Financial crisis of 2007-2008

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False starts, and cherry picking the starting point.
Issue Lie Truth
Financial crisis of 2007-2008 We were under-regulated by removing Glass-Steagall, and it was the greed of Wall Street that inflated the bubble, and under-regulation made the banks “too big to fail”, so the taxpayers “bailed them out” and gave them money for fat bonuses and sheltered them from any consequences. It was all the Republican or evil Jewish Greedy Bankers fault. We had more regulations than ever in history, the crisis was created by bad regulations like CRA (Community Reinvestment Act) and community organizers inflating a real-estate bubble of high-risk toxic loans, when that bubble-popped, other regulations (banking equity laws and FAS-157) magnified the resulting credit crunch and froze financial markets. We LOANED the banks money to get their liquidity up enough (short term) to unfreeze equity markets, and once everything stabilized, they paid all the money back (there was no net loss to taxpayers). No one has ever explained how Glass-Steagall could have stopped it, or why it hadn't happened in Europe/Asia without them ever having Glass-Steagall.


There are two theories of what caused the Financial crisis:

  1. Too little government: Big Banks / Wall St. and under-regulation (the removal of Glass-Steagall) allowed banks to inject risk into the system (with fancy derivatives) which created the bubble, and the bail-out sheltered them from any ramifications
  2. Too much government: The Housing Bubble was over inflated by the CRA, Fannie/Freddie, the risks spread thru MBS’s, and over-regulation (FAS-157) froze the credit markets and magnified the correction.

Both of these fit each sides political agendas. However, while Glass-Steagall theory (GST) is simpler (and more commonly regurgitated), every one of the claims of GST (or “too little government”) falls apart with the slightest scrutiny. The CRAFFT (CRA, Fannie/Freddie theory) matches the data/facts far better, and explains far more. I'll cover both.

NOTE: You can jump to the Financial Terms section, or just reference them as you go; like read what a Bank does (and differences between investment/commercial/universal), what a GSE like Fannie/freddie does, or what an MBS’s are or Mark-to-market accounting is.

Glass-Steagall Theory (GST)

The idea is:

  1. Bill Clinton lifted the Glass-Steagall act (under pressure from Republicans) and signed the bipartisan Gramm-Leach-Bliley Act (GLBA)
  2. This allowed banks/investment houses to merge and over-leverage themselves (using Credit-Default Swaps, and MBS’s) and rampant predatory capitalism of evil bankers caused them to oversell loans to people that people couldn't afford them (subprime mortgages) and get into over-leveraging themselves
  3. The bankers knew they were risking all (and going to crush the economy), thus they were actively defrauding the people by selling/making the loans (criminal activity to get their bonuses), and they should go to prison.
  4. The bubble popped, and everything came down (as expected), but they all got bail-outs / cash from Uncle Sam and consumers paid the bills ($700 billion for TARP AND $831B for ARRA / American Recovery Reinvestment Act / Stimulus), and they walked away scott-free with big bonuses.

To these folks, it was collusion between the the Fed and Banks that allowed crimes to be committed and not punished, the little guy got screwed and got their homes taken away, and because Big-Government did nothing, thus we need Bigger-Government and wealth-redistribution to fix it and go after these crooks and evil 1%’ers. (This is the Occupy theory).

It's a great theory to appeal to emotions (it lets the politicians blame everyone but themselves), but none of it makes sense or fits the facts/evidence, or really explains anything.

Glass-Steagall -
Glass steagall.png
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:
  1. 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).
  2. Adding/removing steps didn't change anything material -- and regulation increased after the repeal by over 17%, with thousands of pages of new regulations.
  3. Banks were less leveraged after the repeal than before -- so Glass-Steagall had done nothing to reduce leverage (risk)
  4. 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!

So while there's a few bad books, articles and movies that promote variants of the G-S theory. Facts, research, articles, Bill Clinton, the CBO, the SEC, and dozens of other economists all concluded the same thing: Glass-Steagall had nothing to do with the crisis, or the credit freeze!

CRA, Fannie/Freddie Theory


The idea of the CRA->Fannie/Freddie theory (CRAFFT) is as follows:

  1. Fannie/Freddie tried to help the poor by lowering loaning standards.
  2. The CRA allowed community organizers to punish those that didn't lower them enough.
  3. Banks capitulated with the laws that the politicians created.
  4. Good intentions often don't have limits... and politicians and community organizers kept lowering the standards until failure.
  5. 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).

Where did the money go?

So the banking market froze up because of Government regulations causing a bigger drop than before, and requiring banks to sell their assets to keep liquidity high enough to comply with other regulations (so they couldn't loan). And they were scared a further drop would squeeze them more, so they didn't want to take on more liability. So what could they have done?

  • The quick/simple fix would have been repealing FAS 157 (which would have freed up assets) -- but that would have been publicized and shown that congress/government was wrong to pass it (and is what caused the problem in the first place). Since that Democrats wouldn't let that happen, instead of playing politics and publicly hammering Democrats to repeal FAS 157, while the economy collapsed around us, he pushed for a compromise: TARP.
  • TARP (Troubled Asset Relief Program) was the Government FORCING banks to take massiveLOANS, to give them a HUGE buffer on their debt-to-equity ratios, so they could start loaning again. On top of that, there were only a few banks that were in trouble, but the Fed made ALL the banks take loans, so people didn't know which banks had the worst problems (and cause a run on those banks). But we know after the fact it mostly the investment banks (not the Unified Banks that G-S theory says should have the problems).
NOTE: Technically, there's nuances to that. Increasing banks equity allows them to loan more, which is how they make money. So the banks did benefit with all that free / low-interest cash. But the reason was so they could loan money to the people. Anyone who claims "the pubic got stuck with the bill", "evil bankers got a bail-out", "the little guy got screwed", are fools or frauds. Like Elizabeth Warren, Bernie Sanders or any of the far left movements that made this a talking point. They just preyed on the ignorance of their base, and mislead people for political profit.

The important thing to remember is that TARP was just LOANS, not give-aways to the banks. Congress authorized more than they needed (to have head-room, in case there was a second wave), but they only loaned $414B out, and the banks pad back $405B (with interest). (Very little was lost).[1] We knew the housing market would find the new floor, once we figured out how much poison was in the system. And once the actual value of MBS's stabilized, the liquidity crunch abated, banks that survived, paid back the government ALL the loans from TARP. Only the few ruined by government regulations did not.

Banks weren't loaned money to benefit the banks/bankers. The money loaned to banks so they had credit to loan out TO THE PEOPLE! The public benefited, not the rich banker, proven by the fact that the banks paid all those loans back.

Obama did pervert TARP, and diverted some of the money to Democrat causes: the auto-companies, Unions, and NOT the bankers or Wall St. And most of that money was NOT paid back. So the public did foot the bill of a few hundred billion in TARP. But not in Bush's Bank TARP (what it was passed as), only in Obama's TARP (what he revised it into). If you've never heard that in the media, it shows you how biased or ignorant the media is.

So when people are screaming that we have a corrupt system because no bankers went to prison, it shows the failing of the media. No bankers went to prison, because there was no crimes you could convict them of, other than complying with the many bad government regulations that nearly destroyed them, and paying back the loans they were forced to take (but most didn’t need), to cover for the few that were most compliant with CRA and Governmental pressure. The real question is why didn't the many Democrat politicians get held accountable for their hand in it? The answer is because the media and Democrats (but I repeat myself), were more effective in blaming someone else for their mistakes. So Bush and Republicans bore the brunt of the hate of the ignorant masses, for something they had warned about and fought against.

Congress/Democrats knew that if they dug too deeply, all the systemic problems pointed back at them: so that's why they didn't hold big public investigations: Some banker was going to explain to the public what had really happened (instead of the Democrat version), and if they did that in ways that the media couldn't ignore, the Democrats in control knew they'd be in trouble. That's why despite Democrats controlling Senate, House and President, they only offered rhetoric -- but very thin "investigations" or prositions. Politicians might be dumb, but they're not THAT dumb.

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:

  1. Massive greed encouraged massive over-leverage, and while everyone (or a few) knew better, they did it because they were dumb, greedy and corrupt.
  2. 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.
  3. 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:

  1. 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.
  2. 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).
  3. 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.
  4. 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.
  5. 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.
  6. 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.


So what did we learn?

  1. ALL the banks paid back all the loans within a couple years (with interest), and most didn't need the money in the first place. In fact, none would have, if it hadn't of been for FAS-157. They weren't crunched because they were over-leveraged for real (their leverage rates going into the crisis was lower than they were when Clinton was in office in the 90's). They only didn't have the paper assets because of Mark-to-market accounting (FAS-157): fuck-you-very-much.
  2. There was never a “bail out” of the banks — there was a bail out of bad regulations. The term "bail out" implies they were given money. They were forced to take loans to cover up Democrats incompetence. And they paid it all back, with interest. The taxpayer lost money, but that was on Fannie/Freddie and the Auto Loans and other policies by the Democrats. The only bail out was of government malfeasance, not of banks.
  3. The Republicans had been warning about for 5+ years before the collapse about Fannie/Freddie’s problems and trying to fix it. Democrats kept blocking republicans from forcing transparency, because of crony-big-government. Now we can debate whether the Republicans attacking was foresight, or just trying to kick Democrats in a soft-spot, and they weren’t 100% innocent either, Bush had let the CRA and Fannie/Freddie continue to lower standards without taking it to the people. But no one knew when the bubble would pop, and he at least had the excuse of 9/11 or Iraq and F/F was in Congresses purview.
  4. There was never any criminal prosecutions because the only thing most were guilty of was compliance with the law (bad regulations), and Democrats in control, they didn’t want that to come out. Which is why they scream so loudly and point fingers at Banks and Wall St. and fund things like Occupy, to distract from their malfeasance. Since the media leans left, they've avoided any real journalism or exposés that might make their party look bad — which is why 90% of Americans don't know/understand what actually happened and why.

The stories about deregulation causing this, and all the other stuff, make no sense on how they could cause anything. Nor do ones about how evil bankers duped the public or the gullible poor into taking loans they couldn't afford. Yes, I'm sure there's a few smarmy sales folks out there (even in banking), but that was a symptom of Fannie/Freddy and government requiring so many of these loans and being so willing to buy them up. If the government was buying only 20% of the loans and the private sector was issuing 80%, I’d firmly blame the banks. But as the numbers were the other way until well into the crisis (and the GSE’s had said their intent was to lower standards), the blame lies on them for the bubble, and on the bad regulations like FAS-157 for the crash afterwards.


📚 References

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Here's some other tidbits (complexities to note):

Feeding the bubble: many foreign investors (and others) lost trust in their governments for a variety of good reasons, they still needed a place to put their money/savings and if they didn't trust their currency/governments, American MBS's was a great/safe place. They needed to put their money somewhere, and that was safer than in their own countries. And you couldn't trust currencies because of manipulation (China, U.S., EU). You couldn't trust the treasury bills because Greenspan was keeping interest rates too low (in order to encourage more leverage/investment and less savings -- e.g. creating a bubble). So socialist corruption in Europe, U.S. and abroad helped fed the American (Dollar) and real-estate bubble.

Feeding the bubble: in America municipal bonds weren't good investments because cities had defaulted (especially in liberal controlled states like California, NY or Michigan), and other states and municipalities looked higher risk because they couldn't control their debts. (See liberal states like California, Michigan, NY, especially). If you don't trust city/state bonds, then more goes into stocks and real-estate (the bubbles that popped). And tax incentives were further inflating the bubble.

Mis-assessing risk: there's no doubt that the credit agencies mis-assessed risks. But imagine you're Moody's -- and there hasn't been a system wide real-estate drop in 70 years, and the majority of the loans are going through GSE's (Government), and you have government agents like Barney Frank screaming that everything is good and safe? You're going to assume these instruments are very low risk too. But black swans hit once in a while. The credit agencies were wrong, for trusting what the government was telling them!

The banks sold sub-prime loans and MBS's too! Yes, a few did. But if you look at scale, they were not most of them (government was), and they were kind of arm-twisted into following by the successes of Fannie/Freddie. So they might be wrong, but they were wrong second -- thus if you want to get to the root of the problem, you look at who did it first and bigger. Banks listened to government and credit agencies that said these things were safe, so they FOLLOWED! (They did not LEAD) into bundling their own MBS's, as well as selling the sub-prime loans that Fannie/Freddie and the CRA was pushing them to. And as long as Government (GSE's) were buying these loans, there was virtually no risk to signing up as many people as you could: it looked like free money (backed up by the government).

After government had chummed the waters, the feeding frenzy started, then investment houses created derivative/instruments to magnify the results (like CDO's) which magnified leverage. (Note derivative and leverage aren't bad things). The reason lefty-politicians focus on it, is because they can make it sound complex and distract people from root causes, and their base doesn't understand that both can LOWER your risk. (In fact, that's what hedging as in hedge-fund managers does). So the fundamental problem here was that investors (and investment banks) listened to Moody's and Government's mis-represented risks, and reacted accordingly. And they paid the price (by being driven out of business).

What about smarmy companies selling bad loans or selling investments they knew were bad? Both are a failure of government: it is their job to stop those criminal activities. If they were widespread (and they really weren't from a systemic level), then it shows how bad government was at doing its job of stopping abuse. Blaming the industry for a few exceptions is daft. Not blaming government for doing their job and catching, stopping, or punishing it, is dafter.

What about Credit default Swaps (CDO's)? These are just two companies insuring each other. I agree that if your assets go down, I'll cover you, as long as you do the same. It's really low cost insurance -- but if BOTH sides go down at once, you're screwed. But we hadn't had a case of that in 70+ years, so they thought (wrongly) that it was safe. Thus there was a lot of greed and failure to assess risks, and this cross insurance and complex derivatives chewed up the Investment Banks and Insurance Companies. They thought they were collecting risk free premiums and got raped for that mis-assumption (and increased leverage). But it wasn't that companies weren't insured, it was that their cross-insuring each other, caused as much exposure as it covered it. But that wasn't because of deregulation (government was writing more new regulation than ever in our history with Sarbanes Oxley and so on), it was a failure of government to realize where we needed new regulation targeted, while simultaneously telling them that there was no risk in housing. (These guys were dumb to believe government -- so both sides own that mess).

Some companies were betting against themselves or their investors? Yes. This is called hedging (or "insurance" in gambling). It's a common technique to lower risk -- if you've made a ton of money on one investment, you normal bet against it (by a short or derivative against it): if it keeps going up, the asset growth will cover the cost of the insurance/hedge, and if the asset goes down, the insurance/hedge will grow in value and cover the cost of the asset drop -- you're not betting against yourself/customers as much as locking in a gain. Some are trying to flim-flam the gullible that hedging is a bad thing -- but the alternatives are usually worse.

CountryWide was the worst! You're correct -- they were the most aggressive at selling MBS's and sub-prime loans. What lead to all that confidence? They owned too many Democrats in congress (and had become a revolving door for congressmen), and they donated heavily, and Barney Frank protected them. So there was a corruption problem with CounrtyWide, but it was government-CountryWide collusion with Democrats. This is the problem of empowering Government/Politicians, they lease that protection to the highest bidder.


Financial crisis of 2007-2008 : CRA, Fannie/Freddie TheoryBig Fraud TheoryGlass-SteagallFinancial Terms