The Blame Game

Here is another politics of finance post.

Moving beyond the point that we need to regulate [through new regulation OR ENFORCEMENT of current regulations that failed]....

The question is: Who's to blame for the current crisis? Or, is there even anyone to blame?

If you're talking to a regular everyday person, they'll probably say it was the banks for making wrong bets and generating excessive risk and the mortgage lenders for making loans they knew people would eventually default on it.

If you talk to someone from Wall Street, they'll say it was the homeowners who bought houses they could not afford.

I think both of them are partly responsible for the mess; however, I believe that Wall Street and the financial institutions have a much bigger part of the blame.

First, let's look at the homeowners.

Yes, many of them did buy houses that were beyond their means. I feel like that is probably the main argument against homeowners. You may even add that the ones who bought the house and took out a home equity loan on top are even more responsible for the mess.

Then, you have the financial institutions, which includes mortgage lenders and the banks that securitized the assets.

First, a lot of mortgage brokers AGGRESSIVELY pushed mortgages on people; sometimes even knowing that they would probably default at some point [see CNBC's House of Cards]. Additionally, a lot of the "sub-prime" loans were given to people with bad credit scores and who showed no documentation of assets or income. Now, who does that?

Nevertheless, you have the argument saying that it is ultimately the homeowner's choice to take the mortgage and thus their responsibility.

However, let's assume that a lot of the people taking these mortgages are less educated relative to the financial wizards. Given that mortgage contracts are complex and long, most people do not fully understand them. If you've never seen a package explaining all the complexities of taking out a mortgage [from all the taxes, to fees, to different arrangements], you should to see what it is all about. Hence, is there not an ethical duty on the part of the brokers to be as transparent as possible on the transaction? Maybe, they are more educated in the field and have some sense of risk management and should have not completed the transactions?

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Aside:

Is it the taker's fault or the giver's?

Say I wanted to be CEO of  a company that owns Nuclear Plants. I'm not qualified [like, really not qualified. And say that I never even showed them I had a High School Diploma] for the position but the veteran board still gives me the position. The company then fails and it also pollutes all the rivers in the United States because of my decisions. Am I responsible for the failure or is it the stupid people who gave me the job knowing that I was not qualified and never asked for any documentation of my qualifications?

Makes me think. The key thing here is to see that I was NO WHERE near being qualified but nothing was done to stop me. Now, imagine if I had been aggressively pressured into taking the mortgage, I mean, the job?

Remember, economics is about INCENTIVES.

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Hence, at the "who-is-responsible-for-taking-the-mortgage" level, you have the homeowner who has the choice or the marketers who aggressively pushed the mortgages and knew better. However, I feel that Wall Street is responsible for the mess due to more reasons.

Say we assume that the homeowner IS responsible for taking out the mortgage, who is to blame for all the other problems?

This is what brings me to the conclusion that the financial institutions are more responsible.

What did they do?

Well, they originated-and-distributed bad loans in excess. Therefore, this created an amount of risk in the economy that could not be absorbed. They exponentially originated and securitized all types of loans for a FEE and distributed them throughout the world. Additionally, they generated all these mortgage-backed securities and Collaterized Debt Obligations through complex and confusing mathematical formulas that most people have no idea what they mean. In general, Wall Street distributed throughout the world opaque securities build from loans that where aggressively pushed on the homeowner. (Plus, they modeled things as if house prices where going to continue to grow at 6-8%, which is just not sustainable relative to the yearly growth in disposable income]

Given that these guys are of "extremely high" intellect, I would have expected them to create something that could withstand the homeowner's bad decision. Better yet, I would have EXPECTED their RISK models to be a little more reliable.

Why?

Given that these institutions say they can SELF-REGULATE and hate any type of regulation talk, I say they should have done a better job in their risk management.

In sum, you have the homeowner who took out a mortgage beyond his or her means vs. the financial institutions which pushed them on the homeowner, securitized all the crap and funneled it throughout the system, and had horrible risk management.

This leads me to conclude that Wall Street is by far the most responsible entity in this crisis. In general, the homeowner made a mistake. However, what that did was uncover all the mistakes and crap Wall Street had been doing for years [excess debt, bad risk management, fraud, etc].

Cheers.

The same people who tend to blame the homeowners for taking mortgages beyond their means also tend to blame the Federal Reserve for keeping rates too low.

However, follow me on this one. If you think that the homeowners are responsible because they had the CHOICE of taking the mortgage, then Wall Street ALSO had the CHOICE of taking excessive debt in their balance sheets and expending excessive credit due to low rates. It is not as if the Federal Reserve put a knife to their throat and said "take excessive debt now".

In general, I just wanted to point out that if you want to be consistent, you cannot blame the homeowner for taking the loan and then say that Wall Street was a victim of low rates from the Fed.

AND THIS IS SOMETHING I HEAR AND SEE ALL OVER THE PLACE, which gets me going crazy, especially because it usually comes from all the major news outlets such as the Wall Street Journal or NYT.

And economics is about INCENTIVES. However, I'll leave that for another day.

Got any different thoughts on the subject? Please share because I know a lot of people have opinions on the matter.