I’m a little late on this piece but better late than never, right? Barry Ritholtz writes perhaps the single most succinct general explanation for the causes by the Financial Crisis of 2008. On Wall Street:
Its Big Lie is that banks and investment houses are merely victims of the crash. You see, the entire boom and bust was caused by misguided government policies. It was not irresponsible lending or derivative or excess leverage or misguided compensation packages, but rather long-standing housing policies that were at fault.
Indeed, the arguments these folks make fail to withstand even casual scrutiny. But that has not stopped people who should know better from repeating them.
The impetus behind the “blame government policies” crowd comes largely from Peter Wallison’s lone dissent from the Financial Crisis Inquiry Commission, where he blames the global crisis on U.S. affordable housing policy. For a brutal takedown of that dissent, read this piece by David Min.
Continuing with Ritholtz, his bullet points on the several factors contributing to the Financial Crisis is very good, but this one in particular always gets me:
The Securities and Exchange Commission changed the leverage rules for just five Wall Street banks in 2004. The “Bear Stearns exemption” replaced the 1977 net capitalization rule’s 12-to-1 leverage limit. In its place, it allowed unlimited leverage for Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns. These banks ramped leverage to 20-, 30-, even 40-to-1. Extreme leverage leaves very little room for error.
Of course they believed that this type of extreme leverage was okay, because the wondrous advent of complex financial products allowed the structural ‘risks’ to be better managed. Except that it was being less well managed than before, and truth be told it made that ‘risk’ far more dangerous because they didn’t believe it was there. Not only did they get it hilariously and devastatingly wrong, they did so in a way that threatened the entire international economy. So yes it’s understandable to experience some embarrassment in 2008, 2009. But not in 2011, or 2o12:
Rather than admit the error of their ways — Repent! — these people are engaged in an active campaign to rewrite history. They are not, of course, exonerated in doing so. And beyond that, they damage the process of repairing what was broken. They muddy the waters when it comes to holding guilty parties responsible. They prevent measures from being put into place to prevent another crisis.
There’s this concept of cognitive dissonance that Ritholtz ascribes those who see to blame only government policies on the Financial Crisis. When confronted with proof that contradicts our particular belief system we tend to suffer a type of intellectual crisis. Now it’s probable that our first reaction won’t be the product of an internally nuanced conflict resolution process, but more likely knee-jerk and emotionally caustic. We’re human, we can be emotionally attached to our belief systems, and I think it’s entirely understandable for a first reaction. What Ritholtz calls the Big Lie, however, is not cognitive dissonance as I understand it. I understand the Big Lie to be exactly what it is…a big lie. It is an intentional untruth, a false statement with intent to deceive because there are political and economic incentives for doing so.
(updated 11/30/11 for clarity)