Dish Check: Who Caused The Financial Collapse?

I referred recently to the Dish's 1.3 million fact-checkers. That would be you. Currently we fact-check organically – if I make a mistake or a reader adds perspective that shifts our view of enpirical reality. On Saturdays, for fun, we use the collective mind to figure out an empirical fact: where on earth is a window view? So I thought it might be fun to do this from time to time with an alleged fact that is critical to a public debate. I'll lay out my position as best I can, with sources, but specifically invite readers to correct or refine the post until we get a conclusion, with a transparent interactive process. Kind of Politifact, but crowd-sourced. Bottom up; not top-down.

So who exactly was responsible for the 2008 financial crisis? Yesterday morning, Mike Bloomberg said it was entirely the fault of Washington because of its "forcing" or "pushing" via Freddie and Fannie poor people to get mortgages they couldn't afford. All Wall Street was doing was following Congress and now they're being blamed, when those mortgages blew up, instead of the Community Reinvestment Act, which set up the incentives to sell subprime mortgages. Money Bloomberg quote:

It was not the banks that created the mortgage crisis. It was, plain and simple, Congress who forced everybody to go and give mortgages to people who were on the cusp. Now, I'm not saying I'm sure that was terrible policy, because a lot of those people who got homes still have them and they wouldn't have gotten them without that. But they were the ones who pushed Fannie and Freddie to make a bunch of loans that were imprudent, if you will. They were the ones that pushed the banks to loan to everybody. And now we want to go vilify the banks because it's one target, it's easy to blame them and congress certainly isn't going to blame themselves. At the same time, Congress is trying to pressure banks to loosen their lending standards to make more loans. This is exactly the same speech they criticized them for.

The most cogent response to this argument that I have found is here. It's a lefty Media Matters post, but it has so many links to other sources it passes the sniff test for me. Money quote:

The Community Reinvestment Act of 1977 did not cause the meltdown of 2007, in no small part because that law didn't apply to the private lenders who dominated the subprime market. The fraudulent practices of those lenders and the financial derivatives the private investment houses used to turn the subprime market into an elaborate game of hot potato were left unregulated by the federal government — but that's not even the basis for Bloomberg's criticism of Washington. He claims Fannie Mae and Freddie Mac 'made a bunch of loans' even though they (1) do not make loans, and (2) were backing out of insuring subprime loans as private, unregulated firms rushed into the derivatives casino.

You do indeed have to explain why this crisis only occurred from 2002 – 2007, when the same incentives existed from 1977 on. But let's stipulate, for the sake of argument, that Fannie and Freddie were tilting the scales toward getting homes for the poor, because this is part of their job description, and that subprime mortgages were one response by the banks. Did that process – underway for years – create the crisis and collapse? Here's the argument in favor:

The banks created the "shady financial instruments" solely BECAUSE Congress passed laws that forced them to take high risks that they knew would result in massive losses… The banks did what any business would do (albeit in a deceptive, but legal, way): they protected their profits. Granted, their methods SHOULD have been illegal, but that's what happens when Congress and bureaucrats start dictating policies to businesses… the businesses consult with their lawyers and they start to get creative. The fact is that there are always consequences and loopholes that no one even imagined when the regulations were written, so government tends to do far more damage than good when they try to regulate the economy.

So here's a provisional conclusion. By creating major incentives and pressure to sell homes to the poor, the feds prompted (but didn't force) the banks to sell and insure dodgy mortgages in ways that disseminated the risks across the entire global financial system via credit default swaps and the like. The banks somehow believed that this dissemination of risk removed risk, and structured the loans so they would only work in a real estate market that never faltered. When it did falter, the insurance mechanisms metastasized a real estate crisis in one country into a financial crises across the entire world economy. At some point, the bankers knew they were peddling crap and some tried to sell it deceptively to clients.

I'd say the feds are partly responsible for a) the existence of Freddie and Fannie in the first place; b) the mortgage interest deduction that rigs the housing market away from rent; and c) not doing anything to prick the housing bubble before it began to get stratospheric.

But the banks' mathematical innovations in selling these mortgages, and in insuring them, made a real estate bust a global depression. I don't see how the government forced these practices into being. And I don't see how government encouragement of selling homes to the poor forces the kinds of reckless loans the bank made or the even more reckless and sometimes fraudulent ways in which those risks were made to look invisible.

Show me where and how I am wrong; and we can asymptotically reach a better empirical conclusion.

If it works – and the Window View contest is almost a text-book example of crowd-sourced factual inquiry – we'll repeat it whenever tricky but critical questions of fact emerge in the campaign. Put "Dish-Check" in the contents line of your email so we can more easily sift the responses.