What Caused the Financial Crisis of 2008?

I recently rewatched one of the best financial movies of all time: Margin Call. It’s expertly acted, intensely dramatic, and has some great cinematography. There’s only one problem for a film about the 2008 financial crisis: it completely misses the root cause.

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Near the end of the film, it’s clear that the filmmakers see greedy bankers as the cause of the 2008 financial crisis (and every preceding one). The only mention of federal agents occurs when some C-level management warn the CEO that the feds will come in and try to stop the firesale that would kick off the largest economic downturn since the Great Depression. They paint a nice fairy tale of a Wild West of careless corporate bigshots willing to destroy the economy in order to get out alive.

They forgot to mention the capitalized gains and the socialized losses in our current crony capitalist system. They forgot to mention the moral hazard that accompanies federal bailouts every 15 years. And, most importantly, they forgot to mention what instigated the risky security package that the careless corporate bigshot gambled on and lost.

Yes, greedy corporations played a part in the financial meltdown of 2008 but they didn’t operate in a vacuum. They were egged on—perhaps even orchestrated—by the federal government.

I explain how in an excerpt from the pop philosophy Everyone Agrees:

It’s clear to most Americans that government has overstepped its charter, especially with the 2008 bailout package. Most Americans were against Bush’s $700 billion corporate welfare plan and practically everyone involved in the legislation of the package agreed that it wasn’t ideal. Even those who said we needed to pass the bill admitted its flaws. President Bush, a self-proclaimed supporter of free enterprise, said that his “natural instinct is to oppose government intervention. I believe companies that make bad decisions should be allowed to go out of business.” In other words, he wouldn’t have promoted the bailout package under normal circumstances. Democratic Congressman Frank agreed that the bailout was a bad move, saying, “We just had to pass a bill that no one was happy to pass.” But under the circumstances leading up to the credit crisis, these politicians felt it was necessary to regulate. After all, they thought, it was the lack of regulation that led to the crisis in the first place.

Financial crisis headlinesBut what was the real cause of the financial crisis? It turns out that unfettered free markets weren’t the problem that caused the financial crisis, government intervention was. In 1999, the government-chartered company Fannie Mae, which bought loans from home mortgage companies and resold them as securities, received pressure from the outgoing Clinton administration to ease its credit requirements for home mortgages. As a result, the new CEO of Fannie Mae, Harold Raines, changed the course of the mortgage giant to emphasize affordable rental housing and home ownership for less qualified buyers. As Raines said, “Fannie Mae has expanded home ownership for millions of families in the 1990s by reducing down payment requirements.” And, backed by the U.S. taxpayer, Fannie Mae had a lot more power than other mortgage companies in order to offer less qualified loans. By 2001, Fannie controlled 43 percent of the mortgage market.

The overall result was that mortgage companies sold loans to buyers they knew could not afford to pay back those loans. Why? Because government-backed Fannie Mae was eager to take the loans off the hands of the banks. The situation was compounded when, in 2004, the U.S. Department of Housing and Urban Development required Fannie Mae (and its partner Freddie Mac) to purchase even more “affordable” loans from banks. Backed by the American taxpayer, government officials increased the amount of bad loans on the books to problematic levels.

The intent of this government intrusion into the free market was good; the Clinton and Bush administrations wanted more people to own a home and enjoy a larger slice of the American pie. However, it’s clear that their policy was misguided. Allowing more people to purchase homes increased the demand, which—no surprise—made home prices skyrocket. The government’s policies blew the housing bubble that saw 20-plus percent gains in home values year after year from 2004 to 2007, making it more difficult for everyone to buy a home. In addition, government policies saddled banks and mortgage companies with trillions of dollars in risky debt which was profitable while the markets charged forward but that became “toxic” once the housing and credit markets began to tighten up when the bubble burst. The mortgage market was plugging along just fine for decades before government policy from the late ‘90s on increased sub-prime lending in an unsustainable way.

Thus, it is reasonable to conclude that irresponsible government intervention in the free market, not the free market itself, caused the financial debacle in the last half of 2008. As the New York Times writer Steven A. Holmes predicted in an article in 1999 about the risky government intervention, “In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s.” Regrettably, that’s exactly what happened. And Bush and Frank’s plan to make innocent people pay for the mistakes of government officials was the inevitable cost of careless legislation. In fact, those politicians along with many others are trying to fix the financial crisis by applying the same techniques (taxpayer-backed bailouts) that got us in to the mess in the first place.

Seeing that unwarranted government intervention into the free markets set us up for the financial crisis in 2008, it’s only reasonable to conclude that more of the same isn’t going to get us out of the mess. The only thing that will get us on solid footing is a return to sound fiscal policies and a return to the small-government mentality that the United States was founded on. This will take an enormous paradigm shift in the public mindset, but I believe that it’s in everyone’s best interest. After all, liberty is something that everyone can agree on.