If you want to look at the causes of the current financial crisis, look no further than to the Democrats that are now pointing the finger at the Republicans and the Bush Administration. While Bush has made his fair share of mistakes, it is tough to say that he was responsible for the current state of the financial world.
It is fairly well accepted that when you boil it down the current financial crisis has been caused by a credit crisis and losses related to credit investments. This credit crisis has its roots in two primary areas, the first was exceedingly low interest rates and willingness on the part of investors to take risk, and the second area was the bursting of the housing bubble.
The first area, low interest rates and willingness on the part of investors to take risk is the natural part of any business cycle. This really isn’t an area that the government or anybody can regulate. This cycle will always occur, to some extent or the other, and in general while causing some problems, typically the issues caused by this cycle are relatively benign and manageable.
The second area, and the area that has really exasperated the impact of this cycle has been the bursting of the housing bubble. Current estimates are that this housing bubble will end up costing hundreds of billions to trillions of dollars. This has been the primary cause of the financial crisis, it was the spark that started the contraction of credit and the gasoline that has fueled the fire that has engulfed our entire financial system. It has forced the government to take unprecedented actions in order to shore up our financial institutions and it threatened our entire way of life in the process. Any discussion about the cause of the financial crisis needs to start and end with an analysis of the housing bubble.
Let’s first address some of the rumors that have been put out by the media. Obama and the Democratic congressmen were quick to point the finger at the “failed economics” of the Republican Party, and specifically the “deregulation” that had been championed by Republicans like McCain.
The fact is the last major piece of financial deregulation was the Gramm-Leach-Bliley Act which repealed part of the Glass-Steagall act of 1933. Specifically this reform allowed commercial banks, investment banks and insurance companies to consolidate. While proposed by Republican Senator Phil Gramm, and Republican Representatives Jim Lech and Thomas Bliley Jr, it should be noted that this bill was signed into law by President Clinton. It should also be noted that none of the problems principally responsible for this particular financial crisis have been attributed to this step of deregulation.
So if it wasn’t government deregulation that wasn’t responsible for this financial crisis, should we assume that the politicians, hands are completely clean in this matter and it was really caused by the private sector run amok? In fact, the government did have a hand in this crisis. It encouraged the private sector to make risky loans to those who couldn’t afford them, provided an implicit backing to Fannie Mae and Freddie Mac which allowed them to grow to unwieldy proportions and then failed to regulate both institutions.
Fannie Mae and Freddie Mac were the major players in the housing market, touching more than half of the nations $12 trillion in mortgages. Their potential collapse was at the center of the start of the credit crisis and it was widely accepted that their balance sheets had grown to out of control proportions and that their potential for failure would have had catastrophic consequences to our financial system.
How did Fannie and Freddie get to be so large and so important to our housing market? Why did Fannie, Freddie and other banks begin to extend loans to borrowers who could not afford their loans?
Here is link to a 1999 NY Times Article that discusses the push by Bill Clinton to extend more high risk loans to low income borrowers that unfortunately couldn’t afford them:
In 2003 it was the Bush Administration and then Treasury Secretary John Snow who pushed to create a new agency within Treasury that would regulate Fannie Mae and Freddie Mac. It was blocked by Congressional Democrats who were afraid that regulation would reduce loans to low income individuals. Barney Frank wanted to keep pressure off these entities so there could be more “affordable housing”. The 2003 NY Times article can be found here:
The Republicans again tried to control Fannie/Freddie in January of 2005 with the Federal Housing and Enterprise Regulatory Reform Act of 2005, which was introduced by Charles Hagel, a Republican Senator. Senator McCain also made a major push to regulate these entities in the early part of 2006:
The key quote for McCain was the following:
“If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.”
It was clear that McCain sounded the warning in advance of the problems that then spiraled out of control. While the regulation of these two entities would have not, in and of itself, solved all the problems, it would have been a significant action that would have helped in a material way to mitigate some of the problems that occurred.
The push for these reforms was once again defeated by Congressional Democrats namely Chris Dodd. Dodd also received $133,900 in contributions from Fannie and Freddie over the past ten years.
Now to Obama’s claim that he was the one called for regulation and warned about the impending financial collapse caused by the subprime mortgage market. Obama was mainly silent on the Fannie and Freddie regulation and was cited by Washington insiders as being mostly supportive of the organizations. In terms of Obama’s warning on the subprime crisis this occurred on March 22nd 2007 well after the vast majority of the problem loans were already made and well after most of the problems were surfacing. In addition the letter focused mainly on the community impacts as opposed to the risks posed to the overall economy. The letter can be found at: