Who is Responsible for Subprime Mess?

First, I should say that some entities have broken laws. Their blame is beyond question. However, the entities on which I'm focusing are those that didn't technically break any laws. They still bear responsibility.

The case, in a nutshell, is that corporations are amoral profit-seeking machines, so it is expected that they will push the legal and ethical limits. As a consequence, you can't blame a dog for acting like a dog, and the same goes with Wall Street and loan originating corporations. Yet, if someone is bitten by a dog, the dog still shares in the blame, even if provoked.

Wall Street's blame is greater than the loan originators. By Wall Street I mean hedge funds, major banks, investment firms, bond raters and other enablers that kept moving bad investment bubble expanding. They helped create the bubble market, in part
by financing the local mortgage lenders. Wall Street should have known better. They were making wind fall profits, many knowing that investors in mortgage backed bonds were going to be left holding the bag. Some were stupid, but when you have your hands on major investments that can rock the nation's economy, being dumb isn't an excuse.

The loan originators were just operating day to day responding to the market created by Wall Street. Their reasoning, "The balloon is still expanding, I'll go originate another loan until I can't do so any more." Although many loan originators used unethical practices, so do car sales men.

The buyers share some of the blame, yet they are clearly price takers, many being forced to operate in a failing market. That is, if your job moved, and you had to move and buy a house, you were forced to do so, while Wall Street operators were profiting handsomely at your expense. When buyers wondered how they could afford the loans, the loan brokers reassured them. They were telling buyers, "this is just the way the market works now. It's been like this in California for decades. The rest of the Nation is just catching up. It's true that some buyers were speculating and flipping real estate, and they deserve more blame than typical buyers. Buyers were duped and forced to deal with a failing market.

And who let the market failure occur and perpetuate? The regulators. They are experts and should have known better than to let profit-seeking machines run amok with so much at stake. Even part-time hobbyists like me could see the disaster coming. Unfortunately, they profess knowledge, but were themselves duped by their own belief that the market is self-correcting. They're partly right. But they failed to consider that the self-correction could be like a plane self-correcting into the ground.

Now the bailouts come, and guess who will pay for it? Not the Wall Street insiders who were spending their bonuses last year on upgrading their Manhattan real estate from a $3 million dollar flat to a bigger flat with a better view. Not the regulators, one of whom named Greenspan has just written his memoirs and re-written history. Not the loan originators. The industry pawns have already paid once by being laid off, and are likely to be paying again, with the rest of us, in direct bail outs of "too big to fail" firms, like Citigroup, and paying in the form of not having government programs that widely benefit the common people (expansion and maintenance of national parks and museums, financial aid for college, improved health care, etc.)

That's the gist of it. But for those who are interested, there's more.

Robert Kuttner points out a contradiction about "free markets" in explaining why regulators should not have allowed this unfolding disaster to happen:

There were regulations on the books that the federal reserve refused to enforce because the Fed claims to believe in free markets, except when they go nuts, then the Fed bails them out.

In other words, the markets are free when the inside crowd is vacuuming in profits from the commoners, but when the self-correction comes, the market is no longer free, and the inside-crowd gets bailed out... by the commoners.

Economist Paul Krugman, who specializes in global financial stability and crises, recently wrote a column for the New York Times entitled, "Innovating Our Way to Financial Crisis."

First, Krugman gives us a sense of the magnitude of the crisis:

How bad is it? Well, I’ve never seen financial insiders this spooked — not even during the Asian crisis of 1997-98, when economic dominoes seemed to be falling all around the world.

This time, market players seem truly horrified — because they’ve suddenly realized that they don’t understand the complex financial system they created.

Others, whom I could quote if I was more diligent, have said this crisis is ten times worse than the Savings and Loan crisis of the 1980s. We tax payers are still paying for that bailout.

Krugman explains the regulator's blunder:

... the problem was ideological: policy makers, committed to the view that the market is always right, simply ignored the warning signs. We know, in particular, that Alan Greenspan brushed aside warnings from Edward Gramlich, who was a member of the Federal Reserve Board, about a potential subprime crisis.

Krugman continues, indicating that the regulators have still not learned their lesson:

Just a few weeks ago Henry Paulson, the Treasury secretary, admitted to Fortune magazine that financial innovation got ahead of regulation — but added, “I don’t think we’d want it the other way around.” Is that your final answer, Mr. Secretary?

I noted that this essay focuses on legal operatives. A potentially valid criticism of this essay is to assume that the whole damn affair wasn't fraught with illegal activity. Some have surely crossed the legal line, particularly in the mortgage lending sector. One is particularly noteworthy.

On the same day that the White House announced that President Bush is nominating California billionaire Roland E. Arnall to be ambassador to the Netherlands, the company he controls said it would set aside $325 million for a possible settlement of allegations of predatory lending tactics.

Arnall's company, Ameriquest Mortgage Co., is being investigated by regulators in 30 states. A $325 million settlement would be one of the largest ever in a predatory lending case.

You can read more in the July 29, 2007 Washington Post.

Another case was the lender "Countrywide." I had a loan with them once. They might have been the one who, upon buying my loan, or maybe it was selling it to another lender, failed to pass along the home owners insurance information. I received a notice from the insurance company that my premium hadn't been paid, and was no longer covered (had the house burned down at that point, I'd have been one seriously fucked individual). It seemed like a scam, because when I went to buy insurance, I had to pay a lot more than before... everything has changed since 9/11, and I think the commoners are paying for it... again.

Everyone interested in this subject should read Inside the Countrywide Lending Spree.

Barowers are being scapegoated. This essay is an attempt to mitigate that misplaced blame. A lot of the innovated lending products were complicated and misrepresented by brokers who bore no risk because they either never owned the mortgage, or they sold it to be bundled with other loans as a mortgage-backed security (bond). This time around, we need to learn the lesson of the S&L scanals. That is, it was three scandals. The first was the Congressional deregulation scandal. The second was the corporate run amok scandal. The third was the Congressional bail out scandal. Lets bail out the duped home buyers, but not the profit reaping inside crowd this time around.

Sources:

This essay was inspired by an interview of Robert Kuttner by Robert McChesney,on the December 2, 2007 episode of the radio show Media Matters. Dr. Kuttner is a founder of the American Prospect Magazine and author of the recent book, "The Squandering of America: How the Failure of Our Politics Undermines Our Prosperity" (Knopf, November 2007), which goes further into these issues.