We’re
approaching the tenth anniversary of the 2008 Credit Crisis, which brought on years
of financial havoc. The Dow fell 54 percent. The unemployment rate more than
doubled to 10.0 percent. It’s true that banks and financial companies lowered their
ethical standards, but this was induced by government requirements. The primary
causes of the downturn were the following eight federal policies:
Since 1933, the Federal Deposit Insurance
Corporation has insured bank deposits. All deposit guarantees are a mistake. They
induce depositors to care about a bank’s interest rate and convenience, but not
the money’s safety. The guarantees enabled debt to expand for decades throughout
the economy. Without them, big depositors would have insisted on the safety of
their money, reducing the nation’s debt level.
Beginning
in the late-1990s, the Federal Reserve Bank expanded the money supply and
lowered interest rates to excess. Increasing government regulations discouraged
business investments. People bought real estate instead, whose prices soared.
In 2004, the Securities and Exchange
Commission authorized five banks to accumulate unlimited debt. Previously, all
banks had been required to restrict their debts to twelve times their assets. But
with borrowings unlimited, Merrill Lynch, Lehman Brothers, and Bear Stearns all
failed, their debts having risen to up to forty times their assets.
By
2005, the Community Reinvestment Act forced banks to lend at least 52 percent
of their available mortgage money to people with low income. Regulators
threatened to put banks out of business that did not comply. To meet the requirement,
banks had to disregard potentially fraudulent loan applications. Ethical
standards do not change quickly without provocation. The 52-percent requirement
had forced banks to lower their underwriting standards.
Fannie Mae and Freddie Mac were sponsored
by the government to bundle groups of mortgages and sell them as mortgage bonds
to investors. This allowed loan originators to sell older loans and reinvest by
offering new ones. In the early-2000s, the government also authorized higher-risk
loans and urged companies to make such loans. The number of mortgages soared. Enormous
profits ensued, especially since Fannie Mae and Freddie Mac had low borrowing
costs due to widespread assumptions that the government would guarantee their
loans. Other banks, with higher borrowing costs, competed by increasing the
risks of their mortgage loans and securities. Large congressional campaign
contributions helped the industry grow in size and risk. It would have been far
safer if the number of mortgage bundlers had been unlimited, with no government
involvement
Standard & Poor’s, Moody’s, and Fitch were
authorized by the government as the nation’s principal evaluators of bonds. The
government’s earnestness about expanding home ownership and the widespread
expectation of real-estate prices rising induced the three agencies to rate many
mortgage bonds, including sub-primes, with the highest triple-A rating. It
would have been far safer if the number of bond evaluators had been unlimited, with
no government involvement
The
Mark-to-Market Rule, part of the Sarbanes-Oxley Act, required banks to value their
mortgage loans and other assets for what they could be sold almost immediately.
It was as if your house had to be sold by the day’s end. After the credit
crisis hit in 2008, the mortgage assets held by banks hardly traded at all, making
reasonable valuations impossible. Banks had to lower their asset values way
down, reducing lending substantially. The mark-to-market rule was repealed in
April of 2009, but not before great damage was done.
After the 2008 bankruptcy of Lehman
Brothers, the Federal Reserve required banks to raise their capital from 4
percent of assets to 7 percent. The credit crisis having already begun, banks were
unable to raise capital in public markets. They had to reduce their loan assets
instead. During the next two years, commercial bank loans fell by 25 percent,
the largest such reduction since the Great Depression.
These
eight federal policies were the primary causes of the 2008 credit crisis and
the economic travails that followed. The people hurt the most were the poor.
