The Gospel Coalition

More bad news today. The U.S. economy in the fourth quarter of 2008 shrunk by 3.8%. Although economists feared the decline might be even worse, it’s still the sharpest quarterly plunge since the 6.4% dive in the first quarter of 1982.

So what’s the problem? Everyone knows that the poor economy has something to do with the “housing bubble” and the “credit crunch.” But where did these problems come from? There are lots of popular villains to choose from, be it President Bush, capitalism, Wall Street fat cats, or just plain greed. But the simplistic answers, in this case, are not the right answers. There are several factors which contributed to the meltdown of 2008.

In the book, A World of Wealth: How Capitalism Turns Profits into Progress (FT Press 2008), Thomas Donlan suggests several reasons for the housing bubble and ensuing credit crunch. The book as a whole is uneven and awkwardly written at times, but Donlan’s list of “candidates for blame” is extremely helpful.

1. Allan Greenspan. He led the Fed to lower interest rates far below normal and supplied credit to almost anyone. The result: people were borrowing at alarming rates.

2. George W. Bush. The President and the Republicans in Congress did not reign in spending.

3. Bill Clinton. His administration’s legislation and regulation made borrowing and lending easier and easier.

4. William R. Fair and Earl J. Isaac. They started a credit analysis company called Fair Isaac which is used in three out of four U.S. mortgages. Fair Isaac’s “objective analytics turned credit decision making from a character judgment into a commodity.” Now hundreds of loans with the same credit score could be packaged together and sold to another buyer.

5. Wall Street Invesment Bankers. Bankers packaged thousands of mortgages into “collateralized mortgage obligations” (CMOs). Investors and speculators started buying up the CMOs, with the promise of high returns. Investors didn’t analyze these bundles on their own. So when bankers started slipping in more and more risky mortgages (people with low credit scores, shady loans, houses appraised too high, etc.), investors didn’t take the time to figure out they were purchasing damaged goods. But as along as investors kept buying up the bundles, people kept getting loans and housing prices kept going up.

6. Rating Agencies. These are the agencies, like Standard and Poor’s, that rated the CMOs. They also believed the hype and gave the securities higher ratings than they deserved. Plus, those issuing the CMOs pay the rating agencies to rate their products. So the rating agencies have an interest in giving good ratings, so as not to bite the hand that feeds them.

7. Investors. Even though the CMOs were producing a relatively small yield on average, investors were still dreaming of high rewards. They ignored the increasing risks and kept investing anyway. That’s where the bubble came from–too much money going too fast into something that is not producing a strong return (like the dot com bubble in the 90s where investors were pouring millions into companies that had yet to make a profit).

8. Predatory Lenders. Some lenders wrote mortgages just because they could. They collected the fees (from people who didn’t need to refinance or couldn’t afford the loan) and sold the mortgage to a hungry market. Some lenders also started selling unhelpful products that put people into loans they could pay in the very short term (because of subprime interest rates), but had no way of paying in a few years once the rates automatically went up.

9. Predatory Appraisers. Lenders need appraisers to assign a high value to a home. Appraisers need the work that the lenders bring their way. The two groups were often happy to help each other out in ways that hurt the consumer. Houses got appraised far too high. As long as prices went up, people bought and sold houses, sometimes buying them just to “flip” them for a profit. Meanwhile builders were building at a record rate, figuring that they could sell their houses at the inflated prices. Eventually reality caught up with prices and the bubble burst.

10. Predatory Borrowers. The fault was not all with the bad guys in corporate America. Many borrowers lied on their loan applications. They lied about income, about assets, about employment, about credit history, about their intentions to live in the house. “As many as 70 percent of mortgages that defaulted in the first year turned out to have false information on the original loan appplication.”

The mess we’re in, as the list makes clear, is complicated. It’s not the fault of any one person or any one orginaztion. It’s the product of sinful motives and sinful actions as well as honest mistakes and unintended consequences. These things happen and they don’t allow for simplistic explanations. Or, for that matter, simplistic solutions. Beware the silver bullet. And beware the love of money.