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Frank made
his opinion about what caused the crisis crystal-clear: "bad
decisions that were made by people in the private sector" sending
the country into dire straits "thanks to a conservative philosophy
that says the market knows best." Which is just about exactly what
progressives said after the October 1929 crash, setting the stage
for the welfare state and Keynesian economics in America.
No direct causal
relationship can be established, but it is once again taken for
granted by many that the free market led us here and that the
current crisis proves the failure of capitalism. Editorials around
the world have endorsed this view, fuelled by populists like the
French president who appeared before world representatives to call
for a "new" or a "moral" capitalism, whatever that might be.
At the core of the attack
that is being mounted against capitalism, prosperity and freedom is
a denial of the American government's responsibility in this mess.
The very same government that is usually blamed first for every
problem occurring in the world is suddenly enjoying a free ride, now
that blaming it would hinder the progressive agenda.
In fact,
beyond the gaffes that obviously did occur in private decisions made
in the ordinary course of business, there exist direct causal
relationships between specific actions of the American government
and the current crisis.
 The Federal Reserve has
in recent years dropped interest rates to record lows in a bid to
avoid a recession, a move that was bound to create an inflationary
bubble and which cannot be blamed on the free market or deregulation.
This bubble arose primarily in real estate and mortgage credit, as
other public decisions moved enormous capital into those sectors.
Fannie Mae and Freddie
Mac, two government-sponsored entities (GSEs) involved in creating
affordable housing, were used to provide liquidities to financial
institutions so that they could keep lending. These GSEs bought
loans made by lenders, pooled them, and then securitized them by
issuing mortgage-backed securities (MBSs). It was also implied and
expected that Washington would bail out Fannie Mae and Freddie Mac
should problems arise, thus creating a moral hazard and pushing the
limits of the housing bubble.
Playing the role of
catalyst in the crisis was the Community Reinvestment Act, a
so-called progressive housing law that dates back to the Carter era
but that was revised by the Clinton administration in the late
1990s, making it more aggressive. On the basis of a lousy study that
found that banks were discriminating against minorities because of
their lower ratio of credit acceptance, some institutions were
forced by the CRA to lend to people with poor or non-existent credit
histories (“subprime loans”). Since these subprime loans were bought
by the GSEs anyway, all banks were pressured to follow suit in order
to protect their market shares. Underwriting standards were lowered
throughout the world’s largest economy. Coupled with low interest
rates, this caused both the demand for and supply of houses and
mortgage credit to explode artificially in the early 2000s.
It worked as long as the
real estate market was not losing steam. Once it did, as it was
meant to, housing values could no longer fully support the mortgages
or refinancing requests, defaults soared, and the MBSs underlying
pools of assets became suspect. The MBSs lost their exchangeability,
mark-to-market accounting rules started to hit, and the whole house
of cards came tumbling down.
Market participants,
whose investment and risk management decisions are usually guided by
information and rules such as credit ratings or the international
Basel Accords, obviously could not be saved from the problems
inherent in this government housing scheme, nor from the effects of
questionable accounting rules forced on the markets(1),
and here we are.
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