What caused the financial crisis of 2007-2008? This explains various theories.
~ Aristotle Sabouni
Created: 2017-05-21 |
Overview[edit | edit source]
There are two theories of what caused the Financial crisis:
- Too little government: Big Banks / Wall St. and under-regulation (the removal of Glass-Steagall) allowed banks to inject risk into the system (with fancy derivatives) which created the bubble, and the bail-out sheltered them from any ramifications
- Too much government: The Housing Bubble was over inflated by the CRA, Fannie/Freddie, the risks spread thru MBS’s, and over-regulation (FAS-157) froze the credit markets and magnified the correction.
Both of these fit each sides political agendas. However, while Glass-Steagall theory (GST) is simpler (and more commonly regurgitated), every one of the claims of GST (or “too little government”) falls apart with the slightest scrutiny. The CRAFFT (CRA, Fannie-Freddie theory) matches the data/facts far better, and explains far more. I'll cover both.
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| You can jump to the Financial Terms section, or just reference them as you go; like read what a Bank does (and differences between investment/commercial/universal), what a GSE like Fannie/freddie does, or what an MBS’s are or Mark-to-market accounting is. |
| Left | Right |
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| We were under-regulated by removing Glass-Steagall, and it was the greed of Wall Street that inflated the bubble, and under-regulation made the banks “too big to fail”, so the taxpayers “bailed them out” and gave them money for fat bonuses and sheltered them from any consequences. It was all the Republican or evil Jewish Greedy Bankers fault. | We had more regulations than ever in history, the crisis was created by bad regulations like CRA (Community Reinvestment Act) and community organizers inflating a real-estate bubble of high-risk toxic loans, when that bubble-popped, other regulations (banking equity laws and FAS-157) magnified the resulting credit crunch and froze financial markets. We LOANED the banks money to get their liquidity up enough (short term) to unfreeze equity markets, and once everything stabilized, they paid all the money back (there was no net loss to taxpayers). No one has ever explained how Glass-Steagall could have stopped it, or why it hadn't happened in Europe/Asia without them ever having Glass-Steagall. |
What is Glass-Steagall?[edit source]
Glass-Steagall was the 1930's new deal regulation that said Commercial and Investment had to be separated. There would be no universal banks (that offered both services).
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Glass-Steagall Theory (GST)[edit source]
The idea is the Financial Crisis of 2007-2008 was caused by:
To these folks, it was collusion between the the Fed and Banks that allowed crimes to be committed and not punished, the little guy got screwed and got their homes taken away, and because Big-Government did nothing, thus we need Bigger-Government and wealth-redistribution to fix it and go after these crooks and evil 1%’ers. (This is the Occupy Wall Street theory). It's a great theory to appeal to emotions (it lets the politicians blame everyone but themselves), but none of it makes sense or fits the facts/evidence, or really explains anything. And it's been discredited by the evidence. |
Big Fraud Theory[edit source]
The problem is no one credible has really offered this as a "theory", because it's not economics, it's politics. And it doesn't explain anything, if you think it through. Why did fraud cause the markets to seize up, why did TARP loans help? It scapegoats without answers. |
CRA, Fannie-Freddie Theory (CRAFFT)[edit source]
 The idea of the CRA->Fannie/Freddie theory (CRAFFT) is as follows:
The Glass-Steagall theory scapegoats greedy bankers/capitalists and sub-prime loans, but it doesn't tell you the what, why, how like the CRAFFT theory does.
So knowing CRAFFT, explains far more -- knowing GST means you can't explain anything, but you get to hate bankers and wallow in virtue (think more government could have fixed it), and you blame the banks for taking money that the government made them take, and they all paid back. |
Financial Terms[edit source]
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TARP[edit source]
So the banking market froze up because of Government regulations causing a bigger drop than before, and requiring banks to sell their assets to keep liquidity high enough to comply with other regulations (so they couldn't loan). And they were scared a further drop would squeeze them more, so they didn't want to take on more liability.
The important thing to remember is that TARP was just LOANS, not give-aways to the banks. Congress authorized more than they needed (to have head-room, in case there was a second wave), but they only loaned $414B out, and the banks pad back $405B (with interest). (Very little was lost).[1]
We knew the housing market would find the new floor, once we figured out how much poison was in the system. And once the actual value of MBS's stabilized, the liquidity crunch abated, banks that survived, paid back the government ALL the loans from TARP. Only the few ruined by government regulations did not. Banks weren't loaned money to benefit the banks/bankers: the money loaned was so they had credit to loan out TO THE PEOPLE! The public benefited, not the rich bankers, proven by the fact that the banks paid all those loans back. Obama did pervert TARP, and diverted some of the money to Democrat causes: the auto-companies, Unions, and NOT the bankers or Wall St. And most of that money was NOT paid back. So the public did foot the bill of a few hundred billion in TARP. But not in Bush's Bank TARP (what it was passed as), only in Obama's DNC-Give-away TARP 2.0 (what he revised it into). If you've never heard that in the media, it shows you how biased or ignorant the media is. So when people are screaming that we have a corrupt system because no bankers went to prison, it shows the failure of the media. No bankers went to prison, because there was no crimes you could convict them of, other than complying with the many bad government regulations that nearly destroyed them, and paying back the loans they were forced to take (but most didn’t need), to cover for the few that were most compliant with CRA and Governmental pressure. The real question is why didn't the many Democrat politicians get held accountable for their hand in it? The answer is because the media and Democrats (but I repeat myself), were more effective in blaming someone else for their mistakes. So Bush and Republicans bore the brunt of the hate of the ignorant masses, for something they had warned about and fought against. Congress/Democrats knew that if they dug too deeply, all the systemic problems pointed back at them: so that's why they didn't hold big public investigations: Some banker was going to explain to the public what had really happened (instead of the Democrat version), and if they did that in ways that the media couldn't ignore, the Democrats in control knew they'd be in trouble. That's why despite Democrats controlling Senate, House and President, they only offered rhetoric -- but very thin "investigations" or prositions. Politicians might be dumb, but they're not THAT dumb. |
Repeal didn't cause the Financial Crisis of 2007[edit source]
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Conclusion[edit | edit source]
So while there's a few bad books, articles and movies that promote variants of the G-S theory. Facts, research, articles, Bill Clinton, the CBO, the SEC, and dozens of other economists all concluded the same thing: Glass-Steagall had nothing to do with the crisis, or the credit freeze!
So what did we learn?
- ALL the banks paid back all the loans within a couple years (with interest), and most didn't need the money in the first place. In fact, none would have, if it hadn't of been for FAS-157. They weren't crunched because they were over-leveraged for real (their leverage rates going into the crisis was lower than they were when Clinton was in office in the 90's). They only didn't have the paper assets because of Mark-to-market accounting (FAS-157): fuck-you-very-much.
- There was never a “bail out” of the banks — there was a bail out of bad regulations. The term "bail out" implies they were given money. They were forced to take loans to cover up Democrats incompetence. And they paid it all back, with interest. The taxpayer lost money, but that was on Fannie/Freddie and the Auto Loans and other policies by the Democrats. The only bail out was of government malfeasance, not of banks.
- The Republicans had been warning about for 5+ years before the collapse about Fannie/Freddie’s problems and trying to fix it. Democrats kept blocking republicans from forcing transparency, because of crony-big-government. Now we can debate whether the Republicans attacking was foresight, or just trying to kick Democrats in a soft-spot, and they weren’t 100% innocent either, Bush had let the CRA and Fannie/Freddie continue to lower standards without taking it to the people. But no one knew when the bubble would pop, and he at least had the excuse of 9/11 or Iraq and F/F was in Congresses purview.
- There was never any criminal prosecutions because the only thing most were guilty of was compliance with the law (bad regulations), and Democrats in control, they didn’t want that to come out. Which is why they scream so loudly and point fingers at Banks and Wall St. and fund things like Occupy, to distract from their malfeasance. Since the media leans left, they've avoided any real journalism or exposés that might make their party look bad — which is why 90% of Americans don't know/understand what actually happened and why.
The stories about deregulation causing this, and all the other stuff, make no sense on how they could cause anything. Nor do ones about how evil bankers duped the public or the gullible poor into taking loans they couldn't afford. Yes, I'm sure there's a few smarmy sales folks out there (even in banking), but that was a symptom of Fannie/Freddy and government requiring so many of these loans and being so willing to buy them up. If the government was buying only 20% of the loans and the private sector was issuing 80%, I’d firmly blame the banks. But as the numbers were the other way until well into the crisis (and the GSE’s had said their intent was to lower standards), the blame lies on them for the bubble, and on the bad regulations like FAS-157 for the crash afterwards.
Financial Terms[edit source]
I’ll keep from getting too nerdy, so these are just some basic terms you should understand before having an opinion on the Financial_crisis_of_2007-2008:
- Commercial banks - Commercial banks loan money to businesses in the form of cash (and give you interest in cash), and you can take out your cash at any time. Most investments are low risk (floating lines of credit, property/asset backed investments, etc.). But the overhead and low-risk investments means you get lower-returns. (This is what most people think of as banks).Commercial banks loan money to businesses in the form of cash (and give you interest in cash), and you can take out your cash at any time. Most investments are low risk (floating lines of credit, property/asset backed investments, etc.). But the overhead and low-risk investments means you get lower-returns. (This is what most people think of as banks).
- Credit market - Banking, Securities, and networks of private investors provide the economy with the "credit market". (Capital). Which is the root of capitalism.Banking, Securities, and networks of private investors provide the economy with the "credit market". (Capital). Which is the root of capitalism. Your right to loan/borrow/invest without going through the government is Capitalism. The government controlling investments is Socialism, Communism or Fascism.
- Fannie Mae • Freddie Mac • GSEs - Fannie/Freddie are GSE's (Government Sponsored Entities) that broker most loans (70-80%) in the U.S. (Banks only give you loans, because someone will buy them off them, and sell them back more diversified/lower risk holdings).Fannie/Freddie are GSE's (Government Sponsored Entities) that broker loans and thus set all the rules/regs that people follow. The whole point of this New Deal era program is to get more people to borrow money (make it easier, especially low end / high risk). With this capital freed up (it's in debt), people will spend more in the economy. But when things turn bad, they can lose everything.
- Glass-Steagall - Glass-Steagall was the 1930's new deal regulation that separated Commercial and Investment banks. That is all.Glass-Steagall was the 1930's new deal regulation that said Commercial and Investment banks had to be separated. There would be no "universal" banks (that did both). In theory, by separating sides there would be more transparency, and people might behave less risky. In truth, there's just more inefficiency and the same risk.
- Investment banks - Investment banks are more about stocks (equity). They help companies and individuals buy/sell stock/bonds/derivatives with each other (stock offerings, bond sales, Mergers & Acquisition, stock accounts and so on). So customers hold these things (paper/securities) that can be turned into cash through trades, but aren't cash themselves (thus there's more volatility/risk). Because customers are accepting more risk (the paper is more volatile than cash), they get much higher returns than traditional banking. (This is what most people think of as Wall St. or eTrade)Investment banks are more about stocks (equity). They help companies and individuals buy/sell stock/bonds/derivatives with each other (stock offerings, bond sales, Mergers & Acquisition, stock accounts and so on). So customers hold these things (paper/securities) that can be turned into cash through trades, but aren't cash themselves (thus there's more volatility/risk). Because customers are accepting more risk (the paper is more volatile than cash), they get much higher returns than traditional banking. (This is what most people think of as Wall St. or eTrade)
- Mark-to-market - Dumb/democrat idea of increasing the volatility of assets held by banks, by marking their value to the last market sale.FAS-157 passed in 2006 by Democrats said that instead of valuing an asset on a low-volatility manner (pegging a value to a 3-5 year rolling average), all assets of a like kind must be pegged to the last market sale. (Mark that value to the last market sale).
- Mortgage Backed Security (MBS) - An MBS is a diversified package of many loans, to lower the risk by not tying it to any one area/demographic.An MBS is a diversified package of many loans, to lower the risk by not tying it to any one area/demographic. It was also used by Fannie/Freddie (and later others) to bundle in high risk loans (poison), with low risk loans. Politicians get to redistribute wealth to lower incomes. But unravelling the bad and good loans in a crisis was a mess. (It magnified the crash).
- Risk-Reward ratio - The more risk you take, the more reward you need to get to be worth the risk.The more risk you take, the more reward you need to get to be worth the risk. Higher risk investments must pay more dividends to offset the risks of losing it, in order to entice investors. Lower risk investments, can pay less (lower interest) because they're "safer".
- TARP - Troubled Asset Relief Program: The government forced Banks to take money for a crisis government created. Then blamed banks.Troubled Asset Relief Program: this was Government forcing Banks to take money, so they could comply with government regulations to make loans. All to get around a crisis that government (mostly Democrats) created. Then Democrats blamed the banks for taking the money, and used it as an excuse to put more regulations on the banks.
- Universal banks - Universal banks are banks that can do bott: investments and commercial banking.Universal banks are banks that can do both (investments and commercial). They're definitely less risky that Investment houses, but arguably safer than either since they're more diversified. These were illegal in the U.S. under Glass-Steagall, but allowed in the rest of the world.
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🗒️ Notes
Nuances
Here's some other tidbits (complexities to note):
Feeding the bubble: many foreign investors (and others) lost trust in their governments for a variety of good reasons, they still needed a place to put their money/savings and if they didn't trust their currency/governments, American MBS's was a great/safe place. They needed to put their money somewhere, and that was safer than in their own countries. And you couldn't trust currencies because of manipulation (China, U.S., EU). You couldn't trust the treasury bills because Greenspan was keeping interest rates too low (in order to encourage more leverage/investment and less savings -- e.g. creating a bubble). So socialist corruption in Europe, U.S. and abroad helped fed the American (Dollar) and real-estate bubble.
Feeding the bubble: in America municipal bonds weren't good investments because cities had defaulted (especially in liberal controlled states like California, NY or Michigan), and other states and municipalities looked higher risk because they couldn't control their debts. (See liberal states like California, Michigan, NY, especially). If you don't trust city/state bonds, then more goes into stocks and real-estate (the bubbles that popped). And tax incentives were further inflating the bubble.
Mis-assessing risk: there's no doubt that the credit agencies mis-assessed risks. But imagine you're Moody's -- and there hasn't been a system wide real-estate drop in 70 years, and the majority of the loans are going through GSE's (Government), and you have government agents like Barney Frank screaming that everything is good and safe? You're going to assume these instruments are very low risk too. But black swans hit once in a while. The credit agencies were wrong, for trusting what the government was telling them!
The banks sold sub-prime loans and MBS's too! Yes, a few did. But if you look at scale, they were not most of them (government was), and they were kind of arm-twisted into following by the successes of Fannie/Freddie. So they might be wrong, but they were wrong second -- thus if you want to get to the root of the problem, you look at who did it first and bigger. Banks listened to government and credit agencies that said these things were safe, so they FOLLOWED! (They did not LEAD) into bundling their own MBS's, as well as selling the sub-prime loans that Fannie/Freddie and the CRA was pushing them to. And as long as Government (GSE's) were buying these loans, there was virtually no risk to signing up as many people as you could: it looked like free money (backed up by the government).
After government had chummed the waters, the feeding frenzy started, then investment houses created derivative/instruments to magnify the results (like CDO's) which magnified leverage. (Note derivative and leverage aren't bad things). The reason lefty-politicians focus on it, is because they can make it sound complex and distract people from root causes, and their base doesn't understand that both can LOWER your risk. (In fact, that's what hedging as in hedge-fund managers does). So the fundamental problem here was that investors (and investment banks) listened to Moody's and Government's mis-represented risks, and reacted accordingly. And they paid the price (by being driven out of business).
What about smarmy companies selling bad loans or selling investments they knew were bad? Both are a failure of government: it is their job to stop those criminal activities. If they were widespread (and they really weren't from a systemic level), then it shows how bad government was at doing its job of stopping abuse. Blaming the industry for a few exceptions is daft. Not blaming government for doing their job and catching, stopping, or punishing it, is dafter.
What about Credit default Swaps (CDO's)? These are just two companies insuring each other. I agree that if your assets go down, I'll cover you, as long as you do the same. It's really low cost insurance -- but if BOTH sides go down at once, you're screwed. But we hadn't had a case of that in 70+ years, so they thought (wrongly) that it was safe. Thus there was a lot of greed and failure to assess risks, and this cross insurance and complex derivatives chewed up the Investment Banks and Insurance Companies. They thought they were collecting risk free premiums and got raped for that mis-assumption (and increased leverage). But it wasn't that companies weren't insured, it was that their cross-insuring each other, caused as much exposure as it covered it. But that wasn't because of deregulation (government was writing more new regulation than ever in our history with Sarbanes Oxley and so on), it was a failure of government to realize where we needed new regulation targeted, while simultaneously telling them that there was no risk in housing. (These guys were dumb to believe government -- so both sides own that mess).
Some companies were betting against themselves or their investors? Yes. This is called hedging (or "insurance" in gambling). It's a common technique to lower risk -- if you've made a ton of money on one investment, you normal bet against it (by a short or derivative against it): if it keeps going up, the asset growth will cover the cost of the insurance/hedge, and if the asset goes down, the insurance/hedge will grow in value and cover the cost of the asset drop -- you're not betting against yourself/customers as much as locking in a gain. Some are trying to flim-flam the gullible that hedging is a bad thing -- but the alternatives are usually worse.
CountryWide was the worst! You're correct -- they were the most aggressive at selling MBS's and sub-prime loans. What lead to all that confidence? They owned too many Democrats in congress (and had become a revolving door for congressmen), and they donated heavily, and Barney Frank protected them. So there was a corruption problem with CounrtyWide, but it was government-CountryWide collusion with Democrats. This is the problem of empowering Government/Politicians, they lease that protection to the highest bidder.
🔗 Links
More Links
- Video of Bush/McCaine pushing for reforms in 2002/2003, but being blocked by Dems (especially Barney Frank and Chuck Schumer): https://www.youtube.com/watch?v=cMnSp4qEXNM
- http://www.wsj.com/news/articles/SB122204078161261183?mod=special_page_campaign2008_mostpop
- http://object.cato.org/sites/cato.org/files/serials/files/policy-report/2009/7/cpr31n4-1.pdf
- https://en.wikipedia.org/wiki/Financial_crisis_of_2007–08
- http://www.investopedia.com/university/credit-crisis/credit-crisis1.asp
- http://spectator.org/articles/42211/true-origins-financial-crisis - 2009 Peter Wallison
- http://spectator.org/articles/37680/true-story-financial-crisis - 2011 Peter Wallison
- http://www.wsj.com/news/articles/SB123414310280561945 - How Government Created the Financial Crisis - John B. Taylor
- http://www.wsj.com/news/articles/SB10001424052748704698004576104500524998280 - Bill Thomas, Keith Hennessey And Douglas Holtz-Eakin - Congress's inquiry commission is offering a simplistic narrative that could lead to the wrong policy reforms
- http://www.wsj.com/articles/SB10001424127887323477604579000571334113350 - The Clinton-Era Roots of the Financial Crisis
- http://hotair.com/archives/2011/11/01/bloomberg-to-ows-congress-caused-the-mortgage-crisis-not-the-banks/
- https://www.washingtonpost.com/opinions/democrats-are-wasting-their-time-obsessing-over-this-depression-era-law/2016/01/19/d026fff8-beab-11e5-bcda-62a36b394160_story.html
- Good video from Harvard (Director of Economic Studies). 3 Myths of Capitalism:
- (1) Pro-capitalism = pro business. Nope, it increases competition.
- (2) Capitalism generates unfair distribution of income. Nope. It rewards productivity, thus unequal talent and effort results in unequal reward. Other ideologies may hinder that (Socialism), their belief is cutting the wings off birds, because not all of us can fly.
- (3) Capitalism was responsible for the 2008 financial crisis - Nope, that was over-regulation. It was "interfering with capitalism" that caused the problem.
- https://www.youtube.com/watch?v=KGPa5Ob-5Ps
- Why the myth persists: http://www.forbes.com/sites/objectivist/2012/11/12/why-the-glass-steagall-myth-persists/#3755247d2b67
- The case against restoring G-S: http://www.americanbanker.com/issues/177_152/the-case-against-restoring-glass-steagall-1051651-1.html
Tags: Economics Left Lies Capitalism Alt-Economics Crisis
- ↑ TARP was a loan, not a "Wall Street Give-Away":
- http://en.wikipedia.org/wiki/Troubled_Asset_Relief_Program
- http://www.politifact.com/new-hampshire/statements/2012/oct/25/barack-obama/barack-obama-says-banks-paid-back-all-federal-bail/
- http://money.cnn.com/2008/10/03/news/economy/house_friday_bailout/index.htm
- http://projects.propublica.org/bailout/
