Best Laid Plans of Mice and Central Bankers Often Go Awry

At Political Realities blog yesterday, a collaborating blogger who goes by Country Thinker posted an article titled “The Crisis Commission Report Can’t Be Taken Seriously” in which he criticizes the Democrat majority’s position that the Federal Reserve and Fannie and Freddy were not responsible for the financial/housing crisis. I left a comment basically agreeing with Country Thinker along with my layman’s analysis of how I thought the crisis came about.

Later last evening, I was thinking about the Country Thinker’s article and my comment and I recalled that I had read and saved an article that I thought might be pertinent to the subject. I finally found the article I had in mind in my archive of stuff I save to use some day as subjects for my own writing.

Randall Hoven is a regular at American Thinker. He is probably best know for the series “Graph of the Day”. He is a wiz at deciphering economic data and presenting it in a way that we all can understand. In April of last year, Randall wrote an article titled “ Fixing the Financial Crisis: Fire, Aim, Ready“. In his article, Randall is concerned that maybe our government doesn’t know what is doing to fix what happened because they don’t know what happened. Here is his opening paragraph:

No one wants to go through another financial crisis like we had in 2008, so our government is busy writing new regulations to fix things. But how do we know what to fix if we don’t know what broke, exactly? To some, it is enough to simply start regulating something, since we know that too little regulation was the problem.

In a very entertaining way, Randall leads us to his interpretation of the collective wisdom of our politicians about how the financial crisis came about: 



Step 1. There was a housing bubble bound to burst. It did in 2007. The cause? Take your pick: the Fed’s easy money, greedy lenders, stupid borrowers, government pressure, an incompetent and corrupt Fannie Mae.


Step 2. All those risky mortgages were bundled into credit default swap thingies and traded among big banks without any regulation whatsoever. Obvious cause: unbridled and unregulated greed.
Step 3. From there it was a quick chain reaction. Risky loans started going south. The credit default thingies then became worthless. Then banks took huge losses that left them no money to lend. Then credit froze, and then everything froze
Step 4. The decline of the U.S. economy caused the economies of Europe and the rest of the world to decline as well, since the U.S. is such an economic hegemon.  



  Randall then explains that these four steps almost make sense except for one tiny problem. They defy the basic concept of  “cause and effect”.   




First, the housing bubble was not confined to the U.S.; it was global. How could any U.S. housing policy affect house prices in, say, France, Sweden, and Greece? They had their own central banks, which Greenspan did not run. They had their own regulations, which Bush did not undo. Fannie Mae did not make loans on Swedish houses. Houses are not fungible commodities; you can’t put them on tankers and ship them through San Francisco harbor. 


Randall goes on to prove beyond any doubt that four step conventional wisdom on what caused the financial crisis and the role of the United States in the in the financial crisis of other countries is completely invalid.
So what did cause the crisis? Well, trust Randall to have a plan:
What, then, could it be? We should be looking for something (1) global in nature, (2) connected to housing and banking, and (3) that changed in fairly recent years.
Believe it or not, there is such a thing: a banking regulation called the “Recourse Rule.” Jeffrey Friedman and Wladimir Kraus of the American Enterprise Institute provided an extensive discussion of it in the Wall Street Journal.
In the U.S., the recourse rule came from the Federal Reserve and other federal regulators in 2001. For the European Union, it came with the Basel II agreements in 2006. The recourse rule forced large banks to put more of their money into asset-backed securities, such as mortgage-backed bonds, as long as those securities had good bond ratings or were issued by government-backed entities such as Fannie Mae and Freddie Mac (to make sure the banks’ investments were more secure, don’t you know).
The WSJ article by Friedman and Krause was an education to read. It was for me the most enlightening article I have ever read on the financial crisis..It really is a must read. Why this article did not get more play I don’t understand.
Here is what I take away from all of this.
  1. The financial crisis that nearly brought the world to its knees was caused by REGULATIONS first implemented here by the Federal Reserve and latter in Europe by their central banks. The regulations were intended to force the banking industry to be more prudent. The result was the MOTHER of all unintended consequences. The Fed’s monetary policy, Fannie and Freddy, and unscrupulous banker all played a role, but it was the Fed’s  Recourse Rule regulations that caused the housing bubble and similar regulations implemented by the central banks of Europe had the same result..
  2. We, the American public, were not told the truth. The Fed and all those in government that know the truth have been involved in the MOTHER of all cover-ups. Our legislatures (Dodd-Frank) have written regulations to fix the wrong problem. These additional regulation may bring even more unintended consequences.
  3. Lastly and of least importance, it seems that the Country Thinker and I were right about the Fed causing the Housing Bubble. But it appears that we, like so many others, were right for the wrong reasons.



2 thoughts on “Best Laid Plans of Mice and Central Bankers Often Go Awry

  1. Now THAT makes sense! I wondered why so much money was tied up in the mortgage backed securities.

    To fix the problem (as opposed to letting Dodd and Frank get anywhere near anything having to do with finance… fer heaven’s sake!) I’m still a fan of Kotlikoff’s Limited Purpose Banking.

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