Does anyone know precisely what caused the economic crisis? That question can’t be answered, at least right now—the matter is far too complex and multifaceted for anyone to fully understand its causes. The sheer number of players involved (banks, mortgage lenders, Fannie and Freddie, and Congress, just to name a few) and the inherent difficulties of economics make comprehending all the causes and reasons for the worldwide credit crunch immensely difficult for even for experts, and virtually impossible for laypeople.
Unless you happen to be a liberal. Then, all the reasons for the crisis can be summed up in one word—deregulation. If a liberal wants to expand on the root causes of the recession, he might mention George Bush, or maybe Wall Street greed. On the Left, there is no doubt that it was laissez-faire economics and deregulation that brought down Wall Street. Barack Obama said that the recession was a “final verdict” on the policies of the Bush Administration.
Deregulation (or perhaps more accurately, poor regulation) undoubtedly played a part in Wall Street’s collapse. But to saddle deregulation with all the blame in to grossly oversimplify the reasons for the current economic situation.
In reality, government is as much responsible as big business for the mess we’re in. At the root of the problem are former mortgage giants Fannie Mae and Freddie Mac—and both were originally created by the federal government. Eventually, both became hybrid corporations—owned by both private individuals and the federal government. So the federal government had a great deal of control over Fannie and Freddie.
Congressmen like homeowners—homeowners tend to be content, and contented voters mean reelection. Fannie and Freddie were in the business of buying mortgages, which meant that the number of mortgages sold was closely connected to the number they would buy. So Congress pressured Fannie and Freddie to accept risky subprime mortgages, thus allowing more Americans to realize the American Dream of owning a house. And Fannie and Freddie did as Congress wanted—both unveiled programs to ensure that low-income buyers could get mortgages, and spent billions on risky subprime mortgages.
Fannie and Freddie both bought and sold mortgages. They didn’t actually sell mortgages to future homeowners, but rather bought them from mortgage lenders. They then kept some, and sold the rest to third-party investors. Fannie and Freddie were seen as safe, reliable investments.
So on one end, Fannie and Freddie determined (in large part) the habits of mortgage companies (and so the housing market), on the other, they sold billions of dollars worth of mortgages, including many to banks and large corporations. Given their size and reach, these institutions were cornerstones of our economy.
Congress thought so too—when billions in subprime loans started worrying banks and other financial institutions, Congress stepped in to help—by pressuring Fannie Mae to buy tens of billions worth of bad debts. That kind of risk (and given the subprime market, this was a disastrous investment) is a horrible way to run a company, and contributed to Fannie Mae’s collapse. But it was a result of government intervention, not regulation run amuck.
But deregulation was to blame for the fact that no one saw the collapse coming, right? Not so much. Early in 2008, Henry Paulson noticed Fannie’s and Freddie’s instability, so he sent Robert K. Steel to deal with the problem. Steel failed miserably—he was unable to get either company to raise any meaningful amount of money to cover bad loans. Had the federal government (or the leadership of Fannie Mae or Freddie Mac, for that matter) done something then, perhaps much of the resulting crisis might have been forestalled.
Finally, in July, Paulson asked Congress for authority to take over Fannie and Freddie should the situation require it. He thought the prospect of a takeover alone should stabilize the situation—he compared the takeover authority to a bazooka—“ff you’ve got a bazooka and people know you’ve got it, you may not have to take it out”—but the idea of a takeover did nothing to stabilize the situation.
After Fannie’s and Freddie’s stock became worthless, banks realized that any mortgages they had bought to shore up their portfolios were now virtually worthless. Fannie Mae’s and Freddie Mac’s collapse sent ripples throughout the economy.
Would better regulation have, possibly, prevented the economic meltdown? Maybe.
But had the federal government not mishandled Fannie and Freddie so terribly, perhaps the economy could have avoided recession, or at least the horribly lengthy and expensive sort we’re in. (Either way, a lot of blame still attaches itself to the Bush Administration—it both pushed deregulation and pressured Fannie and Freddie to accept risky mortgages). Deregulation was certainly not solely, and probably not even primarily, responsible for the economy’s failure.