It’s difficult for me to believe that people have internalised the ‘the government caused the crisis’ arguments, but sadly this is a view that many still cling to – with a healthy dose of wishful thinking, and often an unhealthy dose of concern trolling. I would ask the same people to list five examples they can think of where private enterprise failed significantly – if they can’t, it says a lot about their bias.
Let me note that for the purposes of this post, I am putting considerations over Central Banking failures to one side.
In essence, debates over whether the government ’caused’ the crisis are basically nonsensical and are mired in both Adam’s Fallacy and governments versus markets framing. Even if the government encouraged/incentivised homeownership and loans to the poor, the fact that banks exploited this by committing massive fraud is not the government’s fault. If you think it is, then we should logically blame limited liability laws for the crisis, since that was an example of the government ‘intervening’ to protect enterprise from predatory lending and encouraging start ups, and had the ‘unintended consequence’ of creating too much systemic risk.
However, even if we accept the framing, the facts simply don’t add up:
- For every $4 of bad loans, only $1 was issued by an institution covered by the CRA. Whether or not these loans themselves were a result of the CRA is debatable, as the penalty for not complying with it appeared to me little more than a slap on the wrist. An estimate by Fed economists for the amount of bad loans due to the CRA was about 6%. In fact, the case for the CRA causing the crisis is so weak that Barry Ritholtz has challenged anyone who thinks so to a debate, where the loser pays $100,000 to the winner.
- Fannie and Freddie are often painted as drivers of low income housing, but it’s quite clear that they follow the market and pick up the slack when private institutions experience trouble:
if you go further back, the only reason they had a large market share in the early 200s was from mopping up the S & L mess:
They did fail due to bad management, and they pushed standards as low as they feasibly could within their remit. But despite this, they were not at all involved in the worst of subprime.
- Regulations like Basel II and deposit guarantees are a last resort for government blamers, but the fact is that a single, completely unregulated hedge fund, Magnetar, accounted for between 45-60% of demand for subprime loans by pushing CDOs. The main source of funding during the run up to the crisis was also the repo market – again, completely unregulated. Neither Magnetar or the repo market had anything to do with Basel or deposit insurance.
Furthermore, countries like the UK, Iceland and Ireland, despite having no GSEs or CRA, experienced similarly severe crises, whilst those such as Germany and Sweden, with tighter regulation, did not. And even if it hadn’t been housing it simply would have been something else – banks have a history of creating crises out of whatever they can get their hands on, and the only common theme throughout them is a lack of regulation.
Whichever you paint it, it’s simply not credible to blame the government on a crisis that was clearly created by the private sector.
My main sources here are Michael W. Hudson’s The Monster: How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America – and Spawned a Global Crisis and Yves Smith’s ECONNED