John F Gaski Ph.D.

The Eclectic Professor

An Unsung Underlying Cause of the Financial Mess

It Wasn't the 'Banksters'

Posted Apr 25, 2013

By now, the real reasons for our financial markets crisis of 2008-09—seriously addressed by the G. W. Bush administration, by the way—should be coming into clarifying focus. Unfortunately, they are being widely obfuscated, especially by those in the political class who are largely at fault and ducking blame. And it does not help when politicians bellow the diversionary and demagogic “Wall Street greed.” After all, greed is a constant. So what is different about this time?

Most readers should already know most of this, even if the broader public is confused, but a confluence of the following conditions is pretty explanatory of our (near) mortgage market meltdown. As will be seen, an inherently and totally non-partisan assessment fingers the liberal Democrats as prime culprits.

1. Why would a bank lend so much money to borrowers who can’t afford to repay the loans? Since when does “greed” mean a desire to lose money? Answer: It was the liberal Dems, along with some weak-spined Republicans, who forced banks to do this. Remember the Community Reinvestment Act and similar regulations? (Senior bankers certainly do.) Fatuous and cynical Democrat do-gooders actually sold the idea that unless you make mortgage loans to those too poor to afford them, you are a bigoted red-liner. They imposed the Hobson’s dilemma on our polity that either we destroy the national financial system or we are a racist nation! Is it not overdue for someone to call this absurdity by its true and ugly name? Modern liberalism is nothing if not extreme and incoherent.

2. It was the Democrats in Congress and in the Clinton administration who allowed Fannie Mae and Freddie Mac to lurch out of control, mainly as the fair price for serving as the Dems’ political slush fund. High profile Democrat operatives and Fannie officers Jamie Gorelick (remember her and other partisan things she’s done?), Franklin Raines, and James Johnson were paid hundreds of millions of dollars, and all they had to do in return was direct huge campaign contributions to the Democrat pols, as well as to their porky pet political programs.

3. The Republicans tried to reform and constrain Fannie and Freddie oh so many times but these efforts were stymied by the Democrats, notably Barney Frank and others on the Fannie-Freddie kickback payroll.

4. The “mark-to-market” requirement for bank assets collapsed solvency because assets are written down artificially. It also geometrically magnified the adverse impact on derivative instrument values and, consequently, even capital ratios. Bingo. This standard also was a Democrat brainstorm of the Clinton era. (Maybe President Clinton was distracted by something—maybe even the same thing that caused him to neglect to take out Osama Bin Laden when Clinton had a good shot at him.) Are you beginning to accept that the current financial fiasco was produced by over-regulation more than too little regulation?

5. Two Republican-appointed Fed chairmen, Greenspan and Bernanke, employing a liberal Democrat philosophy, gave away too much free money. Too concerned about the danger of a mild recession, the central bankers panicked and imposed a near-zero real interest rate for years. This induced financial institutions to chase yield with riskier loans, a predictable outcome. Speaking of: Too-low interest rates produce a financial bubble almost every time.

This last factor is also endogenous, however, with respect to a more remote cause, to wit: The Humphrey-Hawkins Act of 1978 created the Fed’s dysfunctional dual mandate of targeting unemployment as well as inflation. Because of that law, imposed by Jimmy Carter and a Democrat congress, Chairmen Greenspan and Bernanke and their successive Open Market committees thought they had no choice but to err on the side of low interest rates. I submit that more enlightened thinking on their part could have averted the disaster they helped inflict. The solution:

Simply recognize that serving the two competing masters of full employment and price stability undermines both, as we are seeing now, because of insufficient fidelity to either goal. Understand further that dedication to restraining inflation is the best course to ensure lower unemployment over the long term, and then the ill-conceived Humphrey-Hawkins impost becomes amenable to finesse. In other words, strict adherence to the law can thus be reconciled with a single-minded allegiance to price stability. (The law’s original language would not seem to prohibit this interpretation, ironically.)

So let’s try it that way from now on, shall we, Mr. Chairman? Do a semantic end-around to circumvent Humphrey-Hawkins, and then the Fed’s traditional and essential inflation fixation can be properly respected, to our economy’s betterment.


 The author is a long-time (but former) registered Democrat, which should nullify any appearance of partisanship.