Playing The Blame Game

With the current financial crisis playing out on the airwaves, around the watercooler and in the halls of government this week, there seems to be general agreement that the narrowly-averted market meltdown was the fault of a few greeder Wall Street traders and CEOs.

Politicians and commentators fall over themselves to blame the so-called "fat cats" in the banking industry, while little attention is being given as to how we have got where we are.

While Wall Street certainly does bear some of the blame for the current crisis, they can certainly not be blamed for the entire mess, which owes a lot to political decisions made in Washington, state capitals and big cities.

Many politicians and commentators are, as always in these situations, also playing the popularist card and slamming the free market as the root cause of all our woes and call for more regulation.

The problem is that, as a commentator in Forbes magazine pointed out some time ago: "All this overlooks a crucial fact: There has been no free market in housing or finance. Government has long exercised massive control over the housing and financial markets--including its creation of Fannie Mae and Freddie Mac (which have now amassed $5 trillion in liabilities)--leading to many of the problems being blamed on the free market today."

The popularists blame the financial markets for the so-called sub-prime mortgage issue forget the impact of the federal Community Reinvestment on mortgage-lending behaviour.

Much of the current crisis can be directly blamed on these sub-prime mortgages, but it was not the bank's who chose to issue them to customers who they believed would have problems paying them off.

As the Forbes piece continued: "The CRA forces banks to make loans in poor communities, loans that banks may otherwise reject as financially unsound. Under the CRA, banks must convince a set of bureaucracies that they are not engaging in discrimination, a charge that the act encourages any CRA-recognized community group to bring forward. Otherwise, any merger or expansion the banks attempt will likely be denied. But what counts as discrimination?

"According to one enforcement agency, 'discrimination exists when a lender's underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants.' Note that these 'arbitrary or outdated criteria' include most of the essentials of responsible lending: income level, income verification, credit history and savings history--the very factors lenders are now being criticized for ignoring.

"The government has promoted bad loans not just through the stick of the CRA but through the carrot of Fannie Mae and Freddie Mac, which purchase, securitize and guarantee loans made by lenders and whose debt is itself implicitly guaranteed by the federal government."

It is true that mortgage brokers on Wall Street took these sub-prime mortgages and bundled them up into derivative products, and it is also true that other financial institutions then bought these products and used them as colateral for further financial transactions.

But we couldn't agree more with the article's conclusion that, "Given that our government was behind the wheel, influencing every aspect of the mortgage crisis, it is absurd to call today's situation the result of insufficient regulation."

It remains to be seen whether the buyouts and increased regulation being proposed and pushed through Congress this week will prove a long-term fix or whether it will end up, as usual for governemnt programs, as a cure that is worse than the problem.