|Big Fraud Theory
There are a few books or movies like "The Big Short", Liar's Poker, or William Black who float this Big-Fraud theory (BFT), It is loved by Hollywood, the Media, Progressives (Elizabeth Warren, Bernie Sanders), and those who know better but want to distract and enrage the gullible. It's becoming the most widely spread theory because simply hate and ignorance spread faster than information, complexity, and introspection. It is really just a variant of GST and "Too Little Government".
The idea is:
- Massive greed encouraged massive over-leverage, and while everyone (or a few) knew better, they did it because they were dumb, greedy and corrupt.
- They screwed the public knowing that the entire system would collapse, but as long as they were making money and bonus's, they didn't care.
- Greed and over-leveraging caused everything.
The problem is no one credible has really offered this as a "theory", because it's not economics, it's politics. And it doesn't explain anything, if you think it through.
NOTE: No one doubts there were a few unsavory actors, or that Countrywide wasn't and aggressively selling LIAR/NINJA loans (preying on consumers that couldn't afford to pay them back). They were doing exactly what Fannie/Freddie and the CRA had demanded, and paid them for (by buying all those loans up, and putting them into MBS's in the first place). But these characters weren't the fundamental cause of the crash (all markets cycle), or the credit crunch caused by over-regulation, and it has nothing to do with Glass-Steagall which couldn't have done anything to stop it. So yes, there were over-aggressive players, taking advantage of the Democrat created credit traps -- and they slightly magnified the problem. But had they not existed, the same exact thing would have happened. And those that try to pin THE blame on these guys, are ignorant or dishonest. These were bad actors, but it's like blaming a pickpocket in the back of the plane for 9/11.
The reality is:
- If Fannie/Freddie weren't buying these loans, it wouldn't have been possible: so it's still a failure of Government Sponsored Entity and thus government.
- The leverage was lower in the 2007 than it was in 1998 -- so their increase in leverage was not the trigger (or it would have gone off in 1998).
- Leverage doesn't cause crashes or markets seizing up -- it can only magnify it (or mitigate / hedge against it, if leverage was being used as a hedge). Whether you have 10% or 20% equity in your home, or if you owe $5K or $20K on your credit card doesn't change whether you're going bankrupt or not. The underlying problem is one of cashflow: money in versus money you have to put out.
- Either Fraud was the cause, and there was no underlying value to the assets being written against, and the market couldn't recover something that didn't exist (the correction would have to have been permanent). Or fraud was a very minor part of the issue, and once the bigger issues were worked out, the market/housing would rebound (as happened). Pick one. The facts that the markets recovered so quickly (a few years), shows that most assets did have underlying value, and it wasn't just smoke-and-mirrors (all leverage), and the Big Fraud Theory is flim-flam.
- This theory doesn't explain is why the credit markets seized. Why do people stop loaning, and why did TARP fix it if it was fraud? So it's saying that fraud helped with the bubble, slightly - but everything else in CRAFFT theory was still at play. So it's not an explanation of anything, it's just an excuse to point fingers somewhere else and hate.
- Why didn't government go after them? To believe the Big Fraud Theory, you have to also believe in a huge conspiracy between Government and Wall Street, that bankers and investors have colluded with Congress to deceive the public and that's why no one went to prison in massive investigations of widespread abuse. But CRAFFT theory explains why, much better.
|CRA, Fannie/Freddie Theory
The idea of the CRA->Fannie/Freddie theory (CRAFFT) is as follows:
- Fannie/Freddie tried to help the poor by lowering loaning standards.
- The CRA allowed community organizers to punish those that didn't lower them enough.
- Banks capitulated with the laws that the politicians created.
- Good intentions often don't have limits... and politicians and community organizers kept lowering the standards until failure.
- Then when things turned to shit, the politicians and community organizers that caused the whole mess weren't going to take responsibility: so they blamed the Banks for complying with the regulations they were required to comply with. (Who doesn't hate a rich guy in a suit?)
The GST theory is great at pointing fingers at who (by scapegoating evil bankers and sub-prime loans), it doesn't tell you the what, why, how like the CRAFFT theory does. Why would they do it (knowing that short term greed would kill the goose that made them rich)? Oh, because they had to by law, now that makes sense. What really happened? Credit markets froze. How did TARP help? By helping banks have enough liquidity (loan them money) to get around the governments own restrictions: it fixed their debt-equity ratios, and that let them loan again. So knowing CRAFFT, explains far more -- knowing GST means you can't explain anything, but you get to hate bankers and wallow in virtue (think more government could have fixed it).
These are a bunch of financial terms (concepts really), that you can scan to get familiar with the jargon and ideas. Especially before reading the Financial crisis of 2007-2008
, but they're good jargon to know when watching financial shows or reading financial press.
|Financial crisis of 2007-2008
What caused the financial crisis of 2007-2008? This is a comparison of the two (or three) most popular theories: whether Glass-Steagall, CRA and FannieMae/FreddieMac, or the Big Fraud caused the meltdown. Along with a full explanation of the strengths and weaknesses of them (which holds up to scrutiny). Links and resources provided.
Glass-Steagall was the 1930's new deal regulation that said Commercial and Investment banks had to be separated. There would be no "universal" banks (that did both). In theory, by separating sides there would be more transparency, and people might behave less risky. In truth, there's just more inefficiency and the same risk. Think of these:
- We know transparency wasn't the problem, as everything they did was known by all. (A few were able to anticipate things by reading the info that had been out there all along).
- Adding/removing steps didn't change anything material -- and regulation increased after the repeal by over 17%, with thousands of pages of new regulations.
- Banks were less leveraged after the repeal than before -- so Glass-Steagall had done nothing to reduce leverage (risk)
- If Glass-Steagall prevented catastrophe, why didn't Asia and Europe have financial meltdowns first: they never had Glass_Steagall?
Most of all, if G-S was the problem, then during the collapse it would have been the unified banks that had the biggest problems (over-leveraged/under-capitalized). It wasn’t. The Unified banks outperformed the Commercial banks (Countrywide) and the Investment Banks went out of business (Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, Bear Stearns). The Unified banks bailed out the others; JP Morgan Chase (Unified) bailed out Bear Stearns (Investment), while B of A (Unified) helped by taking over Merrill Lynch (Investment) and Countrtywide (Commercial). This is backwards from what GST says should have happened!