What Caused The Second Depression In-A-Nutshell

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Everyone is pointing fingers at who is to blame in the current financial and economic crisis. Let's move beyond partisan sniping and take a look and see if we can find some real cause-and-effects...

A friend writes:

I avoid sending you piles of Republican propaganda because it only stirs up flames, however when something as politically fascinating as this comes across my inbox, I have to pass it on to you. Please read this and tell me if there is any truth in it.

http://www.ornery.org/essays/warwatch/2008-10-05-1.html


This housing crisis didn't come out of nowhere. It was not a vague emanation of the evil Bush administration.

It was a direct result of the political decision, back in the late 1990s, to loosen the rules of lending so that home loans would be more accessible to poor people. Fannie Mae and Freddie Mac were authorized to approve risky loans.


Hey, I appreciate the dialogue and I hope you'll read through all this because this isn't a cut-and-paste.... I'm taking the time to write a very thoughtful response with lots of references.

I've seen that rumor before, that Obama and the Democrats have ties to Freddie Mac/Fannie Mae and this is the cause of all the problems.... While SOME of the claims they make regarding Freddie Mac and Fannie Mae have SOME truth to them (as well as a bunch of lies), they engage in a causal fallacy to draw an erroneous conclusion that the failure of those two entities is a fundamental cause of the financial crisis, and another fallacy that making loans to low-income people is also a major part of the problem (and the source of the bad mortgage notes).

Here are the fundamental facts on that issue--and don't take my word for it, research it yourself, but avoid the wingnut, blame-it-on-the-others sites:

#1, and this is very important: The collapse of Fannie Mae and Freddie Mac is not the cause of the financial crisis.

Think about it for a minute. What do AIG, JP Morgan, Bear Stearns, Merril Lynch, Washington Mutual, Wachovia, Shearson Leahman, and all these investment firms have to do with some program to help underwrite low-income loans? Is it wise for ANY investment firm or bank to depend upon any single entity (or two) for their solvency? NO. And they were not dependent upon Fannie Mae or Freddie Mac.

Did you notice how the market started to go up when it looked like a bailout bill was not going to pass? And once it did, it went down even further? No bailout = companies have to clean up their act; bailout = rewarding irresponsibility = no faith in the market. What does Fannie Mae have to do with NASDAQ? Nothing. It's bigger than that.

#2, The cause for the mortgage collapse was because of two things:

a) Greed
b) Lack of regulation


This is a fact. Institutions failed, not because of making a bunch of bad loans, but because they packaged the loans and sold them to other people--but nobody would buy this crap (as should be the case), so they fabricated a special "insurance policy" that promised the notes would be good, and if not, they'd get (at least most) of their money back. Where's the hanky panky? They didn't call these things "insurance" because if they had, then they'd have had to follow certain government regulations (like making sure they had the solvency--the money in reserve--to back up the insurance policies they were writing!)Instead, they called them "credit swaps" as a way to sidestep regulation--regulation that was designed to protect the integrity of the financial institutions! Here's a story on this featuring a very good explanation from 60 Minutes: http://bsalert.com/news/2407/60_Minutes_Uncovers_The_Real_Financial_Crisis.html

But wait! This isn't what you've heard on television right? Regulation is bad..mmmkay? Of course you didn't hear it on TV, because TV is owned by the same companies who want permission to pull this crap. This idea that minimal regulation will create a responsible market is total BS.... For more information on the libertarian lie, see: Dissecting the Libertarian government model For more information on the finance crisis see: Money, debt and finance. Nine months ago, we at BSAlert did podcasts on both of these issues, and foretold some of this mess.

This started originally with a few firms, and then when everybody in the financial sector saw some people making money off these things, they went nuts with greed and everyone jumped on the bandwagon. In effect, it was an inter-bank Ponzi Scheme (or Pyramid Scheme) that was always going to implode, but nobody cared because they were all part of huge monstrous corporate machines, and they convinced themselves that there was no way their company could fail. (Not unlike how Americans keep waving flags and telling each other "We're the greatest country on the planet" while we go bankrupt, become a nation of fat lazy consumers, lose our manufacturing base to Japan and China, see our education and mortality rates approach those of third-world countries, have one of the worst healthcare systems in the civilized world, and are becoming incapable of maintaining a military force to defend ourselves, but we're Amerrrricans, the greatest nation evah!). The big companies simply refused to pay attention to the "big picture," and this is a fundamental flaw of these huge corporate monsters, in which nobody really has a sense of responsibility or takes the blame when things go wrong.

Again, nobody would have underwritten bad loans if they couldn't sell those loans to other institutions. They did this through these unethical "credit swap" contracts. Without the credit swaps, they couldn't have made the loans and sold them, and things would have stopped before they got out of hand.

#3, The idea that "low income loans" are substantive enough to have caused this crisis is ridiculous.

Again, think about it. Do you honestly think all these foreclosed properties are from a bunch of people formerly in the projects and on welfare? They're not. They're all second and third mortgages on middle-class, white Americans! Along with a bunch of really bad business loans given to politically connected people. Have you been watching TV? Seen all the ads for home loans? Think that was targeted just at poor people and mandated by the government? It was not. Any "low income loans" that are part of the bad paper are a fraction of a fraction of a percent. That is not the problem. GET THIS... even if it was, it wasn't the Democrats idea... see: http://www.whitehouse.gov/news/releases/2002/10/20021015-7.html Yes, that's right.... George W. Bush created the program to offer these loans in 2002. But as I've said before, that's not the cause of the problem.

#4 - It's a lie that former Fannie Mae executives are linked to Obama. See: http://www.snopes.com/politics/obama/fanniemae.asp Here's another rumor related to it that is going around: http://www.snopes.com/politics/obama/loans.asp

#5 - So who is responsible for this mess?

That's a bit complicated, but if you want to draw a line to some particular legislation that was enacted by Congress, the buck stops right here:

Gramm-Leach-Bliley Act of 1999

Known to the public laughingly as The Financial Services Modernization Act of 1999



Gramm-Leach-Bliley cleared the way for big financial companies to be all of those things wrapped into one. Big companies with huge internal incentives to take risks, companies that were so complicated they couldn`t really be regulated, and companies that were so big that the government felt that they could not be allowed to fail.

At the time, in 1999, when this was being debated, Democratic Senator Byron Dorgan from North Dakota saw it coming, like he should have a psychic show in Vegas-level saw it coming. On May 6th, 1999, on the Senate floor, Mr. Dorgan said, quote, "This bill will, in my judgment, raise the likelihood of future massive taxpayer bailouts." $1 trillion is massive, right?

Well, to the "New York Times" on November 5th, 1999, Senator Dorgan said, quote "I think we will look back in 10 years` time and say, we should not have done this, but we did because we forgot the lesson of the past, and that which is true in the 1930s is also true in 2010."


Rachael Maddow picks up our story!



Senator Byron Dorgan on CSPAN talks about the problem:

Part 2:



What did this bill do?

It's not what this bill did. It's what it un-did.

After the depression in the 1930s, one thing the government did to make the financial system stable was to pass the Glass-Steagall Act of 1933, which instituted regulations that prohibited banks from engaging in highly speculative activities that would put their solvency at risk. In other words, they separated banking from insurance companies. Banks managed money. Insurance companies managed risk. This is a very important element that made the entire system stronger, more diversified, and separated the value of the monetary system from the uncertainty of underwriting risk. Great idea, right? Well.... In 1999, a bill was passed called the Gramm-Leach-Bliley Act that undermined all this and allowed financial institutions to get into insurance and other speculative areas! The Gramm-Leach-Bliley act allows banks and insurance companies to consolidate into bigger, larger behemoths that engaged in all sorts of speculative activities with peoples' money in ways that had been prohibited since the Great Depression.

But Phil Gramm and the GOP-controlled Congress weren't finished:
Now that he'd built the coffin, Gramm nailed down the lid. In late 2000, as the Clinton administration was becoming the Bush administration, Congress was rushing to pass the annual Omnibus Budget Reconciliation Act to move budget account surpluses to cover shortfalls. At the last minute, Gramm slipped in a 262-page amendment called the Commodity Futures Modernization Act of 2000 (CFMA). The dense and obtusely technical language was passed as part of the budget bill without debate.

This act almost totally deregulated derivatives, aka futures. Now each company that held derivatives, like subprime mortgage bundles, was free to determine the value of those derivatives when calculating the value of their liquid assets, with little or no government verification. Any company that wanted to overextend itself could simply overvalue its derivatives and hope they didn't get caught in a cash crunch.

It's very clear that this removal of regulation enacted after the first depression is a key cause of this second depression! Who voted for it? Can you blame this on Democrats? No. Which is why you don't hear anything about this in the right-wing press. Because this was a bi-partisan effort--this is what the banks wanted and they were a very powerful lobby, so they coerced most of Congress, including the vast majority of Republicans who were in control of both the House and the Senate (98% in the Senate and 98% in the House, compared with 84%/75% of Democrats) to vote for the bill, and it passed, and that paved the way for the downfall of these financial institutions, not unlike how the 1996 Telco Act paved the way for consolidation of radio and tv in the 1990s and led to the crappy partisan media we now have.

Who are Gramm and Leach and Bliley, and why is their name on the bill? Why, that's REPUBLICAN Senator Phil Gramm, and REPUBLICAN House Member Jim Leach, and REPUBLICAN House member Thomas Bliley! Yes... this bill was authored and introduced by REPUBLICANS! And it paved the way for the banks to get into this mess.

What's funny is the article you cite suggests that the news media is being disingenuous by not suggesting the Democrats are responsible for this crisis, when they make a very loose claim that the insolvency of Fannie Mae caused AIG and everyone else to go down. How ridiculous. But what's even more ridiculous is the humongous hypocrisy of their not calling attention to the real issue: THE GRAMM-LEACH-BLILEY ACT, which gave permission for all these institutions to pull this crap in the first place. And yeah, Clinton signed it, but it was a republican invention, and they were holding Clinton's balls to the fire with articles of impeachment--he was a lame duck, and they had enough votes to override him anyway.... although I still think it was crappy for him to sign both that and the 1996 Telco Act into law. It just goes to show you that you shouldn't be loyal to any party... you should focus on the issues.

Let's make this VERY CLEAR: If the Gramm-Leach-Bliley Act had not been passed, THIS WOULD NOT HAVE HAPPENED. Period. Most of what these institutions did to create the financial mess would have still been illegal.

Also, it's worth taking some time to remember that just a few years ago, which political party was suggesting everyone's social security money should be invested in the market? What party was that? I wonder how that would have turned out if that party had been allowed to invest the social security trust fund in AIG?


Dennis Kucinich talks about how the bailout will not help:"


Here Ron Paul claims that more regulation will prolong the "recession." When the collapse initially happened, he was on tv talking about how we needed regulation, now he's back to his old self suggesting that all these corporations will completely behave themselves if the Feds just leave them alone... yea right.



Phil Gramm's legacy:


Lyndon LaRouche talks about how banks have now become corrupted and Glass-Stegall needs to be reinstated:


Debunking the myth that the Community Reinvestment Act is responsible for the finance crisis:


Check out this apocryphal video from 2006 - one guy Peter Schiff knew what was going on:





Phil Gramm first deregulates the industry and then lobbies for the industry he deregulated:



More Reading:


 

Meanie
Posted by John on 2009-02-27 07:54:23
I just really felt compelled to respond to the glossing over of Clinton's (and the democrats') role in this. Look, if Clinton (and the other democrats) thought that this was a bad idea then they should have opposed it (think "House Republicans voting FOR the stimulus package = 0"). Then the voters decide whether or not they agree with their opposition. And another thing, you state that this bill was "slipped in a 262-page amendment called the Commodity Futures Modernization Act of 2000 (CFMA). The dense and obtusely technical language was passed as part of the budget bill without debate". Doesn't this sound like what the democrats just did with the stimulus, except that the stimulus has a lot more pages?
Posted by Pile on 2009-03-24 14:29:02
I don't doubt that anyone who signed off on this legislation bears some responsibility. However, there's a difference between approving a bill and creating and pushing for it. Most of the time when these bills come to the president's desk, they're loaded with all sorts of extra things that would be political suicide to derail. In this case, it was called, "The Financial Services Modernization Act" - so veto'ing it kind of suggests one doesn't want to modernize the finance industry. Plus, what was to happen years later was not very obvious to see... and certainly libertarian-type people would never suggest private institutions cannot be trusted to be shaped by "market forces." Obviously almost everyone was wrong or naive.

This issue screams for another bit of renovation in government, involving limiting the scope of bills before congress so people can't hide insidious items within.
Posted by beedogs on 2009-12-09 06:37:59
Meanie: G-L-B was passed by a veto-proof majority. There wasn't a whole hell of a lot Clinton could do.
Systemic
Posted by Funonymous on 2010-10-01 16:06:57
The parties barely matter, other than that the GOP tends to be a prime actor, and the Dem's just go along with whatever they ask for, or get bullied and lambasted in the media. The problem is that both parties are bought and paid for by the people who benefited from the financial collapse.
Posted by Rich on 2010-10-03 09:57:56
GLB was supported by Bob Rubin, Sandy Weill and the Northeastern Demopcrats who wanted to make inroads in Republican Wall Street. This included Bill Clinton. If Bill Clinton and Bob Rubin wanted to stop GLB, they could have stopped it in the Senate with the use of the 60 vote cloture rule. Spare me, " the Republicans did it Mommy."
false equivalence
Posted by Pile on 2010-12-15 13:00:41
It's a false equivalence fallacy to suggest the architect of a plan shares no more responsibility for the outcome as others who merely went along. As mentioned before, GLB was part of a much larger bill that contains all sorts of earmarks that various other politicians needed for their constituencies.
As Always, it is about the Rich!
Posted by GWL666 on 2011-01-09 14:28:15
I just joined this site (December 2010) and am enjoying reading the comments and viewing these videos. That should explain why I am posting a comment now. Although my comments are late to this blog, they are very relevant and on point.

It is ridiculous to blame just one party for the passage of the Gramm
As Always, it is about the Rich!
Posted by GWL666 on 2011-01-09 14:30:23
Continued from previous post.

It is ridiculous to blame just one party for the passage of the Gramm
Economist
Posted by Marcus on 2011-11-11 02:36:25
It was the Fed who told the banks that the loans created were solvent. It was the Fed that allowed banks to make subprime loans. It was the Fed that caused Fannie and Freddie to buckle. And it was the Fed that prevented the refi of teaser loans. No refi for millions of teaser loans meant millions of extra foreclosures. And it has been the Fed that told the Big Banks not to lend to consumers and to reduce the amount of credit card debt available by trillions. No loans and less credit meant that only the few could buy houses at a time when houses were being foreclosed upon. Supply and demand: due to foreclosures there was a great supply of houses and no demand because banks have not been making loans. So, less demand means recession. It's not been hard to figure out the cause of this great recession. But, you missed the boat when you focus on the Banks and Republicans. It was the Fed that caused all of this mess world wide. And without a discussion of the Fed and its roles, this article is at the least disappointing.
Posted by Tay on 2012-09-07 13:22:42
"The Glass-Stegall Act is no longer relevant" - Bill Clinton

The fact of the matter is this was a bipartisan effort, neither party gets the entire blame. It written by Republicans, supported by politicians across the board, and signed into law without hesitation by Bill Clinton.
 

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