Who’s really to blame for the financial meltdown?

According to a MinnPost.com post by Doug Grow, Rep. Keith Ellison is “steamed” that blame for the financial meltdown is being placed on “poor blacks.”
“Poor blacks caused this,” said Ellison, Minnesota’s the 5th District congressman, scornfully (as quoted by Grow) “That’s what we’re supposed to believe. Little ACORN (Association of Community Organizations for Reform Now) caused this. The mighty captains of Wall Street got taken down by little ACORN and poor black people. That’s what you’re hearing on the right. The gall and audacity of this is beyond imagination.”
I’m not going to question the sincerity of Ellison’s outrage. I would like to think that I can empathize with it despite the handicap of being white and male. I’ll even grant that there are people throwing around the CRA argument from an ideological bent with little understanding of the act itself, and there may be people who really are placing the blame for the meltdown on the poor black people. They are setting up straw men, but so is Ellison.

The problem with the Community Reinvestment Act has little whatsoever to do with poor black people per se. That CRA loans account for “at most, 20 percent of the bad loans that have led to the collapse” is “at best” ancillary to the issue. The CRA is certainly not the primary cause of the meltdown. The relevant issue, however, is the economic impact of the Community Reinvestment Act – both the visible consequences – increasing homeownership especially in minority communities – and the unseen consequences, the trade-offs, many of which are unknowable, resulting from government intervention in the housing market.
It’s the unseen consequences of the Community Reinvestment Act that have the most significant impact on the current crisis.
Trade offs
Economics is all about trade-offs. In a market-based economy, individuals decide what those trade-offs are going to be. Prices are set based on demand, and demand is always at a price. Interest is the price of capital. In a market system interest rates are based on money supply and demand for products and services. Credit expands until individuals acting within the market decide the price of capital (interest) is too steep at the margins – the cost of borrowing the next dollar outweighs the personal value of the end the borrowing would achieve.
In a managed economy, when government intervenes in the market on behalf of one industry or pushes a specific social goal – passes a Community Reinvestment Act – that action alters the market for capital. The Community Reinvestment Act with its implicit (now explicit) government guarantee to lenders that Fannie Mae and Freddie Mac would provide liquidity for their mortgage loans created a virtually risk-free investment with an artificially high return. This caused two problems.
First, guaranteed low risk and artificially inflated reward caused money to flow into housing that otherwise would have been more effectively invested in other segments of the economy. Eventually, the bubble had to burst – an unsupported money expansion can’t go indefinitely.
When housing prices fell, homeowners saw their equity decline. As mortgages flipped “upside down” (subprime or otherwise) – properties were worth less than their mortgages. Holders of mortgaged-backed securities, absent a true market, had no means to price their investments. Lacking a market and under the “mark-to-market” accounting rules of the Sarbane Oxley Act (another bit of panic-inspired legislation), those securities are virtually worthless. They have a value, but lacking a market, no one can actually determine what that value is. The result is what we see today – a drying up of liquidity in the credit market.
Government intervention and deregulation
Was that entirely the fault of the Community Reinvestment Act? No. And it definitely wasn’t the fault of “poor black people.” But soaring real estate values motivated more financial institutions to want in on the market. They had capital to lend, but the market they wanted in on was not an open market. It was highly regulated with legal barriers to entry. That brings us to the second consequence of government intervention – deregulation.
Government intervention in housing lured capital away from where it had had been profitably flowing. Deregulation enabled investment banks to get in on the real estate action. Playing outside the bounds of market discipline in a virtually risk-free market where weighing the possibility of gain against the probability of loss was unnecessary, is it really a surprise that greed and recklessness ran amok?
You can’t regulate greed out of human nature any more than you can legislate the money out of politics, but that impossible task is what a government managed economy must resort to. In a market system, greed is controlled by the discipline of risk vs. reward. Congressman Ron Paul identified the moral culpability in the housing market collapse as the “huge unconstitutional and immoral transfer from working Americans to holders of GSE debt (Government Sponsored Entity, e.g. Fannie Mae).” He is right.
Rep. Ellison may be outraged by the implications of others and his own inferences vis-à-vis the Community Reinvestment Act, but the act is symptomatic of the pervasive intrusion of government into the housing market and the economic damage and moral hazard such intervention creates. The Community Reinvestment Act and deregulation of investment banking are flip sides of the same coin. “Risky” loans motivated by the CRA are not the cause of the meltdown, nor is human greed. Each play a role and both were enabled by damaging government intervention in what otherwise would be a free and open market.
“Greed” may not be the right word, but where is the virtue in a person expecting society to finance a home he cannot afford? Ironically, while the CRA provided a path to home ownership for some, the investment it was funneling from other parts of the economy lowered the standard of living for many more – economics is always about trade-offs. The question is, who decides what those trade-offs are going to be? In this case is it going to be the secretary of the Treasury or individuals bound by the market discipline of risk and reward?
If one finds reason for outrage in the collapse of the financial markets, one will need a superlative adjective when the Social Security, Medicare and Medicaid bills come due.

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Comments (10)

  1. Submitted by Albert Maruggi on 09/26/2008 - 10:12 am.

    Excellent article – I’d contend that 20% of anything is not “ancillary to the issue”, but why quibble with such a nit.

    And those that want to further drive wedges here are not helpful when a thoughtful discussion of the issue is what should be that objective.

    The overall point of this debate is when government attempts to make a free market less free, it causes unintended consequences. The best intentions of both parties may not be the desires of the market.

    Additionally, financial incentives across the mortgage and investment industries, combined with macro pressure to show quarterly earnings (a product of our short-sighted society) all put increased pressure on the dam.

    Now with leaks springing up along the economy’s wall, we use on finger to plug the holes and the other 9 to afix blame. Not a shining moment for democracy or capitalism.

  2. Submitted by Tom Poe on 09/26/2008 - 11:37 am.

    Nice try, Craig. On September 19, 2008, Paulson demanded a corporate welfare package. It was not a request for bailout. We can mark our calendars, for this is the date the Republican Party announced it was no longer the Party of Small Government. It is the date the Republican Party came out of the closet, and is to be known as the Party of Corporate Welfare.

    America does not tolerate corporate welfare. The Republican Party has ceased to exist as a political force in America. Hopefully, you’re not a Republican. If you are, you believe in corporate welfare. Americans don’t tolerate those who believe in corporate welfare.

    McCain is filled with utter fear, today, September 26, 2008, as he is within hours of having to repudiate his Party of Corporate Welfare, and run for elected office as a politician that could not keep the hoodwinking going. He managed to do it when he disguised the S&L crisis as a bailout. That won’t happen this time.

  3. Anonymous Submitted by Anonymous on 09/26/2008 - 01:13 pm.


    Guess again who’s to blame for U.S. mortgage meltdown
    Analysts point not to greed, but to social activist politics
    Posted: September 19, 2008
    By Drew Zahn

    While many pundits are pointing to corporate greed and a lack of government regulation as the cause for the American mortgage and financial crisis, some analysts are saying it wasn’t too little government intervention that cased the mortgage meltdown, but too much, in the form of activists compelling the government to pressure Freddie Mac and Fannie Mae into unsound – though politically correct – lending practices.


    How the Democrats Created the Financial Crisis: Kevin Hassett

    “Oh, and there is one little footnote to the story that’s worth keeping in mind while Democrats point fingers between now and Nov. 4: Senator John McCain was one of the three cosponsors of S.190, the bill that would have averted this mess.”

  4. Submitted by Thomas Swift on 09/26/2008 - 01:16 pm.

    Spot on, Craig. I hope you sent a copy to Ellison’s office.

  5. Submitted by Jon Erik Kingstad on 09/26/2008 - 11:10 pm.

    I’ll ignore the uninformed comments by Albert Maruggi, John Krogstad and Thomas Swift for the moment and address the one thing in Craig’s post that is the primary lie: “The CRA is certainly not the primary cause of the meltdown.”

    This statement is a lie because it is not true: the CRA is not just not a “primary cause” of the “meltdown”; it has nothing to do with the alleged “meltdown” at all. Because there is no consensus that there is a meltdown or what the “meltdown” really is.

    The meltdown, as you call it, has nothing to do with lending to minorities or people whose skin color is not as white as yours, Craig. The “meltdown” is about what to do about estimated $62 trillion in “credit default swaps” or complex derivative instruments which are based on the unregulated mortgages issued in the past twenty-five years. If these things have the power their inventors have claimed, then there is no worry about any “meltdown.” The “free market” will work its wonders without any government intervention. So what’s your worry, Albert, and John Krogstad?

    On the other hand, if these complex derivatives really are a total house of cards waiting to collapse, what can $1 trillion of taxpayer dollars do to prevent that?

    For once, Craig, let’s not start with trying to blame somebody without trying to figure out whether there is really a problem and what it might take to fix it. Paulson, Bernanke, and your idol, Bush, have been blowing smoke for the past two weeks about the need for a bailout, without really explaining what the problem is. What do you have to say about that?

  6. Submitted by Craig Westover on 09/27/2008 - 09:25 am.

    Jon Erik –

    I say you are right – Paulson, Bernanke and Bush (my idol?), Obama, Biden, McCain and Palin, Reed, Frank and Pelosi – don’t know what the problem is. Moreover, they don’t know what the “solution” is, and they can never know. Ecomomics is not about solutions: its about trade-offs.

    Any plan coming out of Washington is based on three dubious and unquestioned assumptions: that the gathered officials possess all relevant information; that their desired objectives are achievable; that they possess the authority to implement their plan.

    Policy-makers are laboring under the misconception that government can somehow come up with a solution that will simultaneously punish the wicked, reward the righteous and leave the ignorant blissfully blameless and all of us financially intact. The reality is that objective is unobtainable; there is no one solution, only trade-offs. And right now armies of lobbyists are clashing on Capitol Hill over just what those trade-offs are going to be and who will impose them on the rest of us.

    When the battle ends, bodies will be buried, poppies planted and victory declared for a “solution” that serves visible collective ends but has only serendipitous connection to the unseen ends important to any individual, of which no bureaucratic planner can ever have complete and timely knowledge, empathy or concern.

    The “house of cards” was built on a foundation of artificially cheap money creating inflated value. $1 trillion in taxpayer money is not going to change that; the market you disparage will make the correction if we have the will to take our lumps.

  7. Submitted by Jon Erik Kingstad on 09/27/2008 - 11:07 am.

    We agree on a few things I see, Craig, and I share your cynicism about the armies of lobbyists swarming over the Capitol. I think where we differ is that I don;t think it necessarily has to be that way. And I disagree on your take on the Community Reinvestment Act. I dare say that is a law that has done far more good than harm.

  8. Submitted by Craig Westover on 09/27/2008 - 12:48 pm.

    Jon Eric —

    From the “Investors Business Daily” series, from which Bachmann quotes:

    “As of last year, the homeownership rate among all Americans was 68.1% — up from 63% in 1970. For black Americans, it’s up from just below 42% in 1970 to 47.2% last year. It’s still below 50%, and still the lowest of any minority group.

    “Today, Americans might rightly ask 31 years after the CRA was passed whether the more than $1 trillion lent under its auspices did what its proponents promised.”

    What we have here is a classic case of the “seen” versus the “unseen.” You can point to that 6 percent gain in homeownership for black Americans and say, “yes, the CRA was worth it; it put those people in homes.” That is the “seen” result.

    The “unseen” consequence of the CRA is that $1 trillion of capital was funneled to less efficient use in housing. We can never know what that $1 trillion might have produced in terms of job and wealth creation. Nonetheless, to deny that the less than efficient use of $1 trillion doesn’t have a negative effect on he economy and doesn’t lower the standard of living for all Americans is quite the article of faith.

    (BTW – If you don’t want armies of lobbyists swarming over Capitol Hill, don’t give them a reason for being there. Return government authority to its enumerated constitutional limits, and there isn’t all that many truffles left for lobbyists to rut for.)

  9. Submitted by Thomas Swift on 09/28/2008 - 01:30 pm.

    An excellent presentation of the forces at play:

    Whom ever put this together has obviously spent a great deal of time researching the issue.

    There is a great deal of information contained in this video, and it moves along pretty fast…use the pause button ‘liberally’.


    I encourage anyone to post reliable disputations of the positions and information contained therein.

  10. Submitted by Albert Maruggi on 05/09/2010 - 11:09 am.

    hmmm? What’s uninformed about my comments Craig?

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