Have you heard this one:
The government forced banks to make bad loans and caused the economic crisis.
If you haven't, you probably haven't talked to any conservatives lately.
Be thankful though when someone brings this up. It's an easy win and you don't have to know anything about economics.
Here's how to drive a giant, non-partisan economic truck through their argument.
From the Wall Street Journal, here's the argument in the words of Russell Roberts:
Beginning in 1992, Congress pushed Fannie Mae and Freddie Mac to increase their purchases of mortgages going to low and moderate income borrowers. For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target -- 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.
Does this sound familiar?
You know where it's headed: banks were just trying to make a profit but they couldn't because the government was forcing them to make bad loans.
In the words of a conservative friend:
The govt forced the banks to take on greater risk by giving loans to those who could not afford it. Glass-steal (sic) was the instrument which allowed the transfer of risk to fanie/Freddie (sic), but the fundamental problem was not the deregulation, it was the micromanagement of the banks which created the problem.
The micromanagement of the banks by the government. Got that? The banks were a victim of government.
The first giant gaping hole
Here's the easiest way to approach this argument: remember that not all of the banks failed.
If the government was forcing banks to make bad decisions as Mr. Russell and others argue, wouldn't all of the banks have failed?
How did some manage to survive this purportedly ruthless victimization where they had to give out super risky loans?
The answer is simple: Some banks made good decisions and some banks took on much greater risk to try and turn huge profits.
Government didn't force any of these decisions.
The second giant gaping hole
If that argument isn't enough for you, I'll drive a second truck through Mr. Russell's argument.
He doesn't even mention the risky derivatives trading and credit default swaps that occurred.
Because he wants you to think that the banks failed ONLY because the government made them make bad loans to low-income people.
Remember a little company called AIG? AIG took a bailout of almost $200 billion because they lost it on insuring credit default swaps, a form of derivatives. They lost it by insuring the risky bets that banks made with each other.
Did the government "make" them place these bets?
Banks had argued for deregulation since at least the 1980s and when Gramm-Leach-Bliley was repealed in 1999, they could finally merge with investment banks and make more risky loans.
For the first time since Glass-Steagall in 1933, banks could use their assets and savings to make risky market bets.
Many didn't. But many did.
The point is that government never "forced" anything on them.
So where are all these ridiculous arguments coming from?
It's hard to tell, but someone sure seems eager to shift blame onto the government. Perhaps it's the people who've been telling us for years that government is the problem.
Maybe the money the Koch brothers have donated to George Mason University has colored Mr. Robert's opinion.
Because he sure seems to leave out a lot of important details.
The third giant gaping hole (if you need more and want to get into economic detail)
If the first two weren't enough, here's a third truck-sized hole that I credit to Joseph Stiglitz. (Ok, in all fairness, I got the second one from Joe too and probably enough of the details to put together the first one.)
People like Mr. Roberts place the blame on Fannie Mae and Freddie Mac and here's my favorite, the Community Reinvestment Act of 1977.
1977. Yes, you heard that right ... 1977.
In the words of Mr. Roberts, here's how they bring in the CRA:
The Community Reinvestment Act (CRA) did the same thing with traditional banks. It encouraged banks to serve two masters -- their bottom line and the so-called common good. First passed in 1977, the CRA was "strengthened" in 1995, causing an increase of 80% in the number of bank loans going to low- and moderate-income families.
A couple points from Mr. Stiglitz's book Freefall:
Default rates on the CRA lending were actually comparable to other areas of lending - showing that such lending, if done well, does not pose greater risks.
Not only does this make sense, but it explains why some banks didn't fail.
Fannie Mae and Freddie Mac's mandate was for "conforming loans," loans to the middle class. The banks jumped into subprime mortgages - an area where, at the time, Freddie Mac and Fannie Mae were not making loans - without any incentives from the government.
A later privatized Fannie and Freddie would get into the market for securities, but the key point here is that many banks moved into these risky loans first, without any incentive from the government.
Why did they do this?
Because they thought they could make massive amounts of money off of the higher interest rates and because they had figured out a way to move these loans off their books by reselling them in the form of securities.
To spell this out, banks recognized what organized crime has known since the dawn of time: you can make a lot of money off of high-interest loans.
So not only did they make subprime loans without the government "forcing" them to do it, they've been lobbying the government to allow them to do it for years.
The first step was to legalize it.
The ability to charge high rates and fees to borrowers was not possible until the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) was adopted in 1980. It preempted state interest rate caps. The Alternative Mortgage Transaction Parity Act (AMTPA) in 1982 permitted the use of variable interest rates and balloon payments.
The next step was to make it viable:
Subprime lending would not become a viable large-scale lending alternative until the Tax Reform Act of 1986 (TRA). The TRA increased the demand for mortgage debt because it prohibited the deduction of interest on consumer loans, yet allowed interest deductions on mortgages for a primary residence as well as one additional home. This made even high-cost mortgage debt cheaper than consumer debt for many homeowners.
And I already mentioned the elimination of Glass-Steagall with the passage of Gramm-Leach-Bliley in 1999.
Now how did Mr. Roberts miss some of this? Isn't he supposed to be a knowledgeable economist?
Why is he only presenting some of the information? Why does he single out 1977 and 1995 as key dates in his argument?
I'll leave you to guess at his motives.
But his arguments? Holier than the Vatican on Easter Sunday.
To summarize, when someone argues that the "government made the banks do it," this is a great opportunity to ask them:
- Why didn't all the banks fail?
- How did government make them trade risky derivatives?
- Why did the banks move into subprime loans without any push from the government?
- Why have the banks spent so much time lobbying to deregulate the market so they could make more risky bets?
When I brought up these points with my conservative friend, he had to admit that:
Agreed... some banks made stupid decisions on their own. Personally, I couldn’t care less. They make bad decisions, then they must suffer the consequences. They should not be bailed out.
Ok, so he's still sipping the "free" market Kool-Aid.
But I can tell I'm getting through to him and, more importantly, I'm getting through to some of his friends as I've seen them start to raise their voices and chime in.
This one's an easy win. And it doesn't take a Ph.D. in economics.