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Steve Szeghi, Professor, Dept of Economics, Wilmington College, Ohio, USA


During the summer and early Fall of 2008, the causes of the global financial crisis which emanated in the United States were amazingly clear to almost every manner of honest analyst, regardless of personal or political philosophy. A summer cover of Business Week magazine declared that the market ate itself. In other words without vigorous enforcement of restrictions on the market, particularly the financial market, the market would tend toward self-destruction. Later that same Fall, the former Chairman of the Federal Reserve and stalwart advocate of de-regulation, publicly proclaimed, “We got it wrong, markets don’t always fix themselves.” Many of those who had championed de-regulation of finance and other markets over the previous thirty years as well as laissez-faire in the face of newfangled financial products such as derivatives and securitization, had for a time, a crisis of conscience and with it second thoughts on their devotion to market fundamentalism.

The global financial system had been shaken to its core and could not have survived had it not been for the rescue provided by many governments across the globe. And so for a time, reality set in, reality held ideology in check. But ever so slowly, as the successful rescue of the financial system by Government became increasingly clear, the ideology of market fundamentalism came back alive. For some there is the renewed hope to make fantastic profits within the context of still largely unregulated financial markets. Their concern is with their ability to make profits and not with the stability of the system as a whole. They hope to pull out with billions or even trillions before the next crisis hits. For them any concerted attempt by government to reasonably regulate activities and products within the financial sector is viewed as placing constraints upon their profit taking.

For others there is a sincere belief in their ideology of market fundamentalism. So for a while the reality of the crisis caused their belief in market fundamentalism to falter, but with time and the shoring up of the financial system, those who were addicted to their belief in markets found other causes of the crisis. At the core the need of some to revise the causes of the crisis is steeped in theology with the unfettered market viewed either as the hand of god or god himself or as natural or as the supreme human. Thus with a supernatural and anthropomorphic view of the market, the market is viewed as being without fault, and so the failures of the market need another agent of blame.

A successful rewriting of the causes of the financial crisis has taken place. This revisionist history of the causes of the financial crisis has been for the most part amazingly successful. It is fueled by the coupling of strong beliefs about markets and freedom on the one hand, and the shortsighted pursuit of profits on the other.

This paper traces the success of the revisionist history, critically evaluates its major tenets, and pleads for the original consensus on the causes of the financial crisis to return, before this tragedy repeats itself all over again.

The Community Reinvestment Act and the Dream of Home Ownership

One of the first alternative explanations of the causes of the financial crisis provided by the market fundamentalists was to blame the Community Reinvestment Act, a law designed to prod banks and other financial institutions to serve in lending to communities (poor and working class) from which they take deposits. Ever since the end of World War II the United States government sought to encourage and make more affordable home ownership for more people. The CRI, originally passed during the Administration of Jimmy Carter out of concern for greater social justice in 1977 was merely another step in that rather long tradition. How exactly this act on the books for decades, as enforced by the George W. Bush Administration was supposed to have prompted the proliferation of the bad loans that was at ground zero of the crisis was never made clear, but it was a convenient way to blame government and therefore take the heat away from market failure. Subprime lending was pioneered by non-banks not subject to the CRI. Also interestingly enough a group of economists prepared a working paper for the Cato Institute (a right wing think tank and leading proponent of market fundamentalism). The paper concluded that the types of home loans at the root of the crisis were not made on behalf of modest homes for the poor and working class, but rather the larger and often second homes for the relatively well to do, who had good credit, that were at issue. The paper is called ‘Complex Mortgages’ and is written by, Gene Amronin, Jennifer Huang, Clemens Sialm, and Edward Zhong. Their intent was to shift the blame from unscrupulous lenders to unscrupulous borrowers but in the process they manage to exonerate the Community Reinvestment Act.

The low interest rate policy of the Federal Reserve

Another alternative explanation was the policy of the Federal Reserve in keeping interest rates low. Even though inflation had not been a problem in the US economy since the early 80’s, and even though in terms of Macro policy most analysts usually heaped great praise upon Alan Greenspan in his alternatively providing stimulus at times and at other times engineering soft landings, since the Federal Reserve is connected with government, then why not blame the Federal Reserve essentially to blame government rather than the market. So in this rendition if only the Federal Reserve would have allowed interest rates to rise, that would have choked off credit to those least worthy and prevented the crisis. But then usually according to the theory of adverse selection, it is the least worthy credit risks that continue to want to borrow at higher and higher rates. So while a low interest rate policy by the Federal Reserve could be blamed for too much growth or too much inflation it can’t really be blamed for credit bubbles bursting due to too much bad debt.

Fannie Mae and Freddie Mac

Yet another way to blame government rather than the market was to blame Fannie Mae and Freddie Mac, even though the financial crisis hit long after Fannie and Freddie had ceased to be government agencies. Fannie Mae and Freddie Mac, these were private corporations, privatized at the behest of the market fundamentalists – such was supposed to make them so much more efficient and savvy and wise. Fannie and Freddie were involved in the securitization and bundling of home mortgages that was going on; but they did not pioneer the practice. They were followers. Since they were still involved and since they used to be US government agencies, then somehow the market fundamentalists thought that by attacking Fannie and Freddie’s role the blame could be shifted away from markets and deregulation to the government. In order to be successful in this attempt of blame shifting, some serious ‘slight’ of hand is involved in the pretention that Fannie and Freddie were still the government instead of private corporations. Of course in the view of many on the right, Fannie and Freddie were originally created with the same wrong idea of promoting asset formation for the very poor and working class as the CRI. Again a concern for social justice could be blamed for the financial crisis, with government cast in the role of coercing the market to make loans to too many poor people.

The Government failed to regulate

The final argument, to pin the blame on government is to actually blame the government for not regulating and to then make the case that since government didn’t regulate that it can’t be trusted to do so in the future and that therefore markets should be free of regulation. It is an interesting argument, somewhat tortured and illogical. To be sure the government and the Federal Reserve should have regulated derivatives, just as the wall of separation between Investment and Commercial Banking should never have been taken down. Prior to the passage of the Commodities Futures Modernization Act and the GLBA, which in turn prevented the regulation of derivatives and allowed for mergers between commercial and investment banks by overturning Glass-Steagall, regulators such as Alan Greenspan conveniently found loopholes to in essence de-regulate prior to the legislation which did so. But why was this? It was precisely because those who were supposed to regulate adopted a philosophy that markets know best, that markets fix themselves. . Government didn’t regulate, as a philosophy of non-regulation had taken hold, therefore government screwed up, and instead of the financial crisis invalidating market fundamentalism, it is somehow twisted into an argument that government didn’t regulate, government can’t regulate and therefore shouldn’t regulate.

Another failure of the government was to not reign in, supervise, or monitor either the securitization process or the rating agencies. But then no agency of government was legally empowered to do so. Today, it appears hopeful that under the Dodd-Frank law the Consumer Protection Bureau is taking steps in this direction.

Easy going for those who create financial and environmental externalities

The financial system, the global financial system, including the rating agencies plunged the world into crisis in 08=09, due to the miscalculation of the players in that system, as well as the very structure of the financial system. In the aftermath of 30 years of deregulation of the financial service industry, the structure of that system was certainly the creation of the major players in that system. The financial crisis plunged the world into a recession. But governments across the globe then undertook increasing deficits both to fight the recession and more significantly bail out the financial service sector. But now the financial system, led by the rating agencies is downgrading government debt, (The USA, Greece, Portugal, Spain, and Italy). In the process these rating agencies are forcing not just more austerity (cutting benefits for ordinary citizens) but more deregulation, be it de jure or de facto, upon governments throughout the world. Both during and after the crisis, the captains of the financial service sector have escaped with huge fortunes for themselves. Did the financial service industry design this? I am not a believer in that kind of conspiracy theory. But it has worked out quite well for them, with little changed except that financial institutions are bigger than ever, and although the Dodd-Frank Act is a slight modest step in the right direction, efforts to reregulate in a substantial way, such as creating a wall of separation between commercial and investment banking, while placing checks on the type and size of executive compensation are at best stymied.

Meanwhile, given the effects of the recession and financial crisis such as continuing high unemployment, environmental concerns have taken at least a back seat in the arena of public opinion, and that only when the public is not downright hostile toward environmental messages. When the economic system is rigged so that economic security depends upon employment and when employment depends upon growth, the lingering effects of a recession coupled with fears of another become effective obstacles towards any significant environmental progress. In addition the austerity and deregulation craze makes for a poor recipe of enforcement of the ecological standards that were previously agreed to by law, treaty, or otherwise. And so the financial crisis has also made life easier for the polluters and destroyers of the environment.

So the financial crisis has made life easier for the financial service industries big players, it has strengthened their hand vis a vis governments across the globe, and the same is true of the big polluters. The continuing effects of the recession continue this trend and perhaps the polluters and the captains of finance wish it so. The emphasis upon budget cutting in turn results in continuing recession or sluggish growth amidst high unemployment.

Summary and Conclusion

They have alternatively blamed the community reinvestment act, low interest rates at the Federal Reserve, Fannie and Freddie and conveniently comingling them with government when they were deregulated private for profit entities at the time of the crisis. They have also blamed the advocacy essentially since WWII that the government should assist in some way the ability of more and more Americans to buy a home and in so doing chose to concentrate on the mere desire to own a single modest home rather than the desire pushed by advertising and enabled by private for profit and un-regulated lender to own bigger and bigger homes, as well as second and third and fourth homes. Deficits and debt of government have if not been blamed for the actual crisis, been cited as obstacles to the economy getting back on track, even though the mushrooming debt and deficits of government are directly attributable to the government shoring up financial institutions, saving the financial system, and ameliorating the crisis and giving the economy some juice.

The cumulative effect of this revisionist history, although much of it goes in cross directions it always manages to blame government, has been to take most of the onus away from a financial system that failed, that without effective regulation quite frankly ate itself. Instead in various ways, under various tones and incantations the government has been blamed for the crisis rather than the people who told policymakers over the decades that all would be fine if we just kept deregulating the financial system. Rather than the collapse of the financial market being blamed on them it is now more often than not blamed on government. Of course government is ultimately at fault in the sense of not regulating when it should have been regulating, but those who focus on government as the cause are quite effectively kicking up a lot of dust and obscuring the fact that it was the lack of effective regulation that caused the meltdown. And now they are telling us that what caused the financial crisis (a lack of effective regulation) is in fact what we need more of at this time. They are telling us that greater and greater de-regulation is the way to go.

It has been quite an effective propagandistic revisionism which has taken place. But then what else is to be expected from market fundamentalists, the financial industry, and academic economists in league with the industry. They have taken the greatest example of market failure since the Great Depression and somehow blamed it on the government rather than the market fundamentalist theorists who championed deregulation. And in so doing not only escape blame for the crisis but use it as an argument for even more de-regulation. They seem to be largely successful in winning the argument in the halls of power and in the media. Amazing!