The search for a scapegoat in the U.S. financial crisis will reach new heights if markets around the world continue to gasp and flounder. Banks are still terrified to lend to each other. Who can you really trust in a high-stakes shell game where mounds of bad assets are hidden somewhere, but where exactly?
One narrative of the financial crisis would lay the blame at the feet of Fannie Mae and Freddie Mac. The two mortgage giants, conservatives contend with increasing vigor, were pushed hard by Congress (especially by Democrats) to lend more to low-income families who had poor credit. What brought this mess upon us, so goes this interpretation of events, were meddling politicians, not failures of regulation or the free market.
It’s a nice story, especially for those who tend to see bleeding-heart liberals behind every tree (or hugging every tree). But it’s like trying to put a size 6 foot inside a size 12 shoe – not a good fit. Sure, Fannie and Freddy screwed up. They did buy home loans made to risky borrowers. And their very structure seriously needs reform. Congress created a monster: private companies with public responsibilities. So they can take risk like a private firm, while knowing the government will be there to bail them out if they get in trouble. Uh oh.
Still, this crisis needed rocket fuel to take off. To be this severe, it needed something beyond a bunch of plain vanilla subprime loans going belly up. And that’s where Wall Street comes in. Firms on the Street dabbled in a lot of sophisticated financial engineering. They sliced and diced lousy mortgages like a financial Ron Popeil, creating a bewildering assortment of securities and derivatives. They pushed their levels of leverage from 12 to 1 to 30 to 1. In short, they made wild bets with massive amounts of borrowed money.
Wall Street embraced unheard-of levels of risk, and that’s the main story, though there were lesser culprits. It’s a complicated narrative that requires an understanding of an alphabet soup of products and entities: ABS, CLOs, CDOs, SIVs. Listeners also have to wrap their minds around the concept of credit default swaps to appreciate how the teetering tower got so tall. But I suspect in the weeks to come, Congressional hearings will give us all a crash course in the story of 21st century risk taking, Wall Street style – and how it brought us to this awful juncture.