Who Really Caused the Crisis?

It’s the question that just won’t go away. You’d think it would be settled now, but it hasn’t been, mainly because of politics.

Democrats believe the financial crisis was caused mainly by a deregulated Wall Street run amok, and some of them consider it a failure of the free market itself.

Republicans blame it largely on the government, principally Fannie Mae and Freddie Mac, which, they claim, lowered lending standards to provide housing to people who couldn’t afford it.

Rep. Barney Frank. Photo: World Economic Forum

It’s become a campaign issue, too. Republican presidential candidate Mitt Romney blames Fannie and Freddie, while former Speaker of the House Newt Gingrich said Rep. Barney Frank and former Sen. Chris Dodd, who oversaw and promoted the two government-sponsored entities (GSEs), should go to jail. That was before it was revealed he had gotten $1.6 million from Freddie Mac himself. Independent New York mayor Michael Bloomberg, whom Wall Street made a billionaire, also blames the GSEs.

A lot is at stake. If you believe the government was primarily responsible, you’d support even less regulation of finance. If you think it was a market failure—or at least a failure of the financial system—then you’d try to rein in the big banks through legislation like the Dodd-Frank Act, which several GOP candidates want to repeal.

The controversy flared up again when well-known blogger Barry Ritholtz published a piece in the Washington Post denouncing the “Big Lie” that “it was not irresponsible lending or derivatives or excess leverage or misguided compensation packages, but rather long-standing housing policies that were at fault.”

Ritholtz has been all over this subject; he even wrote a pretty good book about it called “Bailout Nation” in which he was plenty critical of government actions in bailing out failed companies and especially of former Federal Reserve chairman Alan Greenspan’s reckless policies of keeping interest rates too low for too long. That ultimately turned the housing boom into one of the biggest bubbles ever, Ritholtz claimed, and it’s hard to disagree.

Photo: Flickr Creative Commons/Basic Gov

This is too big a topic to cover in a single blog post; I’ll return to it in the future. But here are a few facts to consider:

  • More than 84% of subprime mortgages originated in 2006, the peak of the bubble, were issued by private lenders, not Fannie and Freddie.
  • Fannie and Freddie lost market share in market originations from 2002 to 2005, the bubble years, while private-label lenders’ share quadrupled from 10% to 40% during those years.
  • Private-label (Wall Street) securitizers were responsible for 42% of all delinquencies while accounting for 13% of all outstanding loans. Fannie and Freddie had 57% of all loans but only 22% of the delinquencies, indicating its loans were generaly of better quality.
  • 84% of the mortgages Fannie and Freddie acquired during the boom were to borrowers with FICO credit scores above 660, but only 5% were to borrowers with FICOs below 620. For the private firms, only 47% of the loans they originated went to credit-worthy borrowers with FICOs above 660, and about one third to shakier borrowers whose scores were under 620.

I do think that Fannie and Freddie succumbed to the housing bubble’s animal spirits, but that happened late in the game.

And though Fannie and Freddie did contribute to the US housing bubble and bust, they didn’t cause the global financial crisis itself, which ultimately claimed them as victims. That was largely due to a highly leveraged and poorly regulated Wall Street, which had few internal controls, in my view.

We’ll revisit this another time, but for now, who do you think was the biggest culprit in the financial crisis? Take our poll, make a comment, and have your say.

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