You know, things were unraveling long before FNMA & FHLMC relaxed their guidelines to allow subprime mortgages. They contributed to the avalanche after it started, but they were far from the cause. Packaging mortgages into CDOs which the rating agencies were giving AAA ratings completely bypassed FNMA and FHLMC because their imprimatur wasn't needed. CDOs were then further leveraged with Credit Default Swaps (also completely independent of not only FNMA & FHLMC but of any regulator).
If you're looking for causes, the principal cause is pretty simple: The assumption on the part of everyone involved in the whole system - from home buyers to hedge fund managers - that Home Prices Can't Go Down. After all, they hadn't gone down for 100 years or whatever (not significantly).
If you're looking for blame (which isn't the same as cause), then you've got a couple things to consider:
- Who Should've known better?
- Who Profited from creating bad debt even though they did know better
- Who should've made sure the incentive system didn't risk the whole system
If I were to pick a single link in the chain to blame for most of the debacle it would be the investment banks.
Citi (formerly Solomon Bros)
and the smaller specialty guys and the London companies too like Barclays.
These guys knew what was going on. They knew the bonds they were making weren't really AAA quality (though they didn't know how bad).
Investment banks are like sausage makers: The put the ground up mystery meat into a casing, put a fancy label on it, and sell it.
If they can remove enough stink to sell it, they've done their job. There's not much incentive for them to care.
There's no one watching really. If they burn enough customers, they'll lose business, so they try to avoid selling stuff that will actually lose money, but it's not a hard rule.
Goldman, being the smartest, deserves the extra blame they got. But stupidity should also get a prize. Merrill Lynch no longer exists.
That would've been hard to imagine just a couple years ago. It was the biggest by many measures. But they were a little stupider than Citi and Morgan (just a little). They held on to their own sausage and when it turned out to be poison, they'd already swallowed tons.
Goldman was smarter and started to bail out (and even bet against the bonds they continued to sell to their sucker customers) before things turned really bad.
But I'm not convinced they're really any more evil than Merril or Morgan. Just smarter. It's easier to hate the winner.
BAD GUY #2:
The rating agencies: But beating up on the rating agency is a little like getting angry at a retarded kid in the special olympics who's caught cheating.
I mean - yeah - he cheated. But he's retarded!
The rating agencies aren't that dumb, but their staff from top to bottom consists of guys who can't get jobs at investment banks. The pay is only different by a factor of 4x (at the lower levels. Many 100x at the higher levels). And these bonds were created by the Investment banks. The rating agencies depend on people from the banks to explain how the bonds work (I used to have to do that for the guys at Standard & Poors & Moody's). Not because their dumb but because they basically have 24-48 hours to rate a new bond issue. In that time they're supposed to get a model working and evaluate the credit supports.
It's an impossible job without trusting what the banks are telling them. It's hard even with the banks. If they can't sign off in time, the bank goes to one of the competing agencies.
That's a fault in the system. Nevertheless, at some point it should've been pretty clear these bonds were not AAA. And the agencies should NEVER have allowed the synthetic CDOs (the ones backed by other CDOs instead of actual mortgages) or worse - backed by credit default swaps - to be rated AAA.
That would be virtually impossible to analyze. Back in my (old fashioned) times, we weren't even allowed to make bonds that used formulas more complicated than simple addition or multiplication for allocating payments. Because it was too difficult to analyze risk.
After that you can start blaming the regulators. But that's hard to do. I mean even AFTER the crisis, the Republicans fought like hell against any real regulation and WON! So you can only imagine how hard anything would be to get passed in normal times (or now).
The regulators were defanged. The SEC was practically decommissioned during the Bush years.
So that's what I think.