Six Errors on the Path to the Financial Crisis

Wild Derivatives — Treasury and Fed refuse former Chairwoman of the CFTC, Brooksley Born’s, request to regulate derivatives.

Sky-High Leverage — SEC allows for the sudden and dramatic increase in leverage in 2004, moving the average from 12:1 to 33:1.

Subprime Surge — Between 2004 and 2007, subprime lending “grew from a small corner of the mortgage market into a large, dangerous one.” Two reasons are attributed to this transformation:

• Bank regulators, despite warnings from those like Ed Gramlich, were “asleep at the switch.”
• Many subprime mortgages were originated outside of the banking system and “beyond the reach of any federal regulator. That regulatory hole needs to be plugged.”

Fiddling on Foreclosures — “The government’s continuing failure to do anything large and serious to limit foreclosures is tragic…Free-market ideology, denial and an unwillingness to commit taxpayer funds all played roles.”

Letting Lehman Go — “perhaps they wanted to make an offering to the moral-hazard gods…After Lehman went over the cliff, no financial institution seemed safe.”

TARP’s Detour — “decisions of [Paulson] about using the TARP’s first $350 billion were an inconsistent mess.”

—Blinder in the NYT

The right and wrong way to bail out the banking sector

The hard choice facing the Obama administration is between partially nationalising the banks, or leaving them in private hands but nationalising their toxic assets. Choosing the first course would inflict great pain on a broad segment of the population – not only on bank shareholders but also on the beneficiaries of pension funds. However, it would clear the air and restart the economy.

The latter course would avoid recognising and coming to terms with the painful economic realities, but it would put the banking system into the same quandary that proved the undoing of the government sponsored enterprises (GSEs) – Fannie Mae and Freddie Mac.

—George Soros in the FT