We last talked about the SEC charges against Goldman Sachs a week ago, in "Thoughts on the Goldman Sachs Charge." Of course a lot has happened since then, including Dodd's 1,400-page financial reform bill, and a global bank tax side dish to go with it.

Before delving back into the Goldman Sachs story, or touching on Dodd's financial reform bill, I think it's important to stop and reflect on the causes of the financial crisis to begin with, and clear up some common misconceptions.

The Blame Game

The general assumption is that the financial collapse was due to "unfettered" or unregulated markets, where self-seeking capitalists became a "great vampire squid wrapped around the face of humanity," and sucked the economy dry.

The problem is that this isn’t true.

Matt Taibbi's "The Great American Bubble Machine" is a great read and includes a lot of important facts. I also recommend that you read it! Just be aware that his economic and financial analysis leaves much to be desired ... It's not all about Goldman Sachs.

What Is the Free Market?

Roots of the Crisis

Since the roots of the financial crisis can get complicated, we'll boil them down to the following 4 major categories.

Monetary Policy

The "easy money" monetary policy of the Federal Reserve, along with implicit and explicit bailout guarantees made by Congress, distorted the process of capital allocation creating structural imbalances in the economy. In other words, market player behavior reflected the incentive structure our Washington authorities designed.

The role of the Federal Reserve in this crisis cannot be understated. Inflationary booms simply cannot last, and will always result in disaster.

Did the Fed Cause the Housing Bubble?

Housing Policy

Fannie Mae was created by the Roosevelt administration to expand the pool of mortgage holders during a time of rising interest rates. Then housing policies were expanded to benefit various voting blocs, including with The Community Reinvestment Act of 1977 (CRA), which lowered lending requirements.

In the 1990's, Congress pushed for yet lower standards, and watered down the CRA. President Bush got elected touting the "ownership society" in 2000, and encouraged the growth of mortgages (particularly second-mortgages) with the help of Federal Reserve Chairman Alan Greenspan.

Can You Afford Not to Hold Them Accountable?


Implicit and explicit bailout guarantees were extended by Congress to cover securities created by Fannie Mae and Freddie Mac. These guarantees allowed lenders to lower capital requirements in relation to their holding of securities backed by Fannie and Freddie - with regulatory approval.

Without these guarantees though, the packaged mortgage security and credit-default swap markets would never have grown out of control. In other words, policies designed by Congress to outwit the markets, resulted in excessive risk-taking by investors instead.

Fannie and Freddie

Keynesian Economics

The Federal Reserve bases its monetary policy on the Keynesian economic theory of inflation and government spending. Leaving aside that we all know what happened to the housing market, as well as the dismal state of the economy, and the size of the government's unsustainable debt ... Not one Keynesian was able to see the bubble coming in the first place.

Alan Greenspan said that he doubted “that bubbles, even if identified early, could be pre-empted short of the central bank inducing a substantial contraction in economic activity—the very outcome we would be seeking to avoid.” Ben Bernanke says even if he “could identify bubbles, monetary policy is far too blunt a tool for effective use against them.” The New York Times "Nobel Laureate" Paul Krugman pushed for more inflationary bubbles!

And these guys are supposed to be the smartest guys in the room?

The problem is that many people predicted the bubble. Rep. Ron Paul warned of a housing bubble as early as 2002, introducing legislation designed to keep the crash from happening (that of course was never approved). Senate candidate Peter Schiff predicted the bubble while on CNBC in 2006 as well. Not being Keynesian theorists though, nobody cared what they said.

Why didn't anyone listen? Because Keynes always prescribes the State as the infallible planner. You don't really think politicians want someone pointing out they're not really needed, or even harmful?

America's Unsustainable Boom

In Summary

The blame game is too easy for both politicians to play and constituents to digest. Rhetoric about "greed" is used to push the facts out of the conversation, thus deflecting those issues until most people forget.

That way, we look to the people who created the crash to begin with ... to "save" us from it instead.