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Thomas M. Miovas Jr.

Don't Blame Wall Street -- The Government Did It!

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Regarding the Wall Street Occupiers, I have written the following essay and have posted it to my website and other places. I didn't see this topic on the masthead under "politics" so I started a new thread.

http://www.appliedphilosophyonline.com/dont_blame_wall_street.htm

Don’t Blame Wall Street

By Thomas M. Miovas, Jr.

10/13/2011

There are a lot of people I know via FaceBook and other forums that are falling for the idea that Wall Street caused the Financial Crises by coming up with and speculating on mortgage backed securities. As they put it, Wall Street was on a speculative binge and eventually the bubble burst because they got too greedy and had to be bailed out. This is an incorrect analysis of the situation.

What caused the bubble and the speculation was the government forcing banks to deal with uncreditworthy people, who bought homes when they couldn’t afford them or signed deals with a variable interest rate thinking interest rates would remain low. Both thoughts were supposedly backed by the government via Freddie Mac and Fanny Mae, semi-government institutions that bought up mortgages to keep people buying houses they couldn’t afford. In other words, what fueled the speculation on the bundling of mortgages into securities was the government forcing there to be a bigger market than would otherwise exist in a free economy. There is nothing wrong with commodity backed securities, and nothing wrong with mortgage backed securities. But the speculation boom and then bust was caused by the government giving false promises of backing up mortgages via Freddie and Fanny. Once the mortgages were not paid back in sufficient numbers, the commodity became devalued and those mortgage backed securities became valueless as an investment tool. But, again, this was caused by the government guaranteeing those mortgages, at least in several statements made by the government, since they were forcing banks to deal with uncreditworthy individuals. Turns out it was an empty promise, so the market crashed when too many people defaulted. So, if you want to blame someone, then don’t blame the banks or Wall Street, but rather governmental interference in the economy – they caused the bubble and they didn’t stand by their promise to back those mortgages or to keep interest rates low.

Now, with that said, I do not think either the banks or Wall Street should have been bailed out when the market crashed. But again, this is governmental interference in the economy, and not a free market, so don’t blame capitalism. The closest system to what the government is trying to institute is fascism – where the government tells private businesses what to do at the point of a gun. It is not freedom and will lead to further government induced speculations as the government bails out one then another business that is doing what the government wants them to do. It is a way of the government accruing power over productive individuals. This is what people ought to be against – the regulations and the forced dealing with businesses that should fail due to making wrong decisions. So, don’t blame the banks or Wall Street for the Financial Crises – the blame rests squarely on the government that forced banks to deal with uncreditworthy individuals and then bailed out the banks and Wall Street when the market crashed. The government is in the process of shifting the blame to Wall Street, with some success, but the evil was committed by the government, not the capitalists.

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The following link provides a good summary of why Fannie and Freddie were NOT to blame:

http://economistsvie...again-it-w.html

More specifically, the graph below shows the rise of "asset backed securities issuers" from 2002, and the fall in market share of Fannie and Freddie (pink line). The asset backed blue line shows non-depository institutions that are NOT required by government to lend to poor people (ie not CRA regulated). Yet they made catastrophically bad loans anyway.

Graph: http://economistsview.typepad.com/.shared/image.html?/photos/uncategorized/2008/09/24/gse.gif

I'm not saying that they didn't contribute to the crisis but blaming Fannie and Freddie for it is a Republican/Austrian/Objectivist/Right-wing red herring.

Edited by IceFive

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The following link provides a good summary of why Fannie and Freddie were NOT to blame:
Are you aware of how much tax-payer money was spent to bail out Fannie and Freddie?

Of course Fannie and Freddie are to blame, as is the Fed and some of the banks -- particularly the ones that were allowed to fail. Behind all this, of course, the person to blame is the American voters who cheered this on. In the final analysis, they are to blame.

And people like the "Occupy Wallstreet" folk represent the intellectual segment among the American voters who are the most to blame.

Edited by softwareNerd

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"Of course Fannie and Freddie are to blame, as is the Fed and some of the banks -- particularly the ones that were allowed to fail. Behind all this, of course, the person to blame is the American voters who cheered this on. In the final analysis, they are to blame.

And people like the "Occupy Wallstreet" folk represent the intellectual segment among the American voters who are the most to blame."

EXACTLY! I heard a segment of an interview with one of the protesters, who was indignant that he had college debt of over $100,000. His major? German Studies! How the hell did this idiot expect to get a job with a major in that, outside academia (and how many of those jobs could there be?) and pay back his loans??!! WTF?

Fannie and Freddie were told to give out mortgages to people who were bad risks. All in the name of "equal opportunity", you see....Years ago, my Father (now 86) would have to have to have had 10% down to buy a house, and the PITI (principle, interest, taxes, insurance) monthly payment could not exceed 20% of my Dad's monthly income. They did away with thosecommon sense provisions in the name of equality, and the overstated idea that homeownership was an unqualified good.

Edited by Avila

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I wasn't trying to imply that Freddie and Fannie were the sole cause of the problem, but they did buy up mortgages like crazy (and even that chart showed that, the pink line). They had substantially more invested in the mortgage markets than any other player, even though the chart was going down years before the financial crises. They were also bailed out by the tax payers several times and I think want $100 billion more from the tax payers now. They contributed by buying up mortgages and then getting bailed out, setting up market signals that there was little risk in sub-prime loans. Had Fanny and Freddie not existed as semi-government institutions, the craze to buy those mortgages would not have existed, and the market would not have taken on so much risk. Nonetheless, they were only the instruments of the problem and not the root of the problem. The root of the problem were laws like the Credit Reinvestment Act that forced banks to lower their standards. Without F & F, many of these banks would have failed -- instead they put it all off on F & F. The whole situation gave false signals that sub-prime was low to medium risk, when it wasn't. This also lead to high speculation on mortgage backed securities that they were low risk.

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The root of the problem were laws like the Credit Reinvestment Act that forced banks to lower their standards. Without F & F, many of these banks would have failed -- instead they put it all off on F & F. The whole situation gave false signals that sub-prime was low to medium risk, when it wasn't. This also lead to high speculation on mortgage backed securities that they were low risk.

I also disagree that the CRA was the root of the problem. Housing bubbles were a global phenomenon and were inflated in most western nations at the same time who had no CRA like regulations.

I also disagree that loose monetary policy on a global basis was mainly to blame. You can't blame low interest rates for an institution lending to someone with 0% down, or no documentation, or no job. Even if low rates makes such lending profitable in the short term, market professionals should have known (being professionals) that such lending would go toxic quickly. The fact is that market "professionals" were voluntarily willing to lower lending standards in order to boost short term profits, therefore they are mainly to blame for the crisis.

What we need to prevent this crisis happening again is government mandated lending standards to force all lenders to act responsibly. For example make it illegal to give someone a mortgage with less than 10% down.

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What we need to prevent this crisis happening again is government mandated lending standards to force all lenders to act responsibly. For example make it illegal to give someone a mortgage with less than 10% down.
It is government standards, enforced by the government-owned lender of last resorts that have caused banks to take increasingly more risks since 1913.

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It is evil to impose a standard onto someone by force. It is evil to impose banking standards onto banks by force. If banks want to take on high risks, that is up to them, but they should not be bailed out when things go wrong. It was the government imposing standards that led to the Financial Crises, because those institutions would not have loaned to uncreditworthy people in the first place without the government forcing them to do so. Perhaps some were acting irresponsibly, but no one should suffer for bad business decisions aside from that business. It was governments tying everyone together under regulations that led to the bubble and it bursting when too many deadbeats bought houses. Leave the force out of it and let banks rise and fall according to who runs their business most profitably. And I'd say the short-sightedness of some banks came about because they thought they were going to be bailed out if they ran into trouble anyhow,which means government force was giving the wrong signals to banks and lending institutions.

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Can you provide a link that supports the statement that the banks were "forced"?

"caused by the government giving false promises of backing up mortgages " I understand this, and it obviously led to some bad business practices on the banks' parts. But as far as I can tell they did this willingly. As Yaron Brooks has said, if they make mistakes like that, they should simply fail.

However "government forcing banks to deal with uncreditworthy people" is something I haven't seen any evidence of. I've certainly heard the argument from many, like Limbaugh and others, but could you direct me to something that shows the banks were "forced", as opposed to just participating in actions that they shouldn't have, thus leading to consequences that should have caused them to fail?

I'm not denying that such evidence exists, I just would like to see it.

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There are several laws and system of laws that prevent "discrimination" on the part of banks and and states that they must loan to a variety of people in their community, even if they are uncreditworthy, or be fined heavy fines if they fail to comply with the law. The Community Reinvestment Act signed by Clinton is one such law, and there are others. The banks are the most heavily regulated of all our industries, and regulations means force -- a real gun pointed at their heads if they do not comply with the laws telling them who they have to do business with. So, the heavy fines or jail time is force -- real force -- aimed at them if they do not comply.

Added on edit: It's not that the laws state that they must deal with uncreditworthy individuals in the text of the law, but rather the only way the banks could comply with the law was to lower their standards of who to loan money to. If the law states that they must invest a certain percentage amount of money into their community, the only way to comply in many cases was to lower their lending standards, or face heavy fines or jail time.

Edited by Thomas M. Miovas Jr.

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It is government standards, enforced by the government-owned lender of last resorts that have caused banks to take increasingly more risks since 1913.

No, it was the private non-regulated asset backed securities issuers who made the NINJA (no-job, no income, no assets) and low-doc loans (blue line in the chart above).

It is evil to impose a standard onto someone by force.

Why?

There are several laws and system of laws that prevent "discrimination" on the part of banks and and states that they must loan to a variety of people in their community, even if they are uncreditworthy, or be fined heavy fines if they fail to comply with the law. The Community Reinvestment Act signed by Clinton is one such law, and there are others. The banks are the most heavily regulated of all our industries, and regulations means force -- a real gun pointed at their heads if they do not comply with the laws telling them who they have to do business with. So, the heavy fines or jail time is force -- real force -- aimed at them if they do not comply.

Again, CRA, Fannie/Freddie, etc were factors but not the main problem. The main problem was asset backed securities issuers (non regulated) who lowered lending standards in order to boost short term profits.

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The CRA was Carter, not Clinton. BTW Thomas Sowell's book on the housing boom and bust is a must read.

That is correct, but under Clinton the program was put into overdrive and became a lot more involved in banking practices. That may have been what Thomas was referring to.

No, it was the private non-regulated asset backed securities issuers who made the NINJA (no-job, no income, no assets) and low-doc loans (blue line in the chart above).

Why?

Again, CRA, Fannie/Freddie, etc were factors but not the main problem. The main problem was asset backed securities issuers (non regulated) who lowered lending standards in order to boost short term profits.

If it wasn't for the implicit backing of potential losses by the government, a lot of these loans wouldn't have been made because the risk would be too great. Bankers normally don't make terrible loans if it's their own money that is at stake. They're not stupid...

Edited by Maarten

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If it wasn't for the implicit backing of potential losses by the government, a lot of these loans wouldn't have been made because the risk would be too great. Bankers normally don't make terrible loans if it's their own money that is at stake. They're not stupid...

House price bubbles occurred globally and most nations did not bail out shareholders. For example across Europe banks were nationalized meaning shareholders were wiped out. Bankers aren't stupid, but they are more interested in short term profits than long term shareholder value (its called the agency/principal market failure).

Everytime you hear someone blame CRA or any other US specific government intervention, you should ask yourself why that meant the Spanish and British real estate markets also experienced a massive bubble.

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House price bubbles occurred globally and most nations did not bail out shareholders. For example across Europe banks were nationalized meaning shareholders were wiped out. Bankers aren't stupid, but they are more interested in short term profits than long term shareholder value (its called the agency/principal market failure).

Everytime you hear someone blame CRA or any other US specific government intervention, you should ask yourself why that meant the Spanish and British real estate markets also experienced a massive bubble.

Most of those countries have their own distortions in the housing market; they're certainly not capitalist paradises that are completely unregulated. And in Europe, to a large extent their bubbles had to do with the Eurozone and many of their banks making terrible investments in peripheral countries, the results of which are currently playing out with all the sovereign problems they're having over there.

Bank nationalizations are a form of bailouts, because the taxpayer assumes the risk at that point. Granted, it's a more explicit form of government involvement, but you can't argue that nationalizations are somehow not a way of bailing out a corporation. Yes, a nationalization wipes out shareholders, but there's a lot of shenanigans that tend to go on behind the scenes that reward certain groups more than others (see auto bailouts over here, where the unions got fat rewards). Ultimately, CEO oversight is something that should be up to the shareholders of a corporation, and not anyone else. If it takes a few terrible bankruptcies for them to learn this, then so be it. Maybe next time people invest in a company they'll demand more oversight and less risky behavior.

Bankruptcy is the only proper, lawful way to resolve these issues.

Edited by Maarten

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No, it was the private non-regulated asset backed securities issuers who made the NINJA (no-job, no income, no assets) and low-doc loans (blue line in the chart above).
I see, so it is your contention that the U.S. banks did a great job of managing risk and that the FDIC was very conservative in backing up the deposits of Washington Mutual and CountryWide!

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I personally believe the economy is simply restructuring due to the Internet and related Tech. This is pretty normal. The same thing happened with Radio (FDR and Hitler) and TV, (The Beatles, Vietnam). What's really happening is that Technology by ts nature, replaces manual labor. That is why the masses, as well central authority are ultimately doomed. :)

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Yes, I was thinking about Carter enacting the CRA, but Clinton giving it teeth (heavy fines for non-compliance).

Here is an article in Forbes.com by Yaron Brook, head of ARI / ARC, that basically states the same thing I'm stating:

http://www.forbes.com/2008/07/18/fannie-freddie-regulation-oped-cx_yb_0718brook.html

There was actually a host of things that went wrong, but the regulations got the banks to lower their standards in order to get more people into houses (a national goal of most administrations over the past 20-30 years). And one reason banks lowered their standards was the thought of being bailed out, as they did for the Savings and Loan Crises and other times, so yes, in some limited sense the banks were at fault for counting on a bail out. However, if one realizes that the regulations came about due to not enough people being in houses (according to the government), then one can see that they regulated down the standards.

Regarding credit default swaps and other financial instruments based upon mortgages. I would say, yes, there was some fault there for thinking the bubble would never burst due to them also thinking everyone was going to be bailed out if things went wrong. If it wasn't for the regulations, they would not have taken such risks and kept buying into mortgage backed securities. But the government was forcing there to be a larger market than there otherwise would be and it seemed like nothing could go wrong so long as Freddie and Fannie were buying up mortgages and being bailed out by the government (which happened several times before the crises).

In short, had the government stayed out of it, the great risks would not have been taken aside from a few risk takers and when it collapsed, it wouldn't have spread to the whole economy. The forced bail outs are part of my calculations, hitting the taxpayer with $700 billion more in debt. A free market is the only solution to the problem. If people want to take extraordinary risks, they are free to do so, but the government cannot back them up and they cannot take others down with them.

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When you're making a serious argument about finance as complex as this, it should probably be more than 2 paragraphs long.

Here's a very good look at the involvement of the CRA that actually changed my mind from the "the CRA didn't do it" camp.

http://articles.businessinsider.com/2009-06-27/wall_street/30009234_1_mortgage-standards-lending-standards-mortgage-rates

And the reason it did that? Because it is a thorough argument. Understand though, that his argument doesn't just lump all the blame on the CRA. Frankly that should be immediately recognized as a specious argument in such a complex system.

Same thing with the F&F arguments, something that have been a bit of a sticky wicket for me. I never actually found any reliable/sourced documents out there that show that F&F securitized subprime loans. From what I understand, they bought subprime securities, but they didn't actually securitize/underwrite any of them.

One of the sticking points on that is that people treat Alt-A loans as subprime, which I'm not sure is a fair definition. F&F definitely did do a fair amount of business in Alt-A mortgages.

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That's a damned good question.

I think a lot of it had to do with the ratings agencies being completely off their meds and the europeans getting caught up in the same speculation fevor everyone else was.

But I don't know for sure.

Really good question.

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