The Real Cause of the Financial Crisis

Unbeknownst to the Occupy Wall Street crowd, those evil corporatists who work on Wall Street were not the main cause of the housing collapse that precipitated the economic downturn in 2008:  it was the federal government.  Conn Carroll at the Washington Examiner explains:

This we do know: Thanks to the widespread belief that the federal government would bail them out, Fannie and Freddie were able to borrow money at below-market interest rates.

This gave them a significant competitive advantage over private-sector firms which, by 1992, the two government-backed corporate entities had turned into an almost 70 percent share in the mortgage securitization market.

That same year, at the direction of the Congress, the Department of Housing and Urban Development began setting "affordable" mortgage goals for the agencies.

Countrywide was a growing force in the mortgage industry when it partnered with Fannie in 1992. But after [Countrywide Financial President Angelo] Mozilo's firm secured a steady government buyer for their loans, business exploded. Revenues went from $92 million in 1992, to $860 million in 1996, to $2 billion in 2000. By 2004, they were the nation's largest mortgage lender.

The secret to Countrywide's success was no mystery: They shredded standard industry lending practices, giving home loans to virtually anybody who asked. Fannie Mae not only knew this, Fannie rewarded it.

In 2000, the Fannie Mae Foundation honored Countrywide for "Outstanding Achievement" in the industry. The foundation's 2000 annual report noted: "When necessary -- in cases where applicants have no established credit history, for example -- Countrywide uses nontraditional credit, a practice now accepted by [Fannie]."

Countrywide continued to be the biggest supplier of loans to Fannie Mae all the way through the height of the housing boom. In 2004, 26 percent of the loans Fannie bought were from Countrywide. In 2007, that number had risen to 28 percent.

In his 1993 Nobel Prize lecture, economist Douglass North said, "If the institutional framework rewards piracy, then piratical organizations will come into existence; and if the institutional framework rewards productive activities then organizations -- firms -- will come into existence to engage in productive activities."

From 1992 through the height of the housing bubble, Fannie Mae and Freddie Mac used their monopoly position in the mortgage securitization industry to reward firms like Countrywide for making bad bets in the housing market. Countrywide's success was a signal to other market participants to lower their standards as well.

Wall Street banks are not blameless for the financial crisis. But they were only responding to the incentives set up by the federal government. Ignoring this history will help no one.

Due to the efforts of Rep. Barney Frank, then-Senator Chris Dodd, and other Democrats, Fannie and Freddie were able to keep their scheme going without any awareness of the consequences that would be just around the corner.