The Poverty of Mainstream Debate, Part II: ‘The Government Caused the Crisis’

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


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  1. #1 by Blue Aurora on March 10, 2012 - 12:28 am

    Did you see Dr. Michael Emmett Brady’s review of Duncan K. Foley’s book? It’s an inaccurately titled book…

    • #2 by Unlearningecon on March 10, 2012 - 2:38 pm

      Yeah that’s true – I did note that in my first post that included the term.

  2. #3 by JMRJ on March 10, 2012 - 2:33 am

    Perhaps you overstate your case just to bring some balance to the discussion, but I can’t believe you really mean to absolve the government entirely while – necessarily, I suppose – placing 100% of the blame on the “private sector”. As I’m sure you’re aware, the cleavage you imply is not nearly so distinct as that, particularly in the area of money, banking and lending, which I think everyone can agree is at the center of the “crisis”.

    I’ll certainly agree that the CRA is a rather mean-spirited red herring.

    The matter is both simple and complex, but simple mostly. The process of money creation, freed from all natural constraint must nevertheless be constrained somehow, so it’s constrained by the “power” to make loans. This power becomes, over time, the central economic and political reality, displacing everything else, including all genuine productive activity, social and business relations, and even including government itself. It’s a power that is, of course, hollow at its core. It is Tolkein’s ring.

    Once this power has attained what looks like near hegemony, everything begins to collapse into it, because there is nothing there. It’s like a black hole, destroying everything by its very existence, which is more like an anti-existence.

    No human being now living is really identifiably at fault for this state of affairs. Perhaps no human being living at any time is.

    The irony, to me, is that it’s relatively easy at the height of the illusory power – that is, at a moment like the present – to stop the anti-matter like destruction through the simple act of renouncing what fuels it (debt, a word that shares some etymology with death, I believe), but at the same time it seems to almost everyone that this relatively easy solution is impossible. And they continue to believe this even though it is glaringly obvious that the vast bulk of the “debt” the system has built up will never be paid anyway, meaning that the alternative – exacting payment – is what is truly impossible, whereas what is perceived as impossible is not only possible but actually rather easy by comparison.

    Except in this one sense: you have to think differently, and change accordingly. It appears this is the absolute most difficult thing for people to do, so difficult they will inflict massive damage and suffering on others and even undergo it themselves rather than suffer the horrifying fate of rethinking, and changing accordingly.

    Maybe we don’t need economists for this, or lawyers either. Maybe what we really need is an exorcist. A good one.

    • #4 by Unlearningecon on March 10, 2012 - 2:47 pm

      Yeah you’re right that the political goal of homeownership is partly to blame and is a pretty poor goal in and of itself.

      Other than that, good post. Although a jubilee would erase a large amount of bank assets.

      • #5 by JMRJ on March 10, 2012 - 3:26 pm

        A jubilee would erase a large amount of bank assets, true enough. It would also erase bank liabilities. Banks would all be solvent. So would everyone else.

        And I wouldn’t say that the political goal of homeownership is a poor goal. People should have a place to live that they own. The real question is whether “ownership” includes heavily encumbered title, which is much more like glorified renting than ownership. It may be that we suffer not so much from too much
        in property rights, but too little.

        The law in the US provides that the right to property is as fundamental as the right to life and liberty, yet as a practical matter property can lawfully be made subject to the terms of a loan contract. The right to own includes the right to “alienate”, but in a mortgage situation this is not a transfer of the use and enjoyment of property but rather a contractual right to dispossess, which defeats the ownership interest.

        Perhaps it is worthwhile to question whether this elevation of contractual rights over property rights is a good idea, more than questioning whether homeownership itself is. Especially when what we call homeownership isn’t really homeownership at all.

      • #6 by Unlearningecon on March 10, 2012 - 4:11 pm

        Fair point about home ‘ownership’ – but I wouldn’t be adversed to widespread renting provided a Land Value Tax was used to ensure the majority of the rent money went into the public purse.

      • #7 by JMRJ on March 10, 2012 - 4:46 pm

        Tax. Interest on a loan. What’s the difference, when banks have been largely nationalized? Or maybe I should say half nationalized: losses, not profits. Go the rest of the way and you don’t need a tax, the rent money (i.e., interest) all goes to the government anyway.

        I have to disagree that widespread renting is just fine and dandy, though. It requires significant income, which in turn requires significant employment. People should be employed and have an income, of course, but there is no “right” to income or employment and never has been. There is a right to property, but that would be an inchoate right at best for someone who doesn’t even own the roof over his head.

        Widespread renting of places to live, in other words, makes our stated devotion to property rights into a lot of double talk. Become unemployed and you’re soon homeless – “property-less”. The desire for employment acquires an element of desperation and coercion at its root, undermining the social tranquility that a regime of natural rights, including property rights, is supposed to foster.

        Not to mention that desperation is its own kind of moral hazard. Desperate men are not inclined to refined moral sensibility, to put it mildly. And that, too, is part of the “crisis” picture, macro and micro.

  3. #8 by Min on March 10, 2012 - 6:16 pm

    As for gov’t causing the crisis, I am surprised that you did not mention deregulation starting with Reagan, continued deregulation despite the S&L crisis, failure to regulate derivatives, failure to investigate and crack down on rampant fraud, and the failure to take away the punchbowl in the ’00s.

    • #9 by Unlearningecon on March 10, 2012 - 6:52 pm

      I think you misinterpret the idea of the government causing the crisis. Adherents of this view are saying that the government caused it actively, not passively.

      • #10 by Unlearningecon on March 10, 2012 - 7:03 pm

        Right but the fact that banks are too big to fail is a fault of capitalism rather than the government.

      • #11 by Min on March 10, 2012 - 11:44 pm

        I was purposely saying what those who claim that the gov’t caused the crisis would not say. 😉 They are against gov’t, and therefore against regulation.

      • #12 by Unlearningecon on March 12, 2012 - 8:17 am

        Well it was a very broad statement. Ultimately, capitalism is a creation of the state anyway so it’s not a distinction particularly worth exploring. However, my point was that, if you look at it from a marxist perspective, as capitalism developed and grew it would have found ways to grow ‘Too Big To Fail’ no matter what.

    • #13 by Min on March 10, 2012 - 6:57 pm

      And let’s not forget the gov’ts adoption of the Too Big to Fail doctrine in 1984(!), which encouraged Big Finance to take on too much risk.

      • #14 by Min on March 10, 2012 - 11:49 pm

        The Too Big to Fail doctrine, adopted by the Reagan administration, is just another example of the privatization of profit and socialization of cost and risk. That is the modus operandi of modern capitalism, in which gov’t plays a big role.

      • #15 by Unlearningecon on March 11, 2012 - 12:02 am

        But TBTF is a direct result of overly large financial institutions, rather than the thing that created them, no?

      • #16 by Min on March 11, 2012 - 2:38 am

        In the aftermath of the Continental Illinois crisis the gov’t explicitly stated that it would not allow the biggest banks to fail. Do you seriously think that the 1984 guarantee had nothing to do with the crisis of 2008?

      • #17 by Unlearningecon on March 11, 2012 - 12:27 pm

        Well it’s impossible to verify but I don’t necessarily think it was a necessary condition. I doubt there would have been no crises at all in the absence of the announcement – history shows that they happen anyway.

        Furthermore, even if the banks did know they were guaranteed, that doesn’t excuse them personally from widespread rent seeking, predatory lending and fraud.

  4. #18 by Aston Lockheed on March 10, 2012 - 8:06 pm

    I’m not wrong? Nothing was really done in the re-regulation front the recent years? The world is still on the same brink of collapse than the early days of 2007…

  5. #20 by John77 on March 11, 2012 - 7:41 pm

    Ah, but which crisis are you talking about? Over here the after-effects of loan defaults by Americans who were gambling on a continued rise in house prices and taking out loans that they could not repay is rather less of a problem than that created by governments who spent money that they didn’t have. Clinton, Greenspan etc contributed to the former but of course the private sector was more to blame. In the latter case, I fail to see how you can argue that anyone other than governments caused the crisis

    • #21 by Unlearningecon on March 11, 2012 - 11:54 pm

      Of course, the latter is not a real crisis but one created as a bait and switch by the ruling elite who saw their power threatened by the indisputable collapse of their ideology.

      To the extent that there are fiscal problems, they are a direct result of the former crisis, except maybe in Greece.

      • #22 by John77 on March 12, 2012 - 9:35 am

        The UK & other government budget deficits preceded “the banking crisis”, so cannot be a result of it. Every left-wing government in Europe ran budget deficits, some just bad but some truly awful. The latest “banking crisis” is, in fact, wholly manufactured by governments whose regulators said banks needed no capital backing for loans to “first-world” governments but did for loans to, for instance, Shell and are now forcing investors to take losses on loans to government and state-owned banks.
        “The indisputable collapse of their ideology” occurred in 1961 when the Berlin Wall was built, not in 1989 when it was pulled down.

      • #23 by Unlearningecon on March 12, 2012 - 10:19 am

        Of course:

        a) Governments are nothing like households and so running deficits isn’t automatically catastrophic

        b) The deficits weren’t big at all, and the majority of the increase in debt was due to the crisis:

        c) The bond markets are not, have never been and are not going to panic any time soon, indicating that there is no problem.

        Again: nothing to see here, just a bait and switch created by people who saw their conservative ideology fail and have to double down and go harder.

        As for that explanation of the crisis, well, it’s certainly new. To be honest it’s so uninformed that I can’t even be bothered to respond to it. Maybe Moira will humour you on your understanding of the loan system.

      • #24 by John77 on March 12, 2012 - 10:52 am

        Your argument goes beyond the “post hoc ergo propter hoc” fallacy to “pre hoc ergo propter hoc”
        How *you* can call *me* uninformed beggars belief.

      • #25 by Unlearningecon on March 12, 2012 - 10:57 am

        You’re right. There is no causal chain between a financial crisis and a fiscal deficit. How silly of me. It must have been something else that caused the massive decline in tax revenue and increase in spending. Something other than mass unemployment created by financial implosion.

      • #26 by John77 on March 12, 2012 - 11:02 am

        Are you a time traveller? Or just confused?

      • #27 by Unlearningecon on March 12, 2012 - 11:06 am

        Do you have any substantive response to my comments?

        Are you aware that, in every other comment on every other post, as well as this one, that you have it clear that you do not understand basic logic?

      • #28 by John77 on March 12, 2012 - 11:52 am

        You say “The deficits weren’t big at all, and the majority of the increase in debt was due to the crisis:” You produce graph drawn by *someone* with no access to underlying data to enable anyone to check its accuracy.
        Alastair Darling said the structural deficit was 9.8% of GDP and the cyclical part was 2.5%.
        The true structural deficit was a lot bigger because he was ignoring the cost (apart from pure cash flow) of unfunded public sector pensions and the increase in the deficit in the funded public sector schemes. Including the true cost of public sector pensions, the structural deficit under Labour was nearer 20% (the exact number depends on pension valuation assumptions) and the public sector debt is more than £1 trillion above the published figure.
        What do *you* call big? A quadrillion?
        You say “The bond markets are not, have never been and are not going to panic any time soon, indicating that there is no problem.” Firstly, that is an utter non sequitur – you might as well say that LTCM investing in Russian government debt meant there was no problem with Russian government debt – secondly, before the Eurozone governments decided on a rescue plan the yields on Spanish and Italian government debts reached a level that meant that interest costs would result in debt comprising an ever-increasing percentage of GDP if the two countries ran balanced budgets for a generation.
        The governments that got in a mess were not conservative so it cannot be due to a failure of conservative ideology.

      • #29 by Unlearningecon on March 12, 2012 - 12:08 pm

        John, this is my last comment on this topic in this thread, because we are completely OT. As I anticipated, you have used a bait and switch tactic to distract from the 2008 failure of conservative ideology.

        Alasdair Darling says a lot of things, but the problem is that that structural deficit is a meaningless concept and it is vacuous to target it from the offset. No surprises the Coalition aren’t doing too well.

        And pension are just more bait and switch scaremongering from the right – expenditure is due to peak next fiscal year:

        Another non starter.

        And I don’t care how big the number is on its own, the context is what matters.

        The fact that you think bond markets are a useless indicator of fiscal solvency bewilders me, but LTCM were one company, whereas the current UK bond market is populated by many individuals. And I’m not talking about Spain and Italy, whose tie to the Euro puts them in a straightjacket.

        Yes, I too judge governments by the name of their party and not their actions. Obama is a socialist!

        EDIT: As for source, they are all at the bottom of this post:

        The rough outlines of those figures are widely known and publicised. But of course, if anyone presents evidence that contradicts your ideology, they simply must be lying, right?

      • #30 by John77 on March 12, 2012 - 1:02 pm

        “I too judge governments by the name of their party and not their actions”
        You may – I don’t.
        That the cyclical surplus in 2005-7 concealed the extent of the structural deficit is also well known and publicised: the figures quoted by the anonymous Extranea have been massively revised since then following the realisation that £20+bn was not a normal level of tax receipts from bank profits and staff bonuses. She does have to be lying – merely incompetent.

      • #31 by Unlearningecon on March 12, 2012 - 1:08 pm

        I’ll bite.

        OK so you didn’t understand that government comment.

        Again, structural deficit: meaningless, impossible to work out, functionally irrelevant. Figures have not been revised, they’re the same as they always were. And there is simply no fiscal crisis. If there were, the bond markets would be panicking. If the bond markets panicked, the BoE would step in and buy bonds.

        All the evidence is against you.

      • #32 by John77 on March 12, 2012 - 3:06 pm

        I have no intention of wasting an hour or three dealing with every single comment.
        I shall limit myself to two points
        i) I am not posting here to defend the banks – I am on record, long before the BBC’s Robert Peston triggered a bank run, as pointing out that Northern Rock had made a mess of its unsecured lending and the management was lying to shareholders.
        ii) My ideology in this case is limited to the belief that “Dr Who” is fiction and so is the thiotolomine effect: that time is linear.

  6. #33 by John77 on March 12, 2012 - 1:03 pm

    Typo alert
    That should be: She does *not* have to be lying – merely incompetent.

    • #34 by John77 on March 12, 2012 - 3:21 pm

      It might be useful for you to actually *read* what I wrote instead of ranting about US banks when I am referring to the intolerable level of debts and future commitments taken on by European governments. I have not defended the banks – who on earth would want to defend Goldman Sachs?

  7. #35 by Unlearningecon on March 12, 2012 - 4:30 pm

    I didn’t say conservatives were against charity…?

    My point is that conservative ideology tends to benefit the powerful- conservatives are more likely to defend the banks. Of course, Democrats are conservative too, though many don’t realise this or simply have no choice.

  8. #36 by Unlearningecon on March 12, 2012 - 7:21 pm

    John, you do not understand economic casual chains or economics in general. You’re just repeating a set of thoroughly debunked RW talking points and trying to distract from the real issue, which is the failure of ‘free market’ ideology in 2007/8.

    I was unaware that Robert Peston caused the NR bank run, I’m sure he’ll be upset to learn that.

    • #37 by John77 on March 12, 2012 - 8:24 pm

      You are clearly unaware of a lot of things. Including the fact that Doctor Who is fiction. You and your friend moira persist in blaming government overspending in the first half and middle of the last decade on the “banking crisis” in the last third of it. You seem to have no idea of the distortions to the UK (and, to a lesser extent, European) bond market caused by insurance and pension fund regulators as well as bank regulators, (have you even noticed the BoE “Quantitative Easing”? – the Bank of England *has* stepped in and bought hundreds of £millions of bonds and indicated that it will do more thereby creating Mervyn King’s equivalent of the “Greenspan put” so buyers of gilt-edged feel there is negligible risk). Pension funds are threatened with higher levies from the Pension Protection Fund if they invest in equities and property (the natural hedge for their liabilities) instead of gilts and AAA commercial bonds and there aren’t enough AAA commercial bonds to fill the PF portfolios because most companies who merit that rating don’t need to borrow much, if at all; insurance companies are required to invest enough to match their liabilities in cash, gilts or AAA- and AA-bonds – the regulator ignores any equity investments when judging capital adequacy. When were the rules on Individual Capital Adequacy or the PPF risk profiling debunked? ICA is being replaced by Solvency II but the actual capital requirements come out much the same.
      May I recommend that you try reading the most left-wing of the “Quality” newspapers :
      It points out that Robert Peston was not responsible for the management failings at Northern Rock, but his scare story did precipitate a “run”.
      The crisis in the UK is not a banking crisis – although some banks had problems, the only one that was actually needed to be bailed out because its assets were less than customer deposits was a Building Society (mutual) in Gordon Brown’s constituency – the others had lost some or all of their shareholders’ money (in one or two cases some of their bondholders’ money as well) but not depositors’ cash. Northern Rock had net assets of more than £1.5bn when nationalised without compensation. The crisis is that the government is unable to raise enough taxation to pay its bills on a medium-term basis – capital levies are not generally repeatable – and private sector workers are objecting to subsidising people who are better off than they are
      Incidentally, (i) there are a *lot* of people who are convinced that replacing the Bank of England as banking regulator by the FSA was a major contributory factor in the so-called “banking crisis” in the UK; (ii) a free market ideology would have let Bear Sterns go bust (I should have).

      • #38 by Unlearningecon on March 12, 2012 - 8:32 pm

        Of course, none of what you said has anything to with the subprime meltdown and QE was after it.

        You truly do have no idea what you’re talking about. You cite ‘a lot’ of people with no qualification:

        And yes, lax regulation did contribute to the crisis, I agree.

        There’s no such thing as a free market, btw, and letting all the banks go bust just would have imploded the financial system.

        Anyway, you’ll never change your opinion on this so its futile. No facts, reasoning or events could make you change your mind. This is evidenced from the fact that, although we are finally talking about the real crisis, you haven’t responded to any of my points in the original post.

  1. “Whichever you paint it, it’s simply not credible to blame the government on a crisis that was clearly created by the private sector.” « - Invisible Backhand -
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