Skip to main content

So Alan Greenspan defended his record as Chairman of the Fed by saying he was right seventy percent of the time.  Where I went to school, that was barely a C.  Not good enough from the most powerful man in the world without a nuclear weapon.

Here are my views on the financial crisis:
• A lot of blame falls on the Fed and other bank supervisory agencies (the FDIC and the Comptroller of the Currency.  Among them, they regulate all banks in the US, including Citibank, Morgan Stanley and others that are now thought "too big to fail."  Each agency has a staff of bank examiners that is supposed to examine the banks in their jurisdiction for loan performance, capital adequacy, risk management and quality of management.  [Full disclosure: I worked for the Fed in the early 1970’s, though not in the Division of Supervision and Regulation.]  Had these functions been adequately staffed and skilled and undertaken their duties properly, a lot of the bad loans would have been identified earlier and set-asides taken.  Greenspan, a follower (until recently) of Ayn Rand’s extreme free market views has publicly said that he thought the market would create incentives for banks to adequately manage risk.  I suspect that means that the bank examiner function was understaffed and discouraged from finding problems.  I have heard that accusation leveled at the Comptroller and the FDIC.
• In Greenspan’s defense, a lot of the problems arose from institutions that were unregulated because of changes in laws sponsored by Phil Gramm (R, Texas) in the late days of the Clinton Administration.  These laws repealed the Glass-Steagall Act that created a wall between commercial banking and investment banking that had been introduced in the Depression era to prevent exactly the kinds of abuses that are now being revealed.  As a result, investment banking and insurance was outside the jurisdiction of any competent regulator.  (The states had jurisdiction over insurance, but state insurance commissioners are generally political appointees for party hacks that fail to get elected, and are no match for the big insurance companies.)  The states that have the largest population of insurance companies are those with the laxest regulation and the most protective senators – Nebraska, Connecticut, Arizona, Georgia.  So Goldman Sachs, Lehman Brothers, AIG, etc were not subject to any real regulation.
• Even if they had been individually subject to effective regulation, there is no entity that oversaw systemic risk.  Here is the problem:
o Mortgage lenders made sub-prime loans to high-risk borrowers.  Let’s say there were a million dollars of such loans made.  They also made mortgage loans to credit-worthy borrowers.  Let’s say they made 100 million dollars of those.  The total loans were then packaged into 100 bundles, each containing 90 low-risk loans and 10 high risk loans.  That way the total risk of the package defaulting was quite low; if 10 percent of the high risk subprime loans defaulted, that would only be one percent of the bundle. So the package could then be sold to investors like banks, pension funds, and insurance companies as AAA rated investments, and so they were.  The investors could claim a low risk profile.  The largest investors in these loans were Fannie Mae and Freddie Mac, who basically went bankrupt.
o But the largest insurance and investment banks would then issue loans, and using Credit Default Swaps (CDRs) basically insure themselves against default on their loans.  The biggest issuer of CDRs was AIG.  This means that all the risk that had been diversified away was now being re-concentrated through these individually low-risk transactions back under the AIG umbrella.  And that was why, when the subprime market imploded, AIG was at the center of the web of risk that reached into every corner of the financial system.
o The upshot?  Individual transactions that looked like they were reducing risk were shifting it to someone else (who was being nicely compensated for shouldering it) but since all roads led back to AIG,  there really was no diversification.
• The Madoff scheme had nothing to do with the financial meltdown except in timing.  That was plain old fraud in a Ponzi scheme.  The failure of the SEC to detect it however, in spite of repeated warnings, is of a piece with the lax regulation that stemmed from the Greenspan – Ayn Rand view of the power of markets.  This view was strongly shared by most regulatory agencies in the Bush Administration with very negative consequences in a variety of sectors. George W Bush himself was probably too poorly educated to evaluate the argument, but it seems reasonable to suppose that he absorbed the lessons at his father’s knee.  I guess the lessons of the Savings and Loan debacle that took place during the George H.W. Bush Administration were forgotten.
• Finally, a word about the absurd accusation that the sub-prime crisis was a result of Carter Administration policies to combat "redlining" and that "forced" lenders to make mortgage loans available to minorities that could not repay them.  The Anti-redlining policy emerged from evidence gathered as follows:  
o Two sets of couples were sent out to make mortgage loan applications.  Each had identical financial profiles and credit ratings, but one was white and the other was not.  The non-white teams were denied the loan much more frequently than the white teams, demonstrating racial bias.
o Another set of evidence came from examining loan applications in neighborhoods that were predominantly minority areas; loans were denied in those areas much more frequently than neighborhoods with similar household incomes in white areas.
o Based on these findings of discrimination, laws were passed to prevent this kind of bias.   The idea that these laws established some kind of "quota" of loans that lenders were required to make to high-risk borrowers is nonsense.  Anti-discrimination laws were not the source of the problem.
o The Clinton Administration policy in 1999 pushed Fannie Mae to relax the standards for buying mortgage loans from lenders and was thereby instrumental in encouraging lenders to extend credit to riskier borrowers.  The sub-prime loans were often in the form of Adjustable Rate Mortgages (ARMs) that were affordable to borrowers at the initial date and interest rate, but became unaffordable when the rates went up.  Fannie Mae issues bonds to fund its purchases of these loans, and those bonds form part of the capital base for many banks and insurance companies.  They are also heavily held by foreign governments like China that essentially prop up the US borrowing that keeps the government operating.  Fannie Mae bonds are technically not guaranteed by the "full faith and credit of the United States" but that distinction made little difference to the bond markets or investors when Fannie Mae was facing default on those bonds. The US had to bail out Fannie Mae in order to keep the bond market from collapsing, and taking with it much of the banking system, and perhaps the value of the US dollar.
o While the general policy of making loans available to lower income groups may bear some of the blame, there is also evidence that minorities were disproportionately targeted for sub-prime loans.  Ethnic minorities disproportionately fall into the category of "subprime borrowers", even when median income levels were comparable, 46% of home buyers in the African American neighborhood of Jamaica Queens, New York City received loans from sub-prime lenders while only 3.6% of those in predominantly white Bay Ridge, Brooklyn received a loan from a subprime lender. Hence there are charges of predatory lending targeting minorities.  (Wikipedia:

Originally posted to DocMartin on Thu Apr 08, 2010 at 03:23 PM PDT.

Your Email has been sent.
You must add at least one tag to this diary before publishing it.

Add keywords that describe this diary. Separate multiple keywords with commas.
Tagging tips - Search For Tags - Browse For Tags


More Tagging tips:

A tag is a way to search for this diary. If someone is searching for "Barack Obama," is this a diary they'd be trying to find?

Use a person's full name, without any title. Senator Obama may become President Obama, and Michelle Obama might run for office.

If your diary covers an election or elected official, use election tags, which are generally the state abbreviation followed by the office. CA-01 is the first district House seat. CA-Sen covers both senate races. NY-GOV covers the New York governor's race.

Tags do not compound: that is, "education reform" is a completely different tag from "education". A tag like "reform" alone is probably not meaningful.

Consider if one or more of these tags fits your diary: Civil Rights, Community, Congress, Culture, Economy, Education, Elections, Energy, Environment, Health Care, International, Labor, Law, Media, Meta, National Security, Science, Transportation, or White House. If your diary is specific to a state, consider adding the state (California, Texas, etc). Keep in mind, though, that there are many wonderful and important diaries that don't fit in any of these tags. Don't worry if yours doesn't.

You can add a private note to this diary when hotlisting it:
Are you sure you want to remove this diary from your hotlist?
Are you sure you want to remove your recommendation? You can only recommend a diary once, so you will not be able to re-recommend it afterwards.
Rescue this diary, and add a note:
Are you sure you want to remove this diary from Rescue?
Choose where to republish this diary. The diary will be added to the queue for that group. Publish it from the queue to make it appear.

You must be a member of a group to use this feature.

Add a quick update to your diary without changing the diary itself:
Are you sure you want to remove this diary?
(The diary will be removed from the site and returned to your drafts for further editing.)
(The diary will be removed.)
Are you sure you want to save these changes to the published diary?

Comment Preferences

Subscribe or Donate to support Daily Kos.

Click here for the mobile view of the site