Government Not Solely to Blame for Subprime Mortgage Meltdown

From New York and Washington elites to speculators in Los Angeles, the Great Recession had many fathers.


Republicans are fond, not altogether without cause, of characterizing Democrats as liberal “ideologues.” But such lockstep thinking is hardly the exclusive preserve of the left.

Take, for example, the purported GOP effort to paint the federal government as the be-all-end-all bogeyman of the ’08 subprime debacle in a forthcoming commission report on the crisis.

According to the Wall Street Journal:

The Republican report sets up a competing set of narratives for the financial crisis. Instead of focusing on the actions of large investment banks, it lists actions by government officials and institutions, and cites the "unprecedented number of subprime and other weak mortgages" that policymakers encouraged during the housing bubble.

This is the kind of Politburo-style reasoning that has driven me bonkers for the last two years.

In the wake of the meltdown, conservatives hurriedly sought and embraced explanations that absolved the private sector of most or any blame. As is well known by now, they fixated on the quasi-governmental enterprises Fannie Mae and Freddie Mac, as well as the Community Reinvestment Act. (This column, headlined “The Government Did It,” literally says it all.)

[See the credit and finance industry's favorite lawmakers.]

In truth, of course, there was plenty of blame to go around: from a sleeping Federal Reserve to excess liquidity (courtesy of the Chinese) to lenders to grossly irresponsible homebuyers themselves.

All that granted, my (inexpert, to be sure) assumption has been that if the melt¬down had simply been the result of the subprime bust, we would not have seen a systemic crisis. Rather, we would have seen a contained housing crisis.

Indeed, it’s highly curious to see Republicans still straining to deflect criticism of Wall Street when elements of Wall Street itself have accepted it. (See, for example, this mea culpa from Timothy Ryan of the Securities Industry and Financial Markets Association, as well as Scott Patterson’s book The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It, which was excerpted in, of all places, the Wall Street Journal.)

The University of Chicago professor (and Cato Institute adjunct scholar) John Cochrane has written:

The underlying decline in wealth from the housing bust was not that large. … Most estimates put subprime losses around $400 billion. The stock market absorbs losses like that in days [emphasis mine]. But it turned out that housing risks are spread very differently from stock market risks.

The difference is that mortgages were held in very fragile financial structures. An extreme example: many mortgages were pooled into securities, and the securities were held in special purpose vehicles (SPVs), funded by rolling over short term commercial paper with an off-the-books credit guarantee from a large bank.

Professor Cochrane’s analysis was hardly a left¬wing indictment of Wall Street (he was writing for Cato, after all). The Panic was triggered, he asserts, by a conflicting signal sent by Washington: bailing out Bear Stearns, but letting Lehman Brothers go under--which proved to be a catastrophically ill-advised time to make a point about moral hazards. (“The middle of a crisis is a terrible time to grow a spine,” as he aptly put it.) [See a roundup of editorial cartoons on the economy.]

Those who are not captive to ideology can agree: Washington screwed up; Wall Street screwed up; the general public screwed up. From elites in New York and Washington to greedy speculators in L.A. exurbs -- the Great Recession had many fathers.

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