Wall Street Whitewash

Paul Krugman makes several very important points:

When the financial crisis struck, many people — myself included — considered it a teachable moment. Above all, we expected the crisis to remind everyone why banks need to be effectively regulated.

How naïve we were. We should have realized that the modern Republican Party is utterly dedicated to the Reaganite slogan that government is always the problem, never the solution. And, therefore, we should have realized that party loyalists, confronted with facts that don’t fit the slogan, would adjust the facts.

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It’s not as if the story of the crisis is particularly obscure. First, there was a widely spread housing bubble, not just in the United States, but in Ireland, Spain, and other countries as well. This bubble was inflated by irresponsible lending, made possible both by bank deregulation and the failure to extend regulation to “shadow banks,” which weren’t covered by traditional regulation but nonetheless engaged in banking activities and created bank-type risks.

Then the bubble burst, with hugely disruptive consequences. It turned out that Wall Street had created a web of interconnection nobody understood, so that the failure of Lehman Brothers, a medium-size investment bank, could threaten to take down the whole world financial system.

It’s a straightforward story, but a story that the Republican members of the commission don’t want told. Literally.

Last week, reports Shahien Nasiripour of The Huffington Post, all four Republicans on the commission voted to exclude the following terms from the report: “deregulation,” “shadow banking,” “interconnection,” and, yes, “Wall Street.”

When Democratic members refused to go along with this insistence that the story of Hamlet be told without the prince, the Republicans went ahead and issued their own report, which did, indeed, avoid using any of the banned terms.

That report is all of nine pages long, with few facts and hardly any numbers. Beyond that, it tells a story that has been widely and repeatedly debunked — without responding at all to the debunkers.

In the world according to the G.O.P. commissioners, it’s all the fault of government do-gooders, who used various levers — especially Fannie Mae and Freddie Mac, the government-sponsored loan-guarantee agencies — to promote loans to low-income borrowers. Wall Street — I mean, the private sector — erred only to the extent that it got suckered into going along with this government-created bubble.

It’s hard to overstate how wrongheaded all of this is. For one thing, as I’ve already noted, the housing bubble was international — and Fannie and Freddie weren’t guaranteeing mortgages in Latvia. Nor were they guaranteeing loans in commercial real estate, which also experienced a huge bubble.

Beyond that, the timing shows that private players weren’t suckered into a government-created bubble. It was the other way around. During the peak years of housing inflation, Fannie and Freddie were pushed to the sidelines; they only got into dubious lending late in the game, as they tried to regain market share.

But the G.O.P. commissioners are just doing their job, which is to sustain the conservative narrative. And a narrative that absolves the banks of any wrongdoing, that places all the blame on meddling politicians, is especially important now that Republicans are about to take over the House. 

A similar opinion is here from the Los Angeles Times editorial board.

Barry Ritholtz has more here. He also offers this chart and three statistics that speak volumes:

-More than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions.

-Private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year.

-Only one of the top 25 subprime lenders in 2006 was directly subject to the housing law that’s being lambasted by conservative critics.

Did the government force every lending institution listed above to make these loans? Obviously not.

Mr. Ritholz has at least 10 questions for the Republicans that blame everything on the government:

To these Reality Challenged people, I pose the following questions:

1. From 2001 to 2003, Alan Greenspan took rates down to levels not seen in almost half a century, then kept them there for an unprecedentedly long period. What was the impact of ultra low interest rates on Housing, credit, the bond markets, and derivatives?

2. How significant were the Ratings Agencies (S&P, Moodys and Fitch) to the collapse? What did their AAA ratings on junk derivatives affect? What about their being paid directly by underwriters for these ratings?

3. The Commodities Futures Modernization Act of 2000 removed all Derivatives from all oversight, including reserve requirements, exchange listings, and disclosures. What effect did the CFMA have on firms such as AIG, Bear, Lehman, Citi, Bank of America?

4. Prior to 2004, Investment Houses were limited to 12-to-1 leverage by the SEC’s net capitalization rule. In 2004, the 5 largest investment banks asked for, and received, a full exemption from leverage restrictions (known as the Bear Stearns exemption) These five firms all jacked up their leverage. What impact did this increased leverage have on the crisis?

5. For seven decades, Glass Steagall separated FDIC insured depository banks from riskier investment houses. Prior to the repeal of Glass Steagall in 1998, the market had regular crashes that did not spill over into the real economy: 1966, 1970, 1974, and most telling of all, 1987. What impact did the repeal of Glass Steagall have on the banking system during the 2008-09 crash?

6. NonBank Lenders: Most of the sub-prime mortgages were made by unregulated non-bank lenders. They had a ”Lend to securitize” business model, and they sold enormous amounts of subprime loans to Wall Street for this purpose. Primarily located in California, they were also unregulated by both the Federal Reserve and the California State legislator. What was the impact of these firms?

7. These firms abdicated traditional  lending standards. They pushed option arms, interest only loans, and negative amortization mortgages, all of which defaulted in huge numbers. Was non-bank sub prime lending a major factor in the crisis?

8. The entire world had a simultaneous global housing boom and bust. US legislation such as the CRA or Fannie & Freddie only covered US housing and lenders.  How did this cause a worldwide boom and bust — even bigger than that in the US ?

9. Prior to the 2004, many States had Anti-Predatory Lending (APL) laws on their books (and lower defaults and foreclosure rates). In 2004, the Office of the Comptroller of the Currency (OCC) Federally Preempted state laws regulating mortgage credit and national banks. What was the impact of this OCC Federal Preemption ?

10. Corporate Structure: None of the Wall Street partnerships got into trouble, only the publicly traded iBanks. Partnerships have full personal liability for their losses. What was the impact of this lack of personal liability of senior management on Wall Street risk management?

I can go on and on — but the concept is rather simple: If you cannot answer these questions, or adequately explain these facts, then how on earth can you explain the credit crisis?

I completely agree with Mr. Ritholz and would love to have those questions answered.

Even more here and here!