Now, this was partially caused by greedy bankers, it is true; but it wasn't entirely their fault. Y'see, what is at the heart of the Credit Crunch is a loss of faith in the value of mortgage loans. One of the reasons—or, rather, the main reason—for this loss of faith was that the bankers had been doling out mortgages to people who would probably not be able to make the payments. These people were not optimal borrowers because they had a high risk of default: in fact, they were not prime borrowers, but sub-prime.
As a result, because the risk of sub-prime borrowers defaulting, their mortgages cost more than those of prime borrowers. These higher-cost mortgages were known as "sub-prime mortgages", for obvious reasons.
(I realise the irony of this system: after all, if their mortgages were not more expensive than prime mortgages, then the chances of these people defaulting would be a little less. However, that is not how risk works.)
Now, a large number of defaulters in the US led to a couple of small banks going bust. This then started something of a panic which escalated into the shit-storm that we see today.
Now, the real question that needs to be asked is "why were so many sub-prime mortgages dealt out?" The risk assessors in banks are generally pretty smart guys, and they have teams of researchers and reams of reports to help them to control their banks' exposure to such problems.
Via Alex Singleton, I have rediscovered a Forbes article, which I saw some time ago, which may go some way to answering the above question and may also provide a counter to those who are lining up to blame the eeeeeevil "free market". [It's worth reading the whole article, but here is the meat of it, with emphasis by me—DK]
All this overlooks a crucial fact: There has been no free market in housing or finance. Government has long exercised massive control over the housing and financial markets—including its creation of Fannie Mae and Freddie Mac (which have now amassed $5 trillion in liabilities)—leading to many of the problems being blamed on the free market today.
Consider the low lending standards that were a significant component of the mortgage crisis. Lenders made millions of loans to borrowers who, under normal market conditions, weren't able to pay them off. These decisions have cost lenders, especially leading financial institutions, tens of billions of dollars.
It is popular to take low lending standards as proof that the free market has failed, that the system that is supposed to reward productive behavior and punish unproductive behavior has failed to do so. Yet this claim ignores that for years irrational lending standards have been forced on lenders by the federal Community Reinvestment Act (CRA) and rewarded (at taxpayers' expense) by multiple government bodies.
The CRA forces banks to make loans in poor communities, loans that banks may otherwise reject as financially unsound. Under the CRA, banks must convince a set of bureaucracies that they are not engaging in discrimination, a charge that the act encourages any CRA-recognized community group to bring forward. Otherwise, any merger or expansion the banks attempt will likely be denied. But what counts as discrimination?
According to one enforcement agency, "discrimination exists when a lender's underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants." Note that these "arbitrary or outdated criteria" include most of the essentials of responsible lending: income level, income verification, credit history and savings history—the very factors lenders are now being criticized for ignoring.
The government has promoted bad loans not just through the stick of the CRA but through the carrot of Fannie Mae and Freddie Mac, which purchase, securitize and guarantee loans made by lenders and whose debt is itself implicitly guaranteed by the federal government. This setup created an easy, artificial profit opportunity for lenders to wrap up bundles of subprime loans and sell them to a government-backed buyer whose primary mandate was to "promote homeownership," not to apply sound lending standards.
Of course, lenders not only sold billions of dollars in suspect loans to Fannie Mae and Freddie Mac, contributing to their present debacle, they also retained some subprime loans themselves and sold others to Wall Street—leading to the huge banking losses we have been witnessing for months. Is this, then, a free market failure? Again, no.
In a free market, lending large amounts of money to low-income, low-credit borrowers with no down payment would quickly prove disastrous. But the Federal Reserve Board's inflationary policy of artificially low interest rates made investing in subprime loans extraordinarily profitable. Subprime borrowers who would normally not be able to pay off their expensive houses could do so, thanks to payments that plummeted along with Fed rates. And the inflationary housing boom meant homeowners rarely defaulted; so long as housing prices went up, even the worst-credit borrowers could always sell or refinance.
Thus, Fed policy turned dubious investments into fabulous successes. Bankers who made the deals lured investors and were showered with bonuses. Concerns about the possibility of mass defaults and foreclosures were assuaged by an administration whose president declared: "We want everybody in America to own their own home."
Further promoting a sense of security, every major financial institution in America—both commercial banks and investment banks—was implicitly protected by the quasi-official policy of "too big to fail." The "too big to fail" doctrine holds that, when they risk insolvency, large financial institutions (like Countrywide or Bear Stearns) must be bailed out through a network of government bodies including the Federal Deposit Insurance Corporation, the Federal Home Loan Banks and the Federal Reserve.
All of these government factors contributed to creating a situation in which millions of people were buying homes they could not afford, in which the participants experienced the illusion of prosperity, in which billions upon billions of dollars were going into bad investments. Eventually the bubble burst; the rest is history.
Given that our government was behind the wheel, influencing every aspect of the mortgage crisis, it is absurd to call today's situation the result of insufficient regulation.
Having read a similar article a long time ago, your humble Devil put forward this idea at a lunchtime meeting of a certain think-tank, and was derided. It seems to me, however, a perfectly logical argument.
As usual, the state made a bunch of laws in order to fulfill a political objective and failed to consider the unintended consequences of said laws. These unintended consequences more often than not come about because politicians—despite being some of the most selfish and corrupt people on the planet—usually fail, wilfully, to recognise that humans are intrinsically self-interested. It is particularly stupid as this is something that Adam Smith recognised many years ago.
It is not from the benevolence of the butcher the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our own necessities, but of their advantages.
One of the things that is really pissing me off at the moment is the glee and self-righteous venom with which comedians, in particular, are seizing upon the misfortunes of bankers; not only are they spouting, in the main, tediously obvious material but comedians are, let's face it, one of the most self-regarding and self-loving strains of human being on this fucking planet. But the comedians' rantings are only the most obvious and pointed manifestation of the equally distasteful tendency towards self-righteousness in everyone else.
Yeah, right: because you guys definitely would not have seized upon the chance to stuff your pockets with money were you in the same situation, eh? You would have protested, wouldn't you? You would have held your hands up and said, "no! I don't want this massive, million pound bonus."
Unless you can look into yourself and absolutely, honestly tell yourself that you wouldn't have done precisely the same thing as these bankers were you in the same position (and I reckon that there are pretty fucking few of us) then I really suggest that you shut the fuck up.
Now, as for the fucking politicians...