It was September 15, 2008 that the financial services firm Lehman Brothers
collapsed and the Federal Reserve Board, Ben Bernanke, proprietor, decided not to bail it out.
Then followed the worst financial crash in the United States of America since the Great Crash of 1929. Look: crashes and panics are part of capitalism, in the same way that invasions and famines are part of agriculture. Oh, and slavery. I'd says that panics and crashes and the subsequent recessions are the better option. But I am biased.
So who was to blame? Greedy bankers? Evil Wall Street firms? Derivatives brokers? Regulators asleep at the switch? Smarmy politicians? Or all of the above?
The following is my individual, idiosyncratic analysis. Your mileage may vary.
The first thing to understand is the message of Walter Bagehot's
Lombard Street. La Wik's page
here. Bagehot wrote the book after the Panic of 1866 following the failure of Overton, Gurney, and Company, "a wholesale discount bank located at 65 Lombard Street, London". During the crisis the Bank of England was unable to stop the panic with loans from its own resources, so it had to be backed up by the UK government.
For me, the message of Bagehot's book is his analysis of the credit system, that is, borrowings in money-denominated securities. The fact is that the credit system is a maze of borrowings to and fro, so when a question arises about the "soundness" of a financial firm -- such as Lehman or Overton -- the people buying and selling in the credit markets start to wonder. They ask themselves how deep their own counterparties were invested in the debt securities of the failed firm. And they get cautious; they wonder if they will get paid. Hello credit crisis.
So Bagehot decreed that two things are necessary for a healthy financial system. First, securities must be properly collateralized so that they can be liquidated without loss to the lender. Second, borrowers must be able to service the loan. If either of these are in question, you gotta panic.
In the boom of the 2000s there were lots of insufficiently collateralized loans which couldn't be fully liquidated if the borrower defaulted, and there were lots of borrowers that really couldn't service their loans. So when the housing market peaked in 2006 there were a lot of insufficiently collateralized mortgages around. Not good.
But why were there all those bad mortgages and "liar loans" to people with bad credit? Greedy bankers? Not exactly. Regulators asleep at the switch? Come on! When do regulators ever do their job?
The second thing to understand about the crash is that it had been federal government policy ever since the Great Depression to subsidize the housing market, to help Americans become homeowners.
One of the policies to help this out was the 30-year fixed mortgage. Hello sanity? You mean to say that you can forecast the economy and the housing market out 30 years and still have a solid security? Before the Great Depression the most you could get was a 10-year mortgage with a balloon payment at the end which meant that you would have to refinance at the then going interest rate.
Plus the government in 1938 started up the
Federal National Mortgage Association, a government-sponsored enterprise that issued bonds based on baskets of mortgages. No problem, right, particularly if Fannie Mae bought good solid well-collateralized mortgages? Well, it all started out pretty nice, but then things got a bit out of hand, as this chart from
usgovernmentspending.com of Agency Debt, mostly Fannie Mae and Freddie Mac, shows.
Golly. Who knew! Agency Debt went from nothing to 10 percent of GDP in 1980, then all the way to 55 percent of GDP when the crash came in 2008. Now remember, the federal debt is about 100 percent of GDP. So here we have an additional 50 percent of GDP effectively guaranteed by the federal government. What could go wrong?
And as the years went by the quality of Agency debt went down, as various federal mandates required banks to extend mortgages to less-qualified borrowers (to fight evil
red-lining). And then Fannie Mae and Freddie Mac started goals of increasing their mortgage purchases of less-qualified borrowers and less collateralized mortgages. Then the derivatives guys got into the action, by using derivatives to lay off the risk on the quality of mortgage packages and provide triple-A securities required by insurance companies and pension funds. What could go wrong?
Thirdly, little Ben Bernanke, Chairman of the Federal Reserve System, failed to follow the dictum of Walter Bagehot that there should be a "lender of last resort" during a financial crisis. Bagehot's idea was that the Bank of England should "Lend freely. At a high rate of interest. On good banking securities." But even then, the Bank of England didn't have enough equity to do the job, so it relied on the credit of the UK Treasury. In our day, I would say that lender of last resort means you don't let any financial institution collapse. Period. Oh, you strip the owners and stockholders of their equity. You make a clean sweep of mansions in the Hamptons. You even make the bondholders take a haircut. But that is after the panic is over. And you use the full faith and credit of the United States government to keep the credit system going. See, in the Crash of 2008, interest rates on US Treasuries went down. People wanted US Treasury securities. They didn't think that the US government was going down. But little Ben Bernanke decided he didn't have the legal authority to take over Lehman Brothers with all those low-rate Treasury bills.
Well, little Ben. Given what we now know about how the Deep State takes care of its own, I think that a bit of courage by you would have gone a long way to moderate the Crash and the Great Recession. Think how cool Obama, the first black president, would have looked as the economy surged in the 2010s! Think how many Latino homeowners wouldn't have been wiped out!
But you choked, Ben. Just like a true Swamp Creature.
OK. But what do we do now?
I think that the basic problem is that governments are used to betting the whole country -- with the National Debt -- on their projects. And why not? If Zimbabwe or Venezuela goes down, the ruler himself doesn't suffer. Not so long as there are Swiss bank accounts.
Let me make this clear. When the ruling class bets the country with debt, or when the ruling class forces college students to bet their futures with college debt, the ruling class usually doesn't suffer if the bet doesn't pan out. But when ordinary people get over their heads with debt then they certainly do suffer.
The fact is that debt is always a big bet on the future. It bets the borrower's future income on a nice house now, and if the borrower fails and the loan can't be fully liquidated then it is the lender that takes the fall. And the borrower is wiped out. But the point of debt financing is that it is supposed to be low risk. Sorry, Charlie. In my book 80 percent 30-year mortgages are not low risk. Not for the borrower; not for the lender. That's why we have all the federal guarantees and subsidies: to paper over the real risks.
We have securities for high risk propositions: they are called stocks, equities. They are really cool.
The problem is that the way that governments finance their wars is by betting the whole country on winning the war by flooding the economy with its debt securities and its paper money. Strictly speaking, wars should be financed with equity. But they are not. Because governments can afford to break the rules, particularly when the whole country is at stake. And maybe that is as it should be.
But should the government bet the country on "affordable housing?" Or on grandpa's Social Security pension? Or grandma's Medicare health care? Or Suzie Snowflake's college education? I don't think so. And the reason is that government just cannot bear to pull the punchbowl away in the middle of the party; they just do not have a clue when it is time to adjust things and maybe pull back a bit. And anyway, politicians and bureaucrats and regulators don't have a clue. You might say that someone
should have known in the 2000s that something was out of kilter with housing. No doubt. So who does the "someone" button-hole? President George W. Bush? But he was executing on a cunning plan to get Latino votes with affordable housing. Liberals that care about the poor and marginalized? But they are clueless about anything except the latest liberal political scam.
Yeah. My solution to housing crises and crashes and so on is to get the government out of it, and that the government only borrow for wars. But I do demand that the little Ben Bernanke of the next panic do his job and act as lender of last resort, and get with the program.
In the Crash of 2008 you may have heard about the $700 billion bailout. But did you know about the $16 trillion guarantee of money-market mutual funds?
Check it out. Do you think that the feds could have managed the whole thing with a federal guarantee instead of the $700 billion TARP game? Who knows.
The main thing to understand about governments and ruling classes and Deep States and Swamps is that they are idiots. They really do not have a clue what they are doing. So the less money they get their hands on the better.
So why doesn't the rest of America agree with me? Are they dumb or something, or am I.