The Truth About the 2008 Financial Crisis

10 Pages Posted: 13 Mar 2014

See all articles by William J. Dodwell

William J. Dodwell

Consultant to Financial Institutions

Date Written: November 27, 2012

Abstract

Government was the primary culprit in the 2008 financial crisis as it forced banks to relax mortgage underwriting standards in the spirit of the 1977 Community Reinvestment Act in order to increase home ownership among low income Americans. Fannie Mae and Freddie Mac which guaranteed most of the resulting subprime mortgages with the backing of the federal government were forced by HUD and the Congress to step up their game by lowering standards for mortgages they purchased from banks. But because a left-leaning media largely suppresses this reality to protect the liberal establishment and its affordable housing agenda, the banks are perceived to be the sole bogey man.

Indeed, the banks were not blameless as they capitalized on the political and regulatory green light to lend aggressively by laying off underwriting risk to investors through the issuance of questionable mortgage-backed securities (MBS) of their own. They also engaged in some loan servicing improprieties. In addition, the rating agencies were derelict in evaluating the creditworthiness of MBS entrusted to them. But the banks themselves suffered from their liberal lending and reliance on rating agencies by amassing huge portfolios of each other’s impaired MBS that depleted regulatory capital forcing mergers and government bailout, as well as dooming others to liquidation. The banks are mum about government-coerced lending, rather choosing to fall on their sword and pay billions in settlements. This is because they fear the political consequences of appearing “anti-poor” and dread government retaliation if they expose the truth. In the meantime, bank securitization, a financing and liquidity tool vital to a vibrant economy, has yet to recover because of the taint acquired from the government created financial crisis.

The government bank bailout was essential to preventing massive contagion in the global financial system from default on myriad lending and borrowing relationships among the banks. In fact, the bailout, along with the accommodations of the Federal Reserve Bank, stabilized the financial markets and set the stage for substantial MBS price recovery.

In the aftermath, government threw out the baby with the bathwater in Dodd-Frank financial reform restricting activities unrelated to the financial crisis. Sound lending standards and stricter capital, leverage and liquidity requirements alone would have sufficed. But Dodd-Frank unduly restricted proprietary trading, derivatives trading and consumer lending to the detriment of market liquidity and credit availability. Many believe financial reform still has not resolved the “too-big-to-fail” problem. In particular, government has not called for breaking up the behemoth banks with their systemic risks because a highly concentrated industry is easier to influence for its political purposes.

Not only was government prominent in causing the financial crisis, it assured the protracted economic malaise that followed by refusing to implement essential fiscal reform.

Keywords: government coercion, lending standards, regulatory failure, derilect rating agenies, bank wrongdoing, government bailout, Dodd-Frank Act, too-big-to-fail

Suggested Citation

Dodwell, William J., The Truth About the 2008 Financial Crisis (November 27, 2012). Available at SSRN: https://ssrn.com/abstract=2408076 or http://dx.doi.org/10.2139/ssrn.2408076

William J. Dodwell (Contact Author)

Consultant to Financial Institutions ( email )

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