US Financial Crisis – Who Is To Be Blamed?
Some thoughts on the current US Financial Crisis – Who is to be blamed? PART-1
Americans have been quick to blame the ‘Greedy Wall Street Executives’ for the current crisis. Given that the elections are just around the corner, the congress members are quick to take-on a populist stand and side with the people. ‘Wall Street’ is an easy target! [These congressmen conveniently forget that the same Wall Street is often times their biggest contributer…!]. However are they the primary cause of this mess?
I contend that the average American consumer is the biggest culprit. Now, I doubt if any elected official would ever show the fortitude to make such a call! The reasoning is simple – The American consumer has been living beyond his/her means for a long time. Credit has become a way of life. Its not just the struggling lower middle class with incomes under $50K who are stuck in deep debt. Debt has also become a way of life in the suburbia as well.
Consider this – a highly paid executive couple with combined earnings of over 300K should be financially very secure, right? Wrong, in many cases! Here’s the problem. This family could live a very comfortable life, buying a nice house in a suburb for say 300K and a couple of nice cars. But in reality, they end up going for a 700K (or maybe even a 1M) mansion..buy expensive luxury cars..modify their lifestyle to resemble that of the ‘super rich’ in most other parts of the world. How do they achieve this? By taking on debt!
The above is just a representative example. Having lived for 13 years in the US, I have always wondered how so many people can routinely live beyond their means. Some people consider debt and deficits as good things. They spur consumption and drive growth. I am not an economist and won’t get into the economic debate here. But the first principles of common sense warn us that something is terribly wrong regarding perennial deficits and debts!
Why blame Wall Street? Isn’t it the consumer who wanted to buy a huge mansion instead of a decent house? Isn’t it the person who wanted to shop like crazy like there is no tomorrow? Or the person who didn’t have money for his children’s college, but still took on debt to build a fancy swimming pool in his house? Or the recently graduated college student who got her first job at a hitech company, and went and bought a 35K Audi?
I think its about time that America realizes that the root of the current financial crisis is the average American consumer who thrives on debt! Wall Street was merely an accessory! I am not saying that the greedy Manhattan executives don’t carry any blame..they do. But they were like any good business – supplying the ‘products’ that the consumer ultimately wanted.
[Continue onto Part-2: ‘US Financial Crisis: Role Of The American Consumer’]
Amit Paranjape's Blog 
Though I agree to what you have said here – just imagine if credit were not easily available, would the student have bought that 35k Audi? I think the administration abetted an environment of easy loans instead of aptly regulating it. Who wouldnt avail of an easily available loan despite having concerns of their ability to pay it back especially knowing that safety nets such as bankruptcy and foreclosures were viable recourses. I think the powers-to-be goaded the Sallie Mae’s and Freddie Mac’s to make loans available to “unqualified” buyers and earned huge paybacks in the short period that the policy seemed to work.
In my mind, the gullible American is partly at blame because s/he wasnt wise enough to see the trap (easy credit) and have now reversed the clock for not only themselves but also for their next generation.
The fault though lies with the administration for not putting the necessary checks and balances into the credit system.
Well, credit is all about estimating risk. People who give out credit, estimate the risk of default and the economic impact of that default.
Thus, those who underestimate risk (i.e. those with a “greater risk appetite”) give out credit (loans etc.) more easily than others who don’t.
In good times, people who take bigger risks get rewarded more.
Similarly, in “bad times”, they should be penalized more.
However, this bailout does exactly the opposite. The way many of these sub-prime loans were given out, many people were conveniently left in the dark about the true cost of those loans.
People who naively took these loans are also to blame, but that’s like saying that if you allow yourself to be robbed/murdered etc. that’s your fault. Logical to some extent, but not, to a large extent.
A large portion of the fault lies with an environment that created this undue optimism (I remember many friends having bought homes here on loan, and many banks giving out those loans). Thus, inadequate regulation for the banks created an environment where people were over-optimistic about borrowing AND lending.
Since time immemorial, there have been loans and also some people who
default (making possible all those “Munimjee” dialogs in Hindi movies). If a “saokar” were to give out bad loans to his borrowers who defaulted, and then the saokar went bankrupt as a result, I am not sure that the blame would entirely lie on the borrowers.
Thus, in my opinion:
Cheap loans – $500 billion
Executive bonuses for giving out those loans $2000 billion
Rescue package to reimburse banks for the exec bonuses – $700 billion (plus more hidden trillions)
Good credit risk management – priceless
Great post!
The “greedy wall street executives” is a criticism which comes only from Republicans. The Democrat line I’ve heard is “lack of adequate regulation”. The consumer by definition will consume whatever he thinks he can and still get by in the future. I’m sure many of those homeowners who bought large homes probably knew fully well that some day they may have to foreclose the house they are buying – but they still bought anyway because they could. The real-estate investors with their “alt-A” mortgages thought they could flip their investments well before they needed to pay the mortgages back. Banks would happily buy these bad loans from mortgage companies because they knew they could pass them off to Fannie and Freddie for a decent profit. In the end I blame Fannie and Freddie for terrible lack of judgement in acquiring bad mortgages from banks and converting them into mortgage backed securities, and I blame the insurers and credit rating agencies who didn’t think twice before rating those securities high grade. Where were the regulators when all this was happening.
My fear is that the “jobless recovery” since 2000 was simply due to these bad loans, where people got money for nothing and started spending.
Good discussion.
I look at it from more conservative angle. It looks like Americans or to that matter even rest of the world has not learnt any lesson from Nick Leeson (Rouge trader: For those who may not know this story, here is a brief. Nick Leeson was a trader at Barrings bank in Singapore. He used some loop holes in back office setttlement process and duped the bank. He wrote a book named “Rogue Trader” explaining the rise and fall). Nick Leeson made and lost all the money becuase he tried to take advantage of certain loop holes which were not under stricter compliance. Investment banking world has progressed too far from the days of Nick Leeson. Now we have more complicated derivatives and other related products which only few in the market can understand. Under the pretext of “Free / Open” economy, these prodcuts are allowed to be traded without any conditions. The result is there to see for all.
Another interesting angle on why certain firms were given bail out and others not. Some of you may know that Henry Paulson was a Goldman CEO before he joined as treasury secretary. He still must be having millions of GS stocks which are either vested or yet to be vested. Like Henry, there are many Wall Street executives who have joined FED or US treasury. It’s not a rocket science why certain companies got “better deal” and others not.
Such a coincidence. I wrote a comment on this blog and read this article.
http://www.washingtonpost.com/wp-dyn/content/article/2008/10/05/AR2008100502684.html
Its been interesting beer/wine discussion here in the US. Here is my take on it. everyone is to blame – from greenspan for not envisioning what cheap credit will let genius minds do, to wall street executives who only care about the bonus and company stock (obviously, thats what they are paid for), to traders who are rewarded only for risky behaviours (being conservative doesnt do them any good), to rating agencies who get kickbacks from the very companies whose products they are supposed to rate, to predatory lenders to uneducated (you can read dumb) consumers, who didnt know that they should not buy anything that they cannot afford.
If you want to trace the timeline, it has to start with cheap credit cheap credit _. exitic products based on derivatives (CDS), leveraged CDOs, to
I meant to complete it with ——
and end with consumers with upside-down mortgages and defaulting.
Totally agree with this.. the individuals are to blame but it is also lack of regulations and oversight which causes this.
Here is another example, not from US but from India, told by my mom during a phone conversation.
She always buys vegetables from a vendor who gets a cart every morning and passes the street. He barely makes enough to survive on a daily basis. Last week Mom spotted him on a red tempo. On inquiring, he said he got 1.5 lac from Bank to buy it.
Does this not sound like a mini subprime in the making?
Qn –
1. Can we blame the individual here.. Possibly not, this is improving his work, life and daily earnings.
2. Should we blame the Bank.. Maybe..
3. Should we blame the sales channel through which such loans are originating (compare these to the 100s of mortgage joints in US) .. Maybe..
4. Or should we blame it to the availability of cheap credit and the fact that everyone is measured on how much loan they can sell and not on the quality of those loans..
Few points to ponder..
I have a comment on Abhay’s comment here.
I assume that he has not written explicitly the assumption he makes in this context. The assumption is that his vegetable vendor would not be able to pay back his loan. His argument is consistent in this light
But suppose there is a considerable increase in this guys sale just because of the new vehicle, and his efficiency increases a lot, then he makes more money and repays the debt and blah blah…. So if the repayment really goes through, i think it adds value to all 🙂 Just another side of the coin
This comment kinda comes late, Amit has already put in the part2, that loans need not necessarily be bad always 🙂
The basic problem is FIAT Money. So long as it remains, we’d see problems of this kind arising in some corner of the world.
One of the reasons why infinite debt creation is possible for US, is the fact that Dollar is the reserve currency of the world so only physical limit on the amount of money that can be printed is the number of trees in the world. The problem is when too much of money (read credit) chases too few things some kind of inflation manifests. When it is Asset Price, we feel happy. When net worth of “technically worthless” equity I hold in a company goes up, I am elated.. Ditto for the Real Estate. When that money starts chasing vegetables and things we need to survive, I complain..
Eventually forces of nature take over all the unwanted debt gets destroyed the inflationary bubble is deflated, things revert to their mean and start all over again. In another fifty seventy years the story will repeat…..
This reminds me of an interesting Anecdote.
While I Was travelling to Austin, one of my senior colleagues was a bit generous in hosting me. One thing I noticed about him was he always paid in cash in whatever expenses we made. I curiously asked him “I find it quite odd that you pay in cash? I haven’t seen people doing it here.” He replied – “Yes I usually follow that practise, we do have credit cards, but we pay _ALL_ the dues monthly.” I was thinking like “Is it not how it is supposed to be? Am I really stupid to pay 2% interest per month?” In Marathi it is called “Saavkaree” 🙂 Though I didn’t say this explicitely to him.
I remember once arguing with my dad about how more consumption leads to prosperous economy. I have grown up since then.
Yes while the question of whether the vegetable vendor can pay or not is there, if you see the current US crisis, it is not that all in subprime mess are not able to pay. Infact a lot of them are. The issue is availability of cheap credit on one side and the eagerness of folks to dole it out without doing the due diligence.
BTW – Is this Abhijit G (last post) – how you doing..
This becomes a bit of a Catch 22, because if the college grads did not buy Audis (or at least Accords) it really means a large chunk of the country with similar credit history won’t buy, your car manufacturers would be in even worse shape, which means they employ even less and so on and so on. Consumers are the engine that run the economy and credit is the grease that helps the engine run. The tricky part is doing the balancing act between debt and savings. Obviously it was way out of whack, and in typical herd-behavior fashion, things are going to the other guardrail to correct.
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