Investment Banks Caused the Crisis – NOT Mortgage Borrowers

Barry Ritholtz of the Washington Post recently published this excellent column about the causes of the current economic crisis. It’s important, because one of the main talking points of the Tea Party delegation in Congress (and in the public) is that the crisis was caused by loose credit.

To give the full-blown loony conspiracy version: ACORN, inspired by the writings of Frances Fox Piven and Richard Cloward, set out to destroy capitalism by overloading the system. Specifically, they:

  • Lobbied to get the Community Reinvestment Act passed, and then to modify it to require banks to issue sub-prime mortgages without credit checks.
  • Organized people, many of them without means, to apply for mortgages they couldn’t afford.
  • Ran fraudulent voter registration drives to register illegal aliens and others to elect Barack Obama and keep the government handing out the money.

There are other parts to it, but you get the picture. And of course it is rare that anyone lays out the full story like this; instead, right-wing voices just mention all the parts and let people put them together for themselves; so anything they say about ACORN, for example, becomes confirming evidence.

The reality is very different. The Community Reinvestment Act requires banks to make loans in the areas they get deposits from; it does not require them to make bad loans! And almost everyone who got a mortgage was able to pay for it initially; the problem was that the mortgage companies, who were going to resell the mortgage anyway, concealed the fact that the rate was likely to go way up at some point in the future.

But there is another, more basic point: the crisis was not caused by people who defaulted on their mortgages. People default on mortgages all the time. High-risk mortgages earn higher interest, and when the markets are working right the high return will balance the risk of loss.

The problem was different. Mortgages known to be high-risk were combined into packages with others thought to be low-risk; then the ratings certified the packages as safe investments, and the packages were sold (or rather, derivatives based on their value were sold) to investors.

When the default rate went up, it suddenly became clear that these safe investments weren’t safe after all. Even more important, investors realized that no one knew what the packages were worth. Since no one knew what to buy or sell them for, the market just collapsed – and there was the crisis.

Well, Ritholtz explains it much better than I, so go back to the top of this post, click on the link, and read his article. I just want to conclude by looking at the implications.

  • If the problem was caused by poor people getting mortgages, then the lesson is that we all have to learn not to live beyond our means. Austerity!
  • But if the problem was caused by the banking system (and it was!), the lesson is different: we have to get the banks under control! Unfortunately, governments around the world are moving in the opposite direction, using the IMF to force us all under the thumbs of the bankers.

2 thoughts on “Investment Banks Caused the Crisis – NOT Mortgage Borrowers”

  1. the problem was caused by the government. when someone lets you gamble w/o risk, you’re gonna take it to the extreme to try and squeeze out as much green on your P/L as you can. this is human nature that has been reflected in the financial markets since its inception. there is nothing wrong with the banking system besides special interests from municipal and federal entities. you claim that problems would be solved if ‘poor people’ learned not to live beyond their means. false, this is beyond absurdity. you can’t expect people to change the one constant in their behavior: greed. accumulation and repayment of debt drive nearly every economic cycle. second: “We should get the banks under control”- also completely absurd. what ‘we’ should do is draw a fine line between wall street and the federal government. meaning, if an investment bank were to speculate on cdo’s, they should be liable 100% for the risk that they take (including the shareholders). not the taxpayers. it is crazy that the people should pay an extra penny out of their pockets each year to make sure that some hack-job federal investigation team will make sure that investment banks are ‘carefully’ managing risk. instead just stop funding their margin calls. duh. you think an investment bank would risk their entire firm’s assets on an a security that would cause billions in losses on just a few basis point moves? No… unless they had insurance (bailouts). cdo’s are actually fantastic and brilliant instruments.

    anyway, i stumbled upon this because we have once again come to one of the largest debt buildups in the history of financial markets.

    1. Thanks for your comment! You make an interesting argument, but I think it depends on what you mean by “cause.” You could argue similarly that the government causes all murders by not locking up the murderers before they commit the crime. It seems to me that that way of defining the problem lets the murderers – and the bankers – off the hook.

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