Bubbles Happen: Partisan Divide, the Minority Report, and the Financial Crisis Inquiry Commission (Part 2)
We are discussing the Report of the Republican Minority on the Financial Crisis Inquiry Commission. The Report was issued on December 15 in an effort to meet the deadline set out in the enabling statute. While meeting the deadline is a laudatory goal, it should not come at the expense of quality. This is not a good report. Despite more than a year of work and investigatory authority, it adds little to the debate over the causes of the financial crisis.
The Minority Report begins inauspiciously by noting that "[b]ubbles happen" as if the explanation is in part the inevitability of these things. Indeed, in describing bubbles, the Minority Report notes that "[t]he recent housing bubble was no different" than prior instances.
True enough that bubbles are recurring events but this particular "bubble" was anything other than ordinary. It was unique (at least since the Great Depression) in its severity and, having been particularly centered on housing, in its impact on ordinary people. The high tech boom in the late 1990s and early years of the new century also had the attributes of a bubble but one that was far less severe and painful than the current example. Had the Minority Report been describing the high tech bubble, the introduction would have been more fitting.
Much of the blame in the Minority Report for the current "bubble" is placed on Fannie Mae and Freddie Mac. See Report at 2 ("Through the GSEs [government-sponsored enterprises], FHA loans, VA loans, the Federal Home Loan Banks, and the Community Reinvestment Act, among other programs, the government subsidized and, in some cases, mandated the extension of credit to high-risk borrowers, propagating risks for financial firms, the mortgage market, taxpayers, and ultimately the financial system."). There is no doubt that Freddie and Fannie contributed to the crisis. But did they cause it? Not everyone thinks so. See Testimony of Thomas H. Stanton, Committee on Oversight and Government Reform U.S. House of Representatives, Dec. 9, 2008 ("That said, it is useful to note that Fannie Mae and Freddie Mac did not cause the housing bubble or the proliferation of subprime and other mortgages that borrowers could not afford to repay."). Pinning blame for the crisis on these pseudo-government agencies required far more thorough analysis than what appeared in the Minority Report.
As for the private sector participants, they mostly provided a positive service. See Report, at 3 ("However, important financial firms principally involved in pure credit intermediation—that is, providing the link between investors and borrowers—were exposed to the downturn as well, but did not understand the risks they were taking at the time."). Their failure? They ultimately, "did not understand the risks they were taking at the time." Report, at 4. As for credit rating agencies, they could be compared to ordinary investors and, as a result, "made many of the same mistakes as mortgage investors." As the Report sums up: "Put simply, the risk of a housing collapse was simply not appreciated. Not by homeowners, not by investors, not by banks, not by rating agencies, and not by regulators." Id. at 5.
As for the immediate cause of the crisis, here is the explanation:
- Following the successive collapses of Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, and American International Group (AIG), what had begun in the second half of 2007 as a run on those firms that the market identified as having large mortgage exposures and acute liquidity risks exploded into a generalized market panic. Depository institutions had failed. Investment banks had failed. A major insurance holding company was rescued by the U.S. government. Even the GSEs, with their implicit guarantee, were taken into conservatorship by their regulator. Few firms were considered safe, and if they were, it was only because they had a government backstop.
Certainly the market was, by September 2008, edgy from many of the examples given in the prior paragraph. But the Minority Report more or less ignored the singular importance of the collapse of Lehman. Most of the examples mentioned in the paragraph above resulted in direct or indirect government bailouts. In other words, the crisis was largely averted as long as the government stood ready to intervene. The market was assured that despite the uncertainty, the government would step in and prevent large failures.
That belief went out the window when Lehman was allowed to fail. Only then did the financial system freeze, the interbank market effectively shut down, and commercial paper markets dried up. In other words, it was the absence of government intervention that set off the crisis. Yet the Report has little to say about this. Instead, it concludes:
- These were the best of a series of bad options, and policymakers had extremely limited information to work with. While we believe that the government deserves quite a lot of the blame for getting our financial system and our nation into trouble in the first place, we applaud the quick and decisive actions taken by our nation’s leaders during the panic.
There are differing views on the cause of the crisis. The debate can benefit from multiple viewpoints, as long as they are well reasoned. This Report, however, provides little insight into what actually happened and why. It provides little help to policy makers should similar circumstances arise again.
One can hope that when the Majority Report is issued in January it will provide more insightful analysis.