Who caused the credit crunch? (Loong post)

I started at 6:30 am to write a brief comment. Six hours and 2,200 words later, I stopped. (Maybe I should submit this post as an article somewhere.)
"Skipper"
[nq:1]The whole housing bubble started with the Community Redevelopment Act under Clinton[/nq]
I think the finger-pointing in the subprime debacle will go on for years.

WHO ARE THE SUSPECTS?
1. The Administration that wrote the legislation that permitted subprimemortgages.
2. The risky homeowners who signed mortgage contracts they could not repay.
3. The bankers and mortgage originators who persuaded risky homeowners thatit was okay to sign the mortgage contracts because they could a) refinance later at better terms; b) get cash now to pay off current debt; c) flip later at a profit; d) make low payments now and high payments later when their salaries were better; e) whatever.
4. The dishonest homeowners or mortgage originators who made falsedeclarations of financial circumstances to ensure a mortgage would be granted.
5. The bankers who approved the subprime mortgages on known riskyhomeowners, or didn't check the facts on the paperwork, and put up the money.
6. The bankers who securitised them, i.e. bundled subprime mortgagestogether, got a AAA rating on them, and sold off the toxic bundle as Mortgage Backed Securities (MBSs) to investment companies.
7. The rating companies (Standard and Poor, Fitch, etc) that classed thebundles of toxic mortgages as AAA, i.e. investment grade, thus ensuring their wide marketability, on the basis of mathematical theory, not of the underlying ability of risky homeowners to repay them.
8. The investment companies that purchased these MBSs believing they wereindeed AAA without doing their own due diligence, and anyway believed they were perfectly safe because they insured them with AIG.
9. Companies that "cloned" the bundles of toxic mortgages and sold them asCollateralised Debt Obligations (CDOs) (i.e. like selling everyone in the neighborhood a fire insurance policy on your house, giving many people an incentive to burn your house down), thus multiplying the money at risk into the multi-trillions. A lot of commercial debt rode on this particular bandwagon as well.
10. The Administration that wrote the legislation that allowed the"cloning" of MBSs and commercial bonds.
11. AIG who wrote insurance (swaps) on bundles of toxic mortgages, andtheir clones, with a face value far beyond AIG's ability to repay because a) AIG didn't have to put up any collateral; b) they assumed the house market would always rise so there was no risk; c) the insurance was purely a formality to comply with accounting standards; the holders of the mortgages would never present them for payment; d) whatever.
12. The Administration that wrote the legislation that allowed AIG to writeswap-type insurance without collateral.
13. Investors who multiplied their folly by buying more toxic securitiesusing their existing toxic securities as collateral.
14. The Administration that wrote the legislation that accepted insuredCDOs and MBSs as rock-solid financial assets for accounting purposes, thus allowing holders of these toxic securities to use them as collateral.
15. The Administration that a) didn't realize trouble was building up andhuge amounts of money were at risk with no hope of repayment; b) did realize
trouble was building up but made no, or ineffectual, moves to correct it.
16. The people whose opinion carries weight (i.e. the financial press;responsible columnists and bloggers; lawyers, bankers and investors involved in the process etc) who saw trouble building up and made no or ineffectual moves to bring it to wide general attention.
17. The very clever "quants" who made the mathematical models that provedthe bundles of toxic mortgages were worth a AAA rating but did not make clear, or did not realize, that they depended on certain assumptions such as 'house prices will always rise' or 'the risks are uncorrelated.'
18. The decision-makers that signed off on investments, insurances, orratings based on mathematical models they didn't fully understand.
19. The academics of high reputation who gave various parts of the processan intellectual rubber stamp.
20. The squatters and thieves who strip and despoil unoccupied houses thuscausing billions in loss of value for the sake of thousands in immediate benefits; and the authorities that are meant to prevent this.
21. The comforting belief, widely held in the government and the privatesector, that certain institutions are 'too big to fail,' on the basis of which some investors and executives will take colossal risks.

ARE THERE DEGREES OF GUILT?
It's a tale of greed, ignorance, dishonesty, stupidity, irresponsibility and lack of integrity, wherever you look. Are some more guilty than others?

I believe yes. There are degrees of guilt.
For me, it's a question of power and responsibility. The fault lies mostly with those who have power and responsibility; then those with responsibility but not power; then those with power but not responsibility.

And within each category, those who were earlier in the transaction stream are more at fault than those who were later because they allowed the problems to build up.
Always bearing in mind what could have reasonably been foreseen at the time given the information at hand. We have the benefit of hindsight.

Note that the cause of the subprime crisis is the inability of risky homeowners to service their mortgages, and the difference between the book value of the properties and their market value, which prevents the properties being onsold to homeowners with a better financial profile.

POWER AND RESPONSIBILTY
We invest in, and reward, their worldly acumen.
a) The bankers who signed off on the risky mortgages are for me the number one culprit. Bankers are supposed to be conservative appraisers of borrowers; they should be reluctant to put other peoples' money at risk. That is their function in society and why most people put their money in bank accounts rather than in slot machines. They could had refused to issue these mortgages and the whole top-heavy financial edifice would not have been built. This applies to banking executives at the top who made the policy to underwrite risky mortgages, all the way down to the branch accountant who approved a mortgage he knew the person in front of him could not pay.
b) Next in line are the rating agencies (Standard and Poor, Fitch, Moody) who certified that risky mortgages become investment-grade securities if they are bundled together a thousand at a time. Common sense tells one that a thousand turds together make a big pile of ***, not an investment-grade security. But the ratings agencies have no common sense, or no integrity. They failed utterly in their professional responsibility and paid competence to evaluate risk. Between the agencies it was a race to the gutter who could make the biggest fees by awarding silk-purse certificates to sow's-ear securities. One of their executives admitted afterwards that their ratings don't actually indicate the risk of an investment. What are they being paid for then?
c) Then there is AIG. As an insurance company, they are supposed to be experts in evaluating risk and pricing it correctly. They failed utterly to recognize the risk that mortgage backed securities could go into default. As a consequence, their premiums to insure the MBOs were far too low, making the securities more attractive and encouraging companies to "clone" them. As a further consequence, AIG did not set aside collateral against the possible default of MBOs, thus opening a frightening crack in the financial edifice which has required emergency plastering.

d) Then the heads of the major banks and investment companies, and the Boards of Directors that support and reward them. They have the job of putting money at risk to make a profit, but they also have the responsibility of soberly evaluating that risk, and reining in their activities when danger threatens. Many have been recklessly irresponsible, whether because of desire to outdo the competition, or failure to appreciate the risks they were taking, or maximizing the benefit to themselves of remuneration systems that awarded colossal bonuses if they succeeded, and no penalties if they failed, thus encouraging risky behavior.
e) Finally the executive arm of the government. The Fed. The Treasury. The Greenspans and Bernankes. They are supposed to take action, and given the power to print money and sell bonds and set interest rates. I think Greenspan in particular will go down in infamy with his low interest rates and naive trust in the professional integrity of bankers. For those who came after him, it is too early to tell.
RESPONSIBILTY BUT NO POWER
We rely on, and respect, their professional ethics.

f) Prime here are the regulators. They write the legislation that permits things to happen, or prevents them from happening. They don't have to be geniuses themselves because they can consult broadly with the best brains in business and academe, and combine theoretical concepts with a realistic appraisal of human nature (especially greed) to develop the rules we must live by. It turned out there were gaps in the legislation that allowed a torrent of malfeasance to pour through. But the regulators have no executive authority to prevent wrongdoing. Once things go wrong, all they can do is write more regulations and hope for the best.

g) Then the auditors and accountants who have a responsibility to the financial system to present information on a company's financial position, bearing in mind the quality of the assets, and whose failure or unwillingness to mark down the value of toxic assets made companies appear sounder than they really were, and needing emergency support when the truth came out.
h) Then the academics, particularly the economists, but also the accounting academics, whose tidy picture fell apart. They have the prestige of honors and awards, and the respect that goes to those of great intelligence, and the authority of those whose ideas have survived the judgment of their peers. Many economists have commented that the academic awards go to the pretty mathematical models rather than to the messier task of understanding 'the way the world works.' The end result is that important economic decisions get influenced by quants and cubicle people who stare at a screen the whole day, rather than by people who are out and about and seeing what goes on in the real world.
i) Then the leaders within industry who see dangers and abuses, but stay silent, because they are making too much money, or don't want to offend clients, or don't want to appear foolish if they are wrong. I believe there are many high street bankers and investment managers who saw what was happening but preferred not to blow the whistle.
j) Finally the financial press, the bloggers on finance and economics, the lawyers and the lobbyists, who are supposed to call out the truth as they see it, but are understood to be biased and partial did they suppress information or draw conclusions they knew to be untrue in order to serve their various interests and masters?
POWER BUT NO RESPONSIBILITY
We regret their human failings.
k) First in the chain of events that led to the subprime mortgage crisis are the salesmen and agents; sleazeballs who sold mortgages they knew the homeowner could never repay, and pocketed the fee, and moved on to the next victim, and pressured them also, and left someone else to clean up the mess behind them.
m) Just behind them are the companies that paid the salesmen's fees and commissions, and warehoused the mortgages, and passed them on in bulk to the money men up the chain, and pocketed their percentage, and left someone else to clean up the mess behind them.
n) Then the salesmen and homeowners who defrauded the mortgage holders by making false declarations on the documentation to obtain these seemingly-attractive mortgages or juicy commissions.

p) Almost as culpable are the homeowners who allowed themselves to be duped into signing impossible-to-service mortgages, or actively colluded in the process, seeing rich profits and low risks in planning on flipping their properties, trusting that there'd always be a bigger fool to buy their properties at higher prices, or hoping they would be able to get off the runaway train in time.
q) Then the lawyers who had to process the documents and knew it would all end in tears some day but it would be someone else's problem.

r) Then the builders and developers who carried on building an insane amount of houses at insane prices, joining in the feeding frenzy while the going was good.
s) Then, the poor schmucks who invested their money in subprime mortgages on the assurance of an 'expert' that they were a good investment.

t) Right now, the robbers who are stripping vacant houses of anything of value, the arsonists who are burning them down, the squatters who are defacing them, the administrators who are neglecting them, and the authorities who have more vacant houses than they can cope with. It all contributes to the decline in the market value of the properties, and worsens the crisis.
u) And right now also, the bottom-feeding investors who are buying up distressed houses cheap, and flipping them to a fresh group of homeowners, who often have no knowledge of their true condition, but who believe that values will go up one day.
And so the gravy train continues (for some).

Martin B