Fifteen years may seem like ancient history given the turbulence of the past few years, but most of us still remember the Global Financial Crisis (GFC) of 2008. Friday marks the fifteenth anniversary of Lehman Brothers’ disorderly bankruptcy. Many claim that event began the 2008 financial crisis and showed that market excess in a world of deregulation was to blame.
But that’s not quite right.
While Lehman’s failure was significant, it hardly precipitated the crisis. Lehman failed on a Monday, yet by Friday the stock market closed higher than it had a week earlier — hardly a crisis nor reason to panic. Yet in the months that followed, stock markets would decline by more than 25% and large financial institutions would fail. The Federal Reserve would engage in unprecedented liquidity programs and emergency lending and Congress would pass the massive (at the time) bailout — The Troubled Asset Relief Program (TARP).
It turns out the TARP was indeed a tarp; used to hide years of government mistakes that created the GFC, from bad regulations that set the stage to repeatedly fumbled responses of government regulators who had spent over a decade distorting mortgage and financial markets.
Throughout the 1990s and into the 2000s, Congress required Fannie Mae and Freddie Mac to purchase ever higher numbers and proportions of risky low-quality mortgages, giving the sellers of these mortgages, shady companies like Countrywide Financial and Golden West Financial, a blank check to issue as many mortgages as they could, regardless of quality. And issue low-quality loans they did!
At the same time, regulators incentivized banks to increase their holdings of mortgage-backed securities because they could hold less capital, and thereby increase their leverage, by doing so. Government officials simultaneously: pushed lower mortgage underwriting standards; encouraged banks to load up on securities backed by these low-quality mortgages; and then let banks hold less capital in the process.
What could go wrong?
Government officials then threw gasoline on the fire with their inconsistent responses. They bailed out Bear Stearns, but not Lehman Brothers. They bailed out AIG, but not Washington Mutual. They bailed out Citibank, Goldman Sachs and Morgan Stanley but not IndyMac or Reserve Primary Fund. Then they waxed melodramatically about another Great Depression if Congress didn’t pass TARP.
Ironically, TARP made things worse.
The Treasury Secretary at the time, Hank Paulson, created panic among investors when he forced all the largest banks in the country to take bailout money — regardless of whether they needed or wanted it — to “hide” the banks that really needed a bailout. Yet the market already had a good sense of the two or three largest banks with significant problems.
This government policy made it seem like every bank and financial institution was on the brink of failure! As a result, nine out of ten of the largest one-day declines in the stock market in 2008 occurred after the bailout program was created to “fix” the crisis!
Unfortunately, the same regulatory agencies and international organizations that set us up for the largest financial crisis in several generations are still proliferating regulations today. The rule-making power regulatory agencies have don’t give much reason for comfort as the economy navigates a post-Covid world with elevated inflation and high interest rates.
In the years ahead, we must reduce the government’s distortion of the housing and mortgage markets, cut back on regulations that create systemic behavior and thereby risk, and reduce the uncertainty of government regulators’ actions by paring back their discretionary authority.
Fortunately, this isn’t Groundhog Day. We’re not doomed to repeat the same mistakes.
Paul Mueller, PhD, is a Senior Research Fellow at the American Institute for Economic Research and the author of Ten Years Later: Why the Conventional Wisdom about the 2008 Financial Crisis is Still Wrong published by Cambridge Scholars Publishing.
The views and opinions expressed in this commentary are those of the author and do not reflect the official position of the Daily Caller News Foundation.
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