Conventional wisdom gets it all wrong—the notion that the crisis was a result of uncontrolled greed on Wall Street, a product of the ‘excess’ of capitalism. The real cause of the 2007-08 financial crisis was overwhelmingly the product of government intervention.
Leading the charge was the loose monetary policy of the Federal Reserve, pumping money into the economy to stave off minor corrections in the early 2000s. While we may have evaded the smaller recessions, this only kicked the can down the road, fueling the largest house price bubble in American history.
The massive government sponsored enterprises, Fannie Mae and Freddie Mac, as well as the Community Reinvestment Act, helped funnel this monetary excess into housing. Beginning in the late 1990s, Congress forced the two mortgage behemoths to lower their underwriting standards in order to meet audacious affordable housing goals. By 2008, 76 percent of subprime mortgages were on the government’s books, with nearly $8 trillion in debt. The subprime bubble was not a coincidence, but an explicit goal of public policy.
Finally, Wall Street, with the protection of government bailouts, was allowed to reap extraordinary profits when times were good, and lay off the losses onto taxpayers when things turned sour. Expecting that they would not face the full cost of their actions, banks were incentivized to take risks they otherwise wouldn’t have. Unfortunately, they were ultimately proven correct, with the government bailing out those that failed. This enshrined the moral hazard of banks—why would you worry about safety and soundness when you bear no consequences for your actions?
The financial crisis wasn’t the result of a greed bubble, as the conventional narrative insists. It was a result of government interventions that incentivized irresponsibility. Easy money, eccentric housing policy, and taxpayer guarantees drove the financial system into chaos. All three of these problems, the real causes of the financial crisis, remain ever-present today. If anything, they have only gotten worse.
Easy money continues to flood the financial system. With a struggling economy, the Federal Reserve has persisted with another decade of ultra-low interest rates. This will almost certainly, however, inflate another asset bubble. The housing bubble of 2003-2006 was built off of the easy money policies combatting previous downturns, and the Fed’s policy to mitigate this crisis will only sow the seeds of the next one.
It should come as no surprise if this monetary excess returns to housing. Astonishingly, nine years after the crisis, Fannie Mae, Freddie Mac, and the Community Reinvestment Act are still yet to be dealt with. Taxpayers continue to back 75 percent of newly written mortgages and as much mortgage debt today as they did during the crisis. These same policies played a central role in the financial crisis, yet the fundamental problems remain unreformed. Without recognition that government policy is driving an unsustainable housing binge, future housing crashes are inevitable.
Further, legislative efforts to rein in Wall Street have barely addressed government guarantees. The Dodd-Frank Act purported to end “too-big-to-fail” and curb the excessive risk taking of Wall Street, yet it has done neither. Sixty percent of the financial system’s liabilities continue to be protected by the federal government. Meanwhile, banks that were deemed too big to fail a decade ago are even bigger today, with the largest five banks making up nearly half of the entire sector’s assets. If these institutions were to fail, there is little doubt that the government would be compelled to save them.
Nine years on from the financial crisis, too little has been done to rein in government meddling in the economy. Rather than reforming the perverse incentives, the Obama administration doubled down on them, and it is clear the financial system is no safer as a result. With Republicans in control of government, there is a unique window of opportunity in financial reform. Dodd-Frank, government housing policy, and the Federal Reserve’s reckless monetary policy cannot last any longer. Nearly a decade on from the financial crisis, ending the government’s stranglehold over the financial system is imperative to preventing the next one.