The financial crisis, reinterpreted

Tuesday’s New York Times contained an article about how the big banks have conceded the fight on finance reform regarding barring them from trading on their own accounts, and were focusing on the language in the bill about derivative trading. The whole article is worth reading, and isn’t too technical, but there’s one passage towards the end of the article that drove me up a wall.

The big banks argue that the Volcker proposal is misguided…the banks assert that the financial crisis of 2008 was a lending-based crisis caused by reckless loans made to unqualified home buyers. It was not, they say, a trading crisis.

[John Dearie, an executive vice president of the Financial Services Forum] said, lending “is arguably the riskiest activity that any financial entity can engage in. It is money out the door that banks hope will be paid back.”

This is a completely disingenuous line of thinking, as there was a lot more going on than just giving out bad mortgages.

First, yes, inherently lending is a risky activity, in as much as that the bank is giving out money that they don’t have 100% certainty will be repaid. However, there are ways you can mitigate that risk significantly, such as undertaking an extensive review of a prospective recipient’s financial history to ensure that they are capable of repaying the loan, or setting a higher interest rate for those clients that are considered high risk, or requiring a down payment, or ensuring that brokers retain some responsibility for the mortgages they originate. These are just items off the top of my head that the financial industry in general failed to perform during the housing boom. Implementing any number of these, and other, actions would have reduced the amount of bad mortgages out there.

The issues with the mortgages above, however, pales in comparison to the impact of what the banks and financial institutions did with those mortgages. They took these mortgages that they knew were bad (or at least should have known were bad), chopped them up into thousands of little pieces, mixed them together with the pieces of other bad mortgages, and created securities based on these borderline junk mortgages and had them rated as AAA prime investments. By the time everyone realized that these securities were barely worth the paper they were printed on, the shit was already starting to hit the fan.

So while risky mortgage loans were involved in the crisis of 2008, to say that these loans were the main cause of it while ignoring the rash actions of the financial institutions that exacerbated the situation is a grave misinterpretation of history. But I wouldn’t expect anyone from the financial services industry to acknowledge that.