In a nutshell, here’s what happened. Some politicians, almost all of them Democrats, decided that banks were not making enough home loans to poor people. Banks were demanding what banks have always demanded of borrowers — proof that the borrowers will have the ability to make the payments on the loan. So how to get the banks to make loans to borrowers who can’t make that showing? A judicious combination of stick and carrot. One piece of the stick involved accusations of racism, that old standby that Democrats use anytime someone is reluctant to go along with what they want. Another piece were threats of investigations by Janet Reno’s Justice Department and refusals of approval for bank mergers. The carrot became cozy relationships between regulators and the private sector banks fostered by Christopher Dodd in the Senate and Barney Frank in the House. The biggest carrot was the relationship between regulators and members of Congress and Fannie Mae and the Federal Reserve. The Fed pumped up the money supply, and Fannie Mae took over the junk paper the private sector banks were generating with sub-prime loans.
So you’re a bank and the government wants you to loan money to borrowers you know can never repay the loan. But the government says if you don’t you’ll be sorry, and besides you don’t need to worry, we have this thing called Fannie Mae that will purchase those junk loans from you and package them up into mortgage-backed securities and sell them to sucker investors.
Lots of details are left out of that, but hey I said it was a nutshell. That’s the gist of it. My nutshell explanation is contrary to the conventional wisdom which lays all of the blame on greedy Wall Street tycoons. There are greedy Wall Street tycoons, but that’s nothing new. There always have been and always will be. It must be understood, however, that like the Mafia, they cannot conduct their nefarious activities without government complicity and assistance. Just as the mere presence of organized crime in a big city tells you for sure that the local police department is corrupt, the mere happening of something like the sub-prime banking crisis tells you without the slightest doubt that there are some rotten apples in the government lending a hand in exchange for some huge payoffs from the greedy tycoons. These payoffs are not in the form of easy to trace and prove suitcases of cash; they are more likely lucrative jobs for friends and relatives, campaign contributions, and other perks that have the appearance of legitimacy making them plausibly defendable.
Now there is a book that fills in the details left out of that simple but not simplistic nutshell. Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon exposes how government regulators and members of Congress (think Democrats. Republicans and the Bush Administration were raising alarms) who were supposed to protect the country from financial harm were actually complicit in the actions that led to the economic and banking meltdown.
John Taylor, professor of economics at Stanford University and senior fellow at Stanford’s Hoover Institution, reviews the book in the Washington Post:
“In ‘Reckless Endangerment,’Gretchen Morgenson and Joshua Rosner argue that cozy connections between government and the financial industry were the primary cause of the financial crisis. In a series of clearly written narratives with many names, dates and figures, they show that government officials took actions that benefited well-connected individuals, who in turn helped the government officials. This mutual support system thwarted good economic policies and encouraged reckless ones. It thereby brought on the crisis, sending the economy into a tailspin.”
The conventional wisdom is pushed back in this book. Good thing, maybe it won’t take 75 years to correct the record as it did with the Great Depression. In that case we lived with the false notion that the New Deal saved the country from the worst of the depression and WW II finally ended it. Several decades ago the idea that the 1929 Wall Street crash caused the depression was put to rest, revealing the true cause to have been the tight money policies of the Federal Reserve, the Hoover Administration’s tax increases, the Smoot-Hawley tariff, and the collapse of foreign trade that resulted as other countries adopted retaliatory tariffs of their own. But only now are economists beginning to understand that the New Deal made the depression much worse than it would otherwise have been, in fact turned what would have been a recession into a depression. And WW II ended the depression only in the sense that it stopped the New Deal.