financial and economic crisis storm.” A confluence of factors came together to create it. In addition to “animal spirits,” to employ Adam Smith’s term for greed, these factors included: 1. Monetary ease; 2. A lack of regulatory and Congressional oversight; 3. Rapid home price appreciation (in many markets after 2000); 4. Funky mortgage products with low start rates and layered risk; 5. Lax underwriting standards; 6. A political establishment enamored with homeownership and an endless need for campaign contributions; 7. An excess of sub-prime wholesalers, brokers and loan officers, all poorly supervised and state regulated; 8. An oftentimes greedy, undisciplined consumer seeking a free lunch; 9. A cheerleading media that, for years, dutifully boosted housing; and 10. A large network of interested parties who promoted housing unendingly—from builders to realtors to brokers. Take all of these ingredients, mix them together and let it ferment for a few years. Presto … a black swan event landed in our laps. The financial mar-
continued from page 25
kets went from equilibrium to mania to panic to crash, to cite the title, Manias, Panics and Crashes, is the title of an important economics text by Charles P. Kindelberger, an economic historian and emeritus professor at MIT. Kindelberger is, in the view of many, the authority on financial crises, having studied them for nearly 50 years. There seems to me a great need for Americans to understand why this crisis occurred and to apportion culpability. Just as a commission was established to examine the causes of the Great Depression, I’d argue that we must do likewise. As the philosopher George Santayana cautioned, “Those who cannot remember the past are condemned to repeat it.” In apportioning blame, I start with the Federal Reserve because that’s where Kindelberger starts with all manias: Phase one, always easy money. To soften the pain from the popping of the tech bubble and the events of 9/11, the Fed eased monetary policy dramatically in 2002. The funds rate was cut to one percent in 2003, lower than at any time even during the Great Depression. It was held there for 13 months after a fast descent in 2002 and a slow, incremental tightening late in 2004. Fed policy essentially flooded the market with credit for five straight years and cheap
credit got borrowed. Without this single ingredient, easy money, the financial crisis could not have occurred. Unfortunately, monetary policy errors weren’t the whole of the Fed’s fatal errors. It and its fellow regulators at the Securities and Exchange Commission (SEC), Federal Deposit Insurance Corporation (FDIC), Office of Thrift Supervision (OTS), etc. also failed to police the financial markets—from the primary mortgage market through Fannie Mae and Freddie Mac, from Wall Street and its structured products to the credit raters. Congressional oversight and the regulators could have, and should have, warned of market excesses: uninsured 100 percent lending, loans paying less than accumulating interest, no income/no asset loans (NINAs), home equity loans. Similarly, a vigilant SEC should have connected the dots in the Madoff scandal a decade ago, not four months ago. But they didn’t kick the tires, not even any periodic jawboning from the Fed or other regulators. Thus, I conclude it was a government failure, not a market failure, that precipitated this crisis, and unfortunately, not the last of the government failures in this crisis. After the central bank, next up in terms of culpability is the federal government—both the legislative and executive branches and both political parties. Presidents Clinton and Bush and senators and representatives— Republicans and Democrats alike— promulgated housing and homeowner-
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ship. They cheered it along beyond reason. The Bush Administration advanced the “ownership society” and Congress led bi-partisan cheers for a 70 percent homeownership goal for the United States. They ignored huge problems at Fannie and Freddie. Sadly, the law of unintended consequences stepped in, and when home prices stopped rising and started falling, we got payback: Delinquencies and defaults. I had written to the HUD Secretary in August 2005 to warn him that his unqualified advocacy of homeownership would backfire. In part I wrote, “Government officials really need to be careful on their advocacy for housing at this point in time or they will lead young working-class families, already confronted by myriad challenges, to financial hardship.” Delinquencies and foreclosures are now running at record levels. After the Federal Reserve—which is neither federal nor holds reserves— the Congress and the federal regulators, I place Fannie Mae and Freddie Mac next up for culpability. Both GSEs were always a flawed business model, as I first suggested 12 years ago. Public choice theory, the capture theory and the law of unintended consequences told me so. Public choice theory is the branch of economics dealing with public decision-making. Captive theory involves relationships between regulated and regulator—for example, continued on page 32
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