What Happened to Cause the Financial Crisis?

To paraphrase an NPR announcer I overheard this morning: A sure sign that a crisis is occurring is when you are trying to figure out things you never thought you’d care about.

In the interest of “knowledge is power” and “knowing is half the battle,” I thought I’d post a selection of some of the best explanations I’ve found so far on the Internet.

Without further ado:

• The giant pool of money – Ira Glass interviews Adam Davidson and Alex Blumberg about the financial crisis. The best explanation I’ve seen so far about how the mortgage market changed from banks holding on to them to banks selling them off quickly and how this loosened the lending rules.
• The SEC’s role – How the SEC gave a special exemption from rules that allowed 5 giant Wall Street firms to increase the amount of debt they could take on.
• Planet Money blog – Day-to-day updates and analysis on the financial crisis.
• What are the Glass-Steagall and Graham-Leach-Bliley Acts? – Past post describing the impact of these Great Depression regulations and the subsequent repeal in 1999.

Many things lead to this crisis, but it’s clear that what finally happened was a crisis of confidence. Lenders were afraid to lend because they had no idea who they could trust. All of the safeguards that should have been in place to assess risk had broken down.

Credit ratings were not believable. Giant Wall Street firms which were supposed to be above failure were failing. And it became clear that a lot of very bad investments had been made because the risk could be quickly transferred to others.

I experienced this in 2004 when I bought a house. My loan was through a mortgage broker. I expected to pay his company, but he sold the loan overnight. Suddenly my loan was owned by a Dutch company – ABN-AMRO (which has subsequently been bought by Citigroup) – that had nothing to do with the original lender.

The overall cause of the problem seems to be a combination of a “free wheeling” market philosophy with little oversight or regulation to make sure it works and a breakdown of the traditional system for assessing risk. In this new system, it’s easy to pass the risk to someone else and so on down the line.

Not only has there been a breakdown in accountability in our financial system, but a breakdown of accountability in our government.

Checks and balances have been destroyed and adherence to a political philosophy has been valued over competence at all levels of government. Willful ignorance, disinformation, and collusion have become the hallmarks of the day.

If we are to truly fix this mess, we must start to value and restore accountability and honest governance not just to Wall Street, but also to Pennsylvania Avenue.