The Grad Voice

Blame Game

Whose Fault is the State of the Economy?

Insong Yun

Issue date: 11/1/08 Section: Financial Crisis

Page 1 of 1

Honorable Mention - You:

Americans make up 5% of the world's population but use more than 20% of its energy.
Even with record exports, we're running record trade deficits because we import more than 60% of our oil.

We love blaming speculators for high energy prices. However, Economics 101 teaches us that prices are up because we demand too much.

10. Clinton Administration/Republican Congress:

Repealed the Glass-Steagall Act and allowed commercial banks to invest in mortgage backed securities.
Passed the Fannie Act, letting Government Sponsored Entities (GSE's) take on mortgages from low credit borrowers.

9. Investment Firms - Tech Bubble:

Inflated the tech bubble and caused conditions that would lead to the current housing/credit crisis (see Alan Greenspan below).

8. Fannie Mae/Freddie Mac:

GSE's whose losses were guaranteed by the government, but were allowed to keep all profits. With no incentive for prudent behavior, it's a wonder they didn't implode sooner.

Americans insipidly view renting as a curse and owning a picketed house as a natural right, as if home ownership were espoused by Hobbes and Locke. The federal government has carried this sentiment for decades through tax laws and the use of GSE's. House-lust is now coming back to bite us.

7. Securities Exchange Commission:

Bullied auditors after Enron/Arthur Anderson into using the most "conservative" mark-to-market valuations. Marking-to-market usually works well, but without reliable market pricing, it feeds panic by forcing banks were to report earnings and assets that are much lower than what reason warrants.
In 2004, allowed firms to hold 3 cents on each dollar of Credit Default Swaps (CDS - a derivative type of insurance on mortgage backed assets). At 33x leverage, firms only need to lose pennies on the dollar to be totally wiped out. The CDS market eventually ballooned to $44 trillion.

6. Ratings Agencies - Moody's/Standard & Poor's:

Absurdly gave AAA ratings to securities they knew no one on Earth understood, giving false confidence to a house of cards.
Engaged in a spiraling race to the bottom, trying to outdo each other in giving high ratings to progressively lower quality debt in a battle for market share.

Moody's and S&P are somehow pulling off a Houdini act, escaping most of the public attention, while arguably having been the most deception companies involved. In an echo of Arthur Anderson, these agencies told lies in exchange for fees that they would've received for a job done honestly.

5. Insurance Entities:

AIG, MBIA, and other financial firms became counter parties in the $44 trillion market in CDS's. $44 trillion is roughly 3-4 times annual US GDP, or about double the value of the entire US stock market. Suffice it to say, these companies do not have that money on hand.
In some instances, tiny hedge funds with millions in assets took on billions of dollars worth of CDS risk.

4. You (Again):

Everybody who bought homes they couldn't afford, tried to flip a house, can't get out of credit card debt, or otherwise spent more than their fair share of credit is to blame.

The corporate deleveraging that we are about to endure will be worse than a medieval blood-letting. It would've been nice if the consumer weren't deleveraging at the same time.

3. Investment Firms (Again) - Housing/Credit Bubble:

Fueled lenders' bad debt writing, encouraged agencies bad ratings, and relied on bad insurance in an attempt to make money that they should've known was too easy.
The smartest people in the world made business decisions out of primal emotion, as they whipsawed the global economy up and down depending on whether the feeling du jour is greed or fear. A few years ago, they were lauded for "financial innovation." In financial terms, "innovation" just means borrowing way too much.

2. Lenders:

Made loans to those who could not afford them based on the notion that housing prices will go up until the end of time itself, and then sold off these loans to raise funds to make more soon-to-fail loans.
Lenders are now scared out of their wits and have doomed the credit markets by ceasing to lend to those even with the best credit.

1. Alan Greenspan, Chairman of the Federal Reserve 1987 - 2006:

It is argued that he over-tightened interest rates and made the 2001-2002 tech bubble recession worse than it should have been.
He then panicked and lowered interest rates during the recession to below zero in real terms. Because of negative real interest rates, banks were awash in liquidity and had nothing better to do with their cash than to lend it out to non-credit worthy borrowers.
Extolled the virtues of adjustable rate mortgages (ARMs), opening the housing market to individuals who did not have the credit to legitimately be there.
Instrumental in repealing Glass-Steagall and passing the Fannie Act.
Deflected attempts by the Clinton administration to increase oversight of unregulated derivatives after the Long Term Capital Management blowout in 1998. In essence, Greenspan accidentally blew the bubble and provided the needle that popped the bubble. One would be hard pressed to devise a plan that would intentionally inflict this much economic damage.

Page 1 of 1