Free Markets, Free People

Why Occupy Wall Street has it wrong

If you listen to those who are semi-coherent in the Occupy Wall Street crowd, they blame Wall Street for the financial straits we’re in. They’ve been convinced (and I’m sure for most it didn’t take much convincing) that it is the greed and recklessness of bankers and Wall Street tycoons which caused the housing bubble and subsequent financial collapse.

However Peter Wallison has taken the time and made the effort to lay out the entire sequence of government actions (and their subsequent consequences) which drove both the housing bubble and its collapse which put us in the financial position we’re in today.

As usual, it was government intrusion – in the name of social justice – that distorted the housing market and created incentives that otherwise wouldn’t have been there. Social engineering, with the best of intentions, that led to catastrophic unintended consequences.

The irony, of course, and what Wallison points out, is the OWS crowd is clueless at best or mendacious at worst. But the fault for our condition should be laid squarely in government’s lap. Where these protests should be taking place is in front of Congress, the White House, Fannie Mae and Freddie Mac and the Federal Housing Administration – not Wall Street.

Beginning in 1992, the government required Fannie Mae and Freddie Mac to direct a substantial portion of their mortgage financing to borrowers who were at or below the median income in their communities. The original legislative quota was 30%. But the Department of Housing and Urban Development was given authority to adjust it, and through the Bill Clinton and George W. Bush administrations HUD raised the quota to 50% by 2000 and 55% by 2007.

It is certainly possible to find prime borrowers among people with incomes below the median. But when more than half of the mortgages Fannie and Freddie were required to buy were required to have that characteristic, these two government-sponsored enterprises had to significantly reduce their underwriting standards.

Fannie and Freddie were not the only government-backed or government-controlled organizations that were enlisted in this process. The Federal Housing Administration was competing with Fannie and Freddie for the same mortgages. And thanks to rules adopted in 1995 under the Community Reinvestment Act, regulated banks as well as savings and loan associations had to make a certain number of loans to borrowers who were at or below 80% of the median income in the areas they served.

So there are the required guidelines – by law – enforced by government. And note, it wasn’t just Democrats. It was Republicans too. But the impetus and driving force behind all of this wasn’t Wall Street. It was government.

Moving on:

Research by Edward Pinto, a former chief credit officer of Fannie Mae (now a colleague of mine at the American Enterprise Institute) has shown that 27 million loans—half of all mortgages in the U.S.—were subprime or otherwise weak by 2008. That is, the loans were made to borrowers with blemished credit, or were loans with no or low down payments, no documentation, or required only interest payments.

Of these, over 70% were held or guaranteed by Fannie and Freddie or some other government agency or government-regulated institution. Thus it is clear where the demand for these deficient mortgages came from.

The huge government investment in subprime mortgages achieved its purpose. Home ownership in the U.S. increased to 69% from 65% (where it had been for 30 years). But it also led to the biggest housing bubble in American history. This bubble, which lasted from 1997 to 2007, also created a huge private market for mortgage-backed securities (MBS) based on pools of subprime loans. [emphasis mine]

Subprime loans, required by law to go to a certain percentage of applicants who otherwise wouldn’t get loans, built to half of all loans closed. Bubble created. Why? Because you’re talking about government “guaranteed” loans – safe money. That created a private market for MBS because the subprime loans in question would have been a poor risk on their own, but were a good risk with the government guarantee.

Demand grew, the bubble grew. But this was a foundation built on financial sand:

As housing bubbles grow, rising prices suppress delinquencies and defaults. People who could not meet their mortgage obligations could refinance or sell, because their houses were now worth more.

Accordingly, by the mid-2000s, investors had begun to notice that securities based on subprime mortgages were producing the high yields, but not showing the large number of defaults, that are usually associated with subprime loans. This triggered strong investor demand for these securities, causing the growth of the first significant private market for MBS based on subprime and other risky mortgages.

Again, because of who was holding or guaranteeing the loans, the real risk was masked, thereby triggering demand for these high-yield securities. How risky could they really be if they’re backed by the full faith and credit of the US, right?

And so the MBS market continued to grow:

By 2008, Mr. Pinto has shown, this market consisted of about 7.8 million subprime loans, somewhat less than one-third of the 27 million that were then outstanding. The private financial sector must certainly share some blame for the financial crisis, but it cannot fairly be accused of causing that crisis when only a small minority of subprime and other risky mortgages outstanding in 2008 were the result of that private activity.

And there is the salient point. No government intrusion, no government guarantees, no laws which “encouraged” or put quotas on loans with a certain percentage in the subprime category and no housing bubble, no demand for risky MBS, no financial crisis.

People, as they have for centuries, would have actually had to meet much stricter criteria for a loan and fewer would have owned homes. The market would have stayed stable, no bubble would have developed and we’d not be in the shape we’re in today. Oh, don’t get me wrong – government would still be out of control and on it’s eternal spending spree – but we wouldn’t have the added financial stress of a recession caused by government.

When the bubble popped, the inevitable happened:

When the bubble deflated in 2007, an unprecedented number of weak mortgages went into default, driving down housing prices throughout the U.S. and throwing Fannie and Freddie into insolvency. Seeing these sudden losses, investors fled from the market for privately issued MBS, and mark-to-market accounting required banks and others to write down the value of their mortgage-backed assets to the distress levels in a market that now had few buyers. This raised questions about the solvency and liquidity of the largest financial institutions and began a period of great investor anxiety.

The government’s rescue of Bear Stearns in March 2008 temporarily calmed the market. But it created significant moral hazard: Market participants were led to believe that the government would rescue all large financial institutions. When Lehman Brothers was allowed to fail in September, investors panicked. They withdrew their funds from the institutions that held large amounts of privately issued MBS, causing banks and others—such as investment banks, finance companies and insurers—to hoard cash against the risk of further withdrawals. Their refusal to lend to one another in these conditions froze credit markets, bringing on what we now call the financial crisis.

And there’s the real litany of how what happened happened. Market distortion by government is the real cause of this debacle. We’ve been pointing this out for quite some time. The problem, of course, is the unintended consequences of such intrusion seem never to be understood by the lawmakers and technocrats who come up with these sorts of grand social justice schemes. And again, understand that it wasn’t just the Democrats who helped this all along.

The bottom line however, as Wallison points out, is that while Wall Street isn’t blameless in all of this, their role, in comparison, is minor. The entire scenario was government inspired. However, that’s not what has been sold to the public. Instead we’ve gotten propaganda and class warfare in a blatant attempt to shift the blame to private concerns:

The narrative that came out of these events—largely propagated by government officials and accepted by a credulous media—was that the private sector’s greed and risk-taking caused the financial crisis and the government’s policies were not responsible. This narrative stimulated the punitive Dodd-Frank Act—fittingly named after Congress’s two key supporters of the government’s destructive housing policies. It also gave us the occupiers of Wall Street.

Indeed. If anyone needs to be in jail it is the perpetrators of the government policy that encouraged/required the market distortion that led to the bubble and ultimately collapse of the housing market.

That wasn’t Wall Street. What happened in the financial community is they reacted to an incentive created and supposedly guaranteed by government. But it was unsustainable. And it finally came to a head, dealing financial destruction all around.

Here’s the bottom line – no government intrusion, no incentive/requirement to push subprime loans. No subprime loans (especially in the amount required by government), no housing bubble. No housing bubble, no financial crisis. No financial crisis, no OWS, who simply have it all wrong.

But then, given the government propaganda effort to this group who want to believe what government is claiming, is anyone surprised?


Twitter: @McQandO

Tweet about this on TwitterShare on FacebookShare on Google+Share on TumblrShare on StumbleUponShare on RedditPin on PinterestEmail this to someone

50 Responses to Why Occupy Wall Street has it wrong

  • I’m sorry, but wallstreet isn’t completely off the hook.  They were drunk on the credit market as well.  Investing in monetized high risk mortgages.  

    Its not like they didn’t know where the debt was coming from who was on the hook for it and even worse that it was based on a unsustainable housing equity bubble. 

    • I think I was pretty clear that Wall Street isn’t off the hook in the post.

      • What would they be on the hook for?
        Also: Read Sowell’s book “Housing: Boom and Bust” for a much more in-depth analysis of all the screwed up interventions the gub’mint pulled. Essentially, the 2008 bust was a perfect storm of political stupidity and statism.

        • Wall Street is on the hook for giving people sub-prime loans when they could afford prime loans. They are on the hook for using ‘robo-signers’ to illegally foreclose on people when the bank may or may not have had the right to do so. This caused further damage to the housing market–by creating uncertainty and making title insurance unavailable–without the influence of government or citizens. The blame lies completely with Wall Street on those two.
          And let’s get real for a minute, were the government policies that enabled the housing bubble enacted in an attempt to help people buy homes or did Wall Street lobby Congress for the policies, knowing that they would bring about a tidal wave of Wall Street profits and create a lucrative housing bubble? Knowing what we all know about the influence of money in government, it is not a stretch to imagine that Wall Street engineered the bubble for their own gain.
          So, that’s the housing crisis. But Wall Street is responsible for other transgressions as well. The gambling casino that Wall Street turned into was created by them. Not government. Not citizens. Does anybody really believe that we went into Iraq or Afghanistan for national security? It is much more believable that it was done for the benefit of corporations that could reap huge profits from the conflict.

          • Oh yeah, Wall Street is also responsible for giving bad mortgages and bad bundled mortgage debt obligations AAA ratings when they did not deserve them.

      • I think it’s a chicken and egg sort of thing.  Fannie and Freddie were required by law to buy the subprime mortgages.
        But who created the Subprime products in the first place?  I don’t recall the stories of thousands of potential borrowers flooding banks with weapons and demanding ‘subprime loans or else!’.

        The housing crisis was aided and abetted by all:  the private sector for creating the products that allowed the loans and the buying and selling of derivatives based upon the bundled loans; the private sector appraisers who willfully allowed rampant inflation of home value so the mortgage orginators could make sure a property ‘qualified’; the public sector in the form of state and local governments who had no incentive to truely watch what the appraisers/mortgage originators were doing since increases in home values resulted in higher property taxes at each closing; and the Feds as documented in this article and others.

    • Except they were NOT considered “high risk”, they were “backed” by Fannie/Freddie, making they akin to Treasuries. IIRC, MBS’s were considered a very LOW risk paper for over 40 years.
      Certainly Wall Street should have been more dubious about government paper that covered the market interventions over the previous years (1994-2008), but free thinkers are not a common fixture in that industry.

    • Markets TEND to be rational.
      When you DISTORT markets, they react RATIONALLY to the distorted reality.
      Market players (from house-flippers to Wall St. derivative traders) were ONLY guilty of not being prescient enough to look narrowly at the distortions and predict where they would lead.
      SOME of them actually had that kind of capacity, and SOME PREDICTED exactly what happened.  Some knew and did not care.
      The EVIIIIIILLLLLLLL ChimpyMcHitler warned 17 times that we were headed for a burst bubble.
      Frank, Dodd, and Waters…among others…DEFEATED all attempts to stop the train wreak.

      • I would say that markets are not rational in the common usage of that term.  Individuals are rational but markets are driven at least as much by emotion, herd instinct, and fear as they are by rationality.
        The individual investor, even should he make a bad investment does so because he rationally perceives some advantage at the time.  But the market in aggregate is an unreasoning beast as is any mob.
        And yes, government distortions make everything worse because they may cause the individual investor to make bad decisions and when that happens enough times, that drives the herd instinct of the market.

        • You’re confusing “the stock market” and the like with MARKETS.  Movement on the stock market CAN be a matter of flocking behavior…sheep following other sheep.  Over time, though, even the stock market TENDS to be rational.
          But MARKET behavior is not much afflicted by that AT ALL.  Individual people may buy an iPhone for some irrational reasons, but the MAIN trend is utterly rational.  Even fads have utility.

    • The WSJ piece has Wall Street responsible for about a 1/3 of the mess.  That leaves an awful lot of blame left over.

    • Here’s the thing though….the assorted rabble in the OWS protests are the ones who have been impacted by Wall Street the LEAST! They’re stupid kids who got hoodwinked by BIG EDUCATION into going deeply into debt to get useless degrees. Or they’re people that would never be successful at any rate, regardless of Wall Street machinations. I’m sorry if there are no jobs for poli-sci majors or Womyn’s studies majors (actually, no I’m not), maybe you should’ve learned plumbing, electrician, or auto mechanic instead of getting your useless degree that you thought was the ticket to the good life.
      It’s the Tea Partiers that were the ones impacted by Fannie and Freddie, the responsible adults with homes or 401Ks who try to make something of themselves. And because they were directly impacted, they correctly diagnosed the problem. The OWS taker-class are so stupid – they’re advocating for the current administration which is massively in bed with Wall Street and business. If this band of dopey kids should be protesting against anyone, it should be the govt, the education cartel (not my phrasing but I love it) and their sh*tty boomer-era parents who most especially sold them out. Mom and dad got theirs (and will continue to get theirs until the boomers mercifully shuffle off the stage of history) but junior got stuck with the bill.

      • Are you really so blinkered in your thinking to not see that the ENTIRE country, no the WORLD, has been affected by the sub prime issues? Do you think OWS folks aren’t dealing with the same financial insecurity that has come of things as the Tea Partiers?!? Lack of jobs, no healthcare, no ability to even contemplate INVESTING, let alone saving for anything beyond….It’s bizarre that the response from some folks like you is to assail OWS folks for being smelly students with nothing better to do while holding up the Tea Party as the bastion banner wielding saviors of democracy.

  • Since Freddie Mac and Fannie Mae are probably the biggest ongoing receivers of federal bailout largesse, you’d think they would be over at Fannie Mae (3900 Wisconsin Avenue, NW, DC) or Freddie Mac (8200 Jones Branch Drive, McLean, VA) protesting.

  • Warren Buffet said, “When the tide goes out, you see who’s swimming naked.”
    What we’ve learned, my take away anyway, is that government is no longer accountable to the public when bad things happen. It’s just another triumph of good intentions over prudence. Why is it that Franklin Raines and his co-conspirators could cook the books at Fannie Mae, years before the great real estate crash, award themselves tens of millions of dollars in bonuses and not be in jail and forced to disgorge their ill gotten gains. They were the managers of a government sponsored enterprise, a classification that enabled them to borrow money at near Treasury rates because they were guaranteed by the taxpayers.

    • What do you mean ?  Maxine Waters told us that Fannie Mae was “under the outstanding leadership of Franklin Raines”

  • This may not be the best thread for it but dailykos has a nice little chart up the Tea Party and this bunch of loons.

  • It would be foolish to think the US Government would demand that banks lend to people who could not pay the monthly payments. Tea Baggers and Fox News viewers will use the lie to spit on their fellow Americans. Thoughtful people will understand that companies in business to make a profit – and have shareholders/Boards of Directors to answer to – cannot create loans dedicated to not performing. You know, you don’t have to believe all the BS – you can use your own brain to decide what sounds most likely.

    • Funny.  There HAD been standards that ALLLLLLLLL mortgage lenders applied.
      Mortgages were KNOWN for their low risk levels, due to those standards.
      You COULD find (if you had a working mind) the quotes from Janet Reno threatening banks with DOJ prosecution, and withholding permissive mergers IF they did not toe the MANDATED line.  MANDATING that the standard of care for lenders be abandoned.
      But you are too stupid and your skull too packed with crap to exercise yourself.
      Fine with me.

      • Angelo says to not mention Chris Dodd & Kent Conrad.  He also says thank you Barney Frank, Nancy Pelosi & Joe Biden.

    • ” cannot create loans dedicated to not performing”  – right exactly!  So what exactly had them suddenly running around handing out money to people who couldn’t afford the homes they were buying?
      Let me guess how old you are, let me guess how many mortgages you’ve applied for and WHEN you applied for them.
      I’ve seen both versions of the home loan market, and the earlier version (say, 1984) was much more rigorous in who got loans and how much they got.

    • Jimbo:
      City Journal had a nice piece on the CRA and how it and other gov’t-mandated policies were no good.  Take note: <a href=””>this article is from 2000.</a>

    • Not mentioned in the piece was that reserve requirements for sub-prime loans were 1/5 of what was required for a typical business loan.
      The reserve levels were set internationally, so there is plenty of blame to spread around the globe.

      • For secured or unsecured debt?  I makes a HUGE difference.
        A BIG reason that mortgages were HISTORICALLY low-risk is that they were secured by real property.
        Even in bankruptcy, you were GOING to get the asset (the property on which the loan was issued), so you were not going to eat the whole loan.
        The CRA stood that on its head.

    • it is really too bad that you have never used your brain, ever. No loan officer had to answer to the board of directors for making a loan backed by the full faith and credit of the United States government idiot.

  • Wot! Wot?  Are you saying the markets that need government to adjust them were screwed up by government!!!!!!
    Solyndrus sir!  I mean slanderous sir!

  • <b>Indeed.  If anyone needs to be in jail it is the perpetrators of the government policy that encouraged/required the market distortion that led to the bubble and ultimately collapse of the housing market.</b>

    “Congressman Frank? There’s a police officer here to see you.”

  • Would you not agree that the federal government in general, and the political class in particular, has a vested interest in the American people NOT understanding economics and markets?
    After all, the more Americans understand them, the more Americans realize that prosperity is maximized when the government does not interfere.  But that enlightened condition is contrary to the interests of the political class, who continually want to aggregate more power to themselves, economic and otherwise.
    The more the people remain economically ignorant, the more they will ask the political class to exert greater control.  Thus, we have the Occupy Wall Street people who certainly seem ignorant, and want authorities to abolish “greed” and whatnot.
    Exception: there is a small contingent of protesters who claim to want to “decentralize everything”.  But whether they understand that this disempowers government, I’m not sure.
    —Tom Nally, New Orleans

  • Government policy did not cause the crisis.  The government did not regulate OTC derivative trade, and bonds based on subprime loans mushroomed because the big banks wanted all the mortgages they could get in order to turn them into bonds.  They were the ones that were pushing up demand, NOT government policy.  Indeed, Fannie and Freddie were very conservative in comparison.  Fannie and Freddie did things wrong too, but if not for the big financial institutions the subprime loans could not have caused this crisis.  That was caused by the private sector, this is a private sector crisis.  Sure, you can find someone on the right who will write an “analysis” and claim it’s all due to government, and people with their mind made up and closed to anything that disagrees with their opinion will be persuaded by such polemics.   But no serious scholar blames government policy alone, or primarily government policy — and when they do it’s the free market refusal to regulate that usually gets blamed (see Frontline’s episode “The Warning.”
    For good analysis try Roger Lowenstein’s “The End of Wall Street,” or Nocera and McLean’s “All the Devils are Here” (which also criticizes Freddie and Fannie, though in perspective of everything else going on), or William Cohan’s “House of Cards,” or if you really want something provocative from the left, Matt Taibbi’s Griftopia.  To say it’s just government is so silly that it is to be mocked as out of touch with reality.
    OWS is the start of a new social movement that will probably be around for some time and change America like the counter culture movement of the late sixties/early seventies.  I really don’t think you understand – the tea party was a brief reactionary moment, but the future is what you see in every city around the country, the future is the youth.  I don’t think you realize how “20th Century” your thinking is — and how quickly it is about to pass.

    • OWS is the start of a new social movement that will probably be around for some time
      >>>> No, this is not new, communism has been around for quite awhile already.

    • IOW – The science is settled! Just because you proved the government created the market for sub-prime mortgages, and literally required that lenders give out a certain percentage of sub-primes mortgages, doesn’t mean the evil banks had to take advantage the system by giving out so many. They had the option of lowering the market’s overall risk by turning away huge numbers of fully-qualified buyers, and chose not to take it merely because the government created profit incentives.

      By the same logic, used car sellers are primarily to blame for the number of teen drivers that have accidents with serious injuries. The state governments may allow them to drive when they are 16, but they don’t regulate that they all have well-maintained Volvos with ABS. That falls to the private sector, and they have obviosly failed.

      • Can you even differentiate between different political or economic systems? Do you understand that Communism, Marxism, and Socialism are not one and the same?  You really are stuck in 20th century thinking, closer to 1950’s Cold War thought…

    • Poor Erb, various like-minded hip, with-it, middle-aged 20th century analysts thought that the riots in England were the start of a new revolution as well… the yoof in the van of a dawning of an age of Aquarius or some such day-dreamy Marxist shite. How disappointed they were to find out that the yoof were just looters, gang-bangers, nihilistic thrill-seekers etc.
      Maybe if they had come up with some 21st Century hash-tag to stick on their “movement” they’d have made some change… or not. The problem is everyone with half a brain knows that any leftist “movement” is going to turn violent in fairly short order and the vast majority of western countries abhor that. Doesn’t matter if they’re rich or poor, specially poor, they simply do not like it because the violent lefties invariably shit in their own nests and trash their neighbors.
      Which is a major difference from the Tea Partiers. No one expects them to get violent, despite the left’s and the media’s fervent wish that someone shoots a black man at one of their assemblies. So, the Tea Partiers have a clear agenda and civil attitude to their fellow citizens, while the Occupiers (and their Collaborators) are one step away from organized violence with no agenda. Thus the Tea Party gets political traction and the Occupiers and Collaborators get to shit on police cars and wonder why the 99% ignore them.
      Still I’m only a Gen-Xer who thought that the same style of muppets who did the same thing back in the old 20th century were just as useless and deluded. God willing we will soon be rid of the various old-age hippies who desperately want the 60s to come back so they can get some more free sex and drugs rather than continue to rebel against their parents at the age of 66.

    • From ACE:

      “The left has all of their eggs in the basket of proto-socialist revolution, then.
      This is what they’ve got left. They see it crumbling all around them. They’re desperate. Desperate enough to drop the pretense that they’re really sensible capitalists who merely want a reasonable social safety net, and to start unmasking themselves as genuine socialists.”

    • “I don’t think you realize how “20th Century” your thinking is — and how quickly it is about to pass.”
      Well, heh, it beats your Soviet Union thinking, which has, much to the delight of a good portion of the world, already passed.
      All except for the Occupy Coffee Shops movement.  Why don’t YOU do something about the cost of college education Professor, lead a protest, take a pay cut, demand your schools lower tuition and stop enslaving these poor kids to college loans.
      Yeah, uh huh, thought so.

    • I believe, Erp, if you tried, you could find the Paul Krugman editorial where he called for the inflation of a housing bubble in the U.S.
      This would have been around the turn of the century (I love saying that!).  It was followed in short order by Fed policy that pretty much did just what Krugman suggested.
      This was the gasoline on the fire lit by the CRA.
      You are such an intellectual lightweight you cannot allow cause and effect to penetrate your preconceptions.
      The Attack of the Eloi IS the reactionary force to the TEA Party, you fool.  It is Soros funded and founded, and run out of the White House.  And it is already turning destructive and violent.

    • By the way, one thing you haven’t considered…..the “brief, reactionary” tea party GOT CANDIDATES ELECTED TO CONGRESS. They got candidates elected to state and local govts. That means they’ll have lasting impact. When we’re talking about possible Pres. Rubio within a decade, we’ll see if the OWS movement left anything behind that was more lasting than their compost

  • “Government policy did not cause the crisis. … Fannie and Freddie did things wrong too, but if not for the big financial institutions the subprime loans could not have caused this crisis.”

    Subprime mortgages are a direct result of government policy.  Without this artificial pressure, banks would not lend to high risk borrowers without large down payments and high interest rates to mitigate the risk.
    Ergo, without Freddie and Fannie and the other government influences, this particular crisis would never have happened.

    • Really? Big banks would have walked away from the lucrative sub-prime mortgages? I would like to see that happen! They knew that Fannie/Freddy would get stuck with the delinquent mortgages and the issuing banks could walk away with the loot and pay themselves fat bonuses.

  • I have to quibble with this, Bruce. The banks themselves have admitted that the law was not the reason they were issuing so many subprime loans. They issued subprime loans because they were extremely profitable. Prime rates were so low that lenders could charge rates sufficiently high to guarantee profit but still low in absolute terms. The real kicker came when Fannie Mae decided it needed to get in on this profit action and agreed to purchase loans from the subprime lenders (Franklin Raines should be shot), further reducing the banks downside and providing perverse incentive to make ridiculous lending decisions. The CRA was really irrelevant.

    • CRA set the policy (and regulatory) basis for the crisis. As you read in the post, there were quotas for loans to people who otherwise wouldn’t have qualified. Those were usually subprime. And, they were thought, given the fact that Fannie or Freddie bought most of them, to be mostly risk free. Without the impetus from government there would have been no reason to expand the subprime market to the degree it was expanded.

  • Wall Street and big corporations steer government in almost every decision it makes these days. I suspect that the housing bubble was engineered by big banks who knew that they could make a killing off it. Low and behold, that is certainly what happened. Usually people don’t make obscene amounts of money by mere accident.