And the Dodd-Frank reforms, he insists, “would place the blame for the financial crisis solely on the private sector and do nothing to reform a government-backed housing finance system.”
Such arguments ignore that there is overwhelming bipartisan support for restructuring or phasing out Fannie and Freddie; yesterday alone a House subcommittee debated seven separate reform bills.
Wallison is correct that placing all the blame on one factor in the economic meltdown is unfair and will do little to avoid another one. But those who claim that federally backed home loans were the sole cause of our troubles, Wallison among them, are the ones pushing the false narrative.
(William D. Cohan, a former investment banker and the author of “Money and Power: How Goldman Sachs Came to Rule the World,” is a Bloomberg View columnist. The opinions expressed are his own.)
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