Root of the 2008 Financial Collapse

The root of the 2008 financial collapse can to be traced to two competing views. The first view is that there was a failure of market discipline and the second a failure of the regulatory agencies and interference of politicians. The first has been attributed by Stiglitz as a failure of the capitalist system, and by Gorton as a failure of the various regulatory agencies. My view is that political interference through the agencies of Fannie Mae and Freddie Mac wherein politicians directly forced the pseudo-governmental mortgage insurance agencies to lend money to those who had either no ability to pay back money borrow (many @ 125% of the home's value), or who had no incentive (very little or no money invested as a down-payment).


The politicians who were most directly involved in this, Rep Barney Frank (D MA5) and Senator Chris Dodd (D CT) were the authors of the 2315 Dodd-Frank "Wall Street Reform and Consumer Protection Act of 2010". This Act uses the failure of regulatory agencies as the basis of the financial collapse and refuses to recognize that it will in fact worsen future systemic risk.

That there was very little discipline in the various markets has become obvious, but that is more a feature of political interference, than of regulatory failure. Contrary to the media pushed meme of regulatory failure (this has been the talking points of the MSM and Democratic Party for most of the past 18 months), regulators didn't fail to mitigate the risks inherent in the system, they induced it. To make matters worse, politicians openly encouraged it.

In 2003, then President Bush attempted to reign in the Governmental sponsored enterprises (GSE)'s of Fannie Mae and Freddie Mac but was forcefully rebuffed by the above named politicians with the assistance of Senator Charles Schumer (D NY). Again in 2005 Senator John McCain (R AZ) introduced legislation that would have kept the GSE's from lending in risky financial sub-prime lending was defeated by Democratic Senators from Connecticut, New York and California. This ensured that the GSE's and those financial institutions that were deemed too big to fail (TBTF) would do so...

What the Wall Street Reform Act guarantees is that the government will, in the future, be forced to bail out any financial institution that does fail. Those companies protected by the act, are too large to be effectively regulated in the first place, and secondly use book keeping methods that ensure their failure in the future. But by choosing "Wall Street" as a political scapegoat ignores the political causes of the financial collapse. Kevin Villani argues that,

While some (e.g. Krugman, 2009, and Stiglitz, 2009) blame Reagan and Bush era deregulation, there are few specific references to either legislation or administrative action. The reduction of bank branching barriers preceded Reagan, as did the decision lending to the eventual complete elimination of Glass-Steagall restrictions in the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 signed by President Clinton. Moreover, this deregulation has not been directly implicated in specific activities that created the crisis, and such diversification has generally made the banks stronger. Others note the failure to adopt new derivative regulations, e.g. Levine (2009), Johnson (2010). but this failure generally reflects the ongoing political turf wars among Congressional Committees (e.g. Agriculture versus Finance) rather than ideology, as demonstrated once again in the Dodd-Frank debates. While derivatives were used to ultimately prick the bubble there is no compelling link between the disputed regulatory proposals and the sub-prime mortgage lending bubble. Kevin Villani, "How Politicians & Regulators Caused the Sub-Prime Financial Crisis of 2007...", 2010, Page 5

The interference of politicians who often don't understand the economic impact of the policies they desire virtually guarantees that there will be a repeat of the 2007-8 financial crisis. Neither of the principal "authors" of the Dodd-Franks bill have a back ground in either economics or finance and because of this have built a bill that isn't either understood, nor is effective in correcting the actual market regulatory problems. It will merely exacerbate those issues that are now enshrined in the system and guarantee a repeat of the massive bailouts of 2009-2010. Villani concludes that,

...Dodd-Frank ignored the source of the consumeer problem, i.e. that Senator Dodd and Congressman Frank pushed quotas that led to unqualified people getting mortgages. So if it dos it's job of protecting consumers, then lenders will be in violation of affordable housing, CRA and other goals. This blame the lender mentality motivating the creation of a new watchdog agency can harm consumers in several ways. First, lawyers are among the few winners in the financial system collapse: ex ante consumer education remains preferable to ex post class action, which could seriously discourage home mortgage lending in the future [this has in fact occured, editor]. Second, mandating certain features, for example prohibiting a pre-payment penalty, means that ll consumers will pay for what could be an increasingly expensive feature valuable only to a few. So quotas remain, and all borrowers will likely pay for more credit.

Therein lies the problem. Politcally motivated lending to those unqualified, unable to actually pay for the money they borrow will guarantee that the system collapses again at some future date.