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Congressional Committee on Financial Crisis Goes Light on Government Blame

Blame goes to "captains of finance and the public stewards" of the financial system, but little said about the vigorous government housing and mortgage lending policy that precipitated the crisis and determined its magnitude.

The complexity of the U.S. financial crisis makes it hard to understand but easy to explain to one's taste by cherry-picking from among its multiple cause. That is what members of the Financial Crisis Inquiry Commission seem to have done in a draft report on the causes of the financial crisis. According to a Reuters report published at I&T, the draft report was issued by the Democratic majority of the panel; Republican members have criticized the draft report and plan to issue a report of their own. [UPDATE: Republican members of the panel released their report this morning, Jan. 27.]

The Commission's overarching conclusion - that the financial crisis could have been avoided - is hard to dispute. Nor would I take much issue with the parties they blame in their more general statements, as drawn from the Reuters story:

The Democratic majority of the 10-member Financial Crisis Inquiry Commission spreads the blame widely to regulators, politicians, financial firms and credit rating agencies.

The lists seems thorough, but judging by the Reuters story, the report goes light on blame for politicians. The report mentions Clinton administration officials who pushed to shield over-the-counter derivatives from regulation, according to the story, but apparently leaves out the various government promoters of homeownership, principally through eased mortgage underwriting standards and their follow-on effects.

The report is right to blame risky or negligent behavior on various parties, including financial companies, rating agencies and the Fed. However, the weaknesses associated with these parties' actions would not have produced such devastating results without massive government intervention in the mortgage lending industry.

Both Republican and Democratic presidential administrations, going back to Clinton, fostered the inflation of a housing bubble, supporting policies that enabled more home ownership than the market could bear. Various government entities undermined traditional mortgage underwriting standards and fostered the creation of an industry to write bad loans on a massive scale and bundle them into securities. While the administration of George W. Bush was guilty of home ownership pandering, to its credit it identified the "government supported entities" (GSEs) Fannie Mae and Freddy Mac as a potential source of "systemic risk" in the first couple of years of Bush's presidency.

There's been a lot of talk about systemic risk since the crisis struck, but politicians have been more likely to use the term in reference to AIG or the big investment banks than to government involvement in the GSEs. The Financial Crisis Inquiry Commission sums up responsibility for the financial crisis as follows:

"The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand, and manage evolving risks within a system essential to the well-being of the American public."

We don't have access to the full text yet, but one hopes that it would single out, along with named financial services companies and chairmen of the Federal Reserve Bank, Rep. Barney Frank who, along with Democratic Party allies, stoutly resisted reform of the GSEs over a period of years. Rep. Frank certainly exemplifies the culture of excessive risk taking criticized in the report. In a Sept. 2003 House Financial Services Committee hearing, Frank made the following comment, as rendered by the Wall Street Journal:

"I do not want the same kind of focus on safety and soundness that we have in OCC [Office of the Comptroller of the Currency] and OTS [Office of Thrift Supervision]. I want to roll the dice a little bit more in this situation towards subsidized housing."

One of the best sources I've found on the effect of government policies on mortgage underwriting standards — and the fruit of those policies in the financial crisis - is "Anatomy of a Train Wreck," by Stan J. Liebowitz of The Independent Institute. The essay also shows that adjustable rate mortgages (as opposed to subprime) played a more important role than generally recognized.

For an essay that touches on the risky and negligent behavior of the financial companies and regulators I recommend the essay "Gambling With Other People's Money: How Perverted Incentives Caused the Financial Crisis," by Russell Roberts at the Mercatus Center, George Mason University.

Many have tried to characterize the U.S. financial meltdown as a crisis of capitalism. Roberts doesn't hesitate to blame the financial barons involved in the crisis, but he demonstrates that the crisis was in great measure the fruit of government regulation (or deregulation) of both mortgage lending and financial services. The chief subject of his essay is the all-too-cozy relationship between financial service players and regulators that has led to a system that encourages irresponsible risk-taking. By Roberts' critique, we suffered a crisis not of capitalism but of crony capitalism, where profit is privatized and risk socialized.

Anthony O'Donnell has covered technology in the insurance industry since 2000, when he joined the editorial staff of Insurance & Technology. As an editor and reporter for I&T and the InformationWeek Financial Services of TechWeb he has written on all areas of information ... View Full Bio

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