Tuesday, September 30, 2008

A Thumbnail Sketch of the Current Financial Crisis: Who is Responsible for It?

Beginning in the mid-1990's, the CRA and ACORN caused banks to make bad mortgages. The risk of these was too great to bear alone, so they were bundled together in large bundles called mortgage-backed securities (MBSs) along with sound mortgages, a technique pioneered by the Democrats' Fannie and Freddy (FMs). The risk was still too great, so these were insured by Credit Default Swap (CDS) insurance-like instruments. Banks started making tons of mortgages to fill up the MBSs, lining their pockets with the fees. They could easily pass mortgages along to the FMs, who were eager to receive them. Fannie and Freddy were lapping up the mortgages as they were required by the CRA to do and cooking their books to make the mess look possible and to line the pockets of their executives, under the protection of Congressional Democrats.

Bush, McCain, Greenspan, and House GOP repeatedly tried rein in the FMs. Democrats blocked the attempts. The FM execs got golden parachutes out of their sleaze.

The Bush administration failed to regulate the CDS market which would go on to trigger the bomb set by the system. AIG put a fuse in the CRA/FM bomb and lit it by concentrating the risk exposure in itself in the form of CDSs. The new Sarbanes-Oxley regulations forced the MBSs to be evaluated at market: which when values dropped was a few points lower than bought, thanks to the deflating housing bubble. CDS claims were triggered in order to cover the losses on bank balance sheets when their MBS values dropped a few points, causing a ratings change. The result was a "run on the bank" at AIG. Ka-blam! Credit crunch, looming depression.

Bush admin should have done something about what AIG was doing with CDSs: putting a fuse in the CRA/FM/MBS bomb and lighting it. The Democrats manufactured the bomb and blocked the GOP's repeated efforts to disarm it. Investors and bankers were too zealous in creating too many bad mortgages in order to make big bucks fulfilling the FM's lust for big MBSs; in any event they were forced to do this by the CRA. There is blame to go around on Wall Street and in the White House, but this is primarily a Democrat-caused disaster.

In short: The disaster was caused primarily by over-regulation of the market, in the form of the Democratic institutions: CRA, ACORN, Fannie, and Freddy, which forced banks to make bad loans and encouraged them to make more bad loans by offering to buy the bad loans from them. The GOP and Greenspan tried to revise these regulations in order to prevent the present disaster. Democrats blocked the GOP efforts. The disaster was also caused by under-regulation of the market, as the GOP failed to regulate the exacerbation of the Democrat-caused problem in the CDS market. The disaster was also caused by over-zealousness amongst lenders who, if they were sagely, would have refrained from making as many of the mortgages that their government's system was both encouraging and requiring them to make. Ka-blam!

Please correct this account in the comments. Thank you.

UPDATE: This post has just been edited for content (12:42 pm Sept 30). Special thanks to Charlie Martin for his comments. UPDATE: Thanks also to comments from Rick Ballard.