Reflections on a Depression: I’ve Got All This Blame, Where do I Put it?

Wherever he is, Chicken Little is probably grinning. For many Americans these days, it feels like the sky is falling, and financially speaking, the evidence supports Mr. Little’s claim. The consensus around here is that we are experiencing the largest financial crisis since the Great Depression. The Dow succeeded in halving itself last week, banks are taking more dives than Italian soccer players, and the bailout bill hasn’t yet found its legs. In times like these, when few are exempt from feeling the squeeze, people demand answers. And the most sought-after answer seems to chase this question: "So who’s to blame?"

Unfortunately for those looking for a place to direct their angry mob, the answer to this question is not as sound-bite-ready as you might hope. Nor is it accessible to groupthink. Who is to blame, like the problem itself, is deep and diverse.

I walked along Wall Street just after closing on Friday and, at first glance, I thought I’d discovered the culprit (or at least who the world wants the culprit to be) without much effort. No shortage of rubber-necking to be found, the steps and sidewalks of the buildings adjacent to the NYSE were filled with spectators. There were frequent flashes as tourists captured the scene for their travel blogs and Flickr albums. On Friday, the schadenfreude on Wall Street was thick.

But how excessive is this delight in Wall Street’s misery? Some of it is summarily warranted, absolutely. Over the last few years especially, in the long-term bull market, Wall Street became accustomed to making very, very risky investments — greedy investments that never should have been sanctioned. And of course, as investors saw their portfolios rising due to these risky investments, few asked questions and few bought insurance to protect against the inevitable bubble-burst and subsequent market collapse.

What’s more, many players on Wall Street embraced the misguided view that U.S. housing prices would remain high and that cheap short-term money (i.e. loans and credit) would always be available. They created, bought, and sold securities for huge profits that no one (not even they) really understood. Not to mention the biggest flaw in Wall Street’s business plan: its massive leverage. To finance their risky investments and bets on securities, firms were borrowing extensively against little capital. And when portfolios are highly leveraged, a firm’s capital can vanish overnight when the debt market becomes unstable, which it inexorably did. Wall Street showed a horrendous lack of foresight and a penchant for greed that played an integral role in the economic downturn, so yes, Wall Street certainly shares some of the blame.

Unhappily, however, this situation was not created solely by speculators or miscreants on Wall Street; this is the result of a deep, multifold, complex problem — and maybe system. The fact of the matter is that it's easy to pile on Wall Street NOW, but where have these finger pointers been for the past five years — the past ten?

Once upon a time, Adam Smith told us that, in a free-market economy, there is an Invisible Hand that provides the potential for private vices to become public benefits. Individuals pursuing their own self-interest can sometimes benefit the system and the community at large. The key word here being "sometimes." In a de-regulated, free market, laissez faire economy, greed plays an important role in the functionality of the system. So, to me, it seems perhaps a bit ridiculous for those who benefit from American free-market capitalism — even if they did not adopt it rote or necessarily ascribe to it themselves — to pretend they didn't know that greed plays a role AND that this can have serious potential to backfire and wreak even more serious havoc on the system at large.

When the U.S. government helped to create Fannie Mae during the Great Depression, there was a consensus that low-income Americans should be able to buy houses, to afford mortgages. Fannie Mae was established to ensure liquidity in the mortgage markets by ensuring banks and the various institutions that lent (and lend) money to homebuyers. Along the way, Fannie Mae began to buy riskier "subprime" mortgages. Here, one might be able to blame the ratings agencies that labeled these mortgages salable and provided Fannie Mae with the incentive to buy. Or perhaps the blame could also be put on Fannie Mae for the securitization of these mortgages, the chopping of them into little pieces to be sold to investors. Or the proliferation of credit default swaps — a practice that became a staple of business practice around the globe.

There is some truth to the claim that this problem began on Wall Street, but we are all now responsible for letting it get so out of hand.

Which is why, at this point, I also offer a lack of governmental oversight as a prime cause of this economic calamity. It is absolutely the government’s responsibility to keep up with the markets it has the duty to regulate, and clearly, it has failed to do so. The U.S. is badly in need of oversight and governance, and it is negligent of a government to undertake the responsibility of oversight—to represent that it is fulfilling that function—and then to fail to fulfill this.

The market requires individual actors to move in their own self-interest. Should they have ethics, and think about the greater good? Absolutely—but they are required by law to act in the best economic interest of their shareholders, and that mandates greed. So can we blame financiers who made highly leveraged bets that housing prices would continue to go up, without the cash to pay those debts off were they to lose? Sure—but it seems that the executive branch of the Federal Government should hold some responsibility for this crisis as well as — for being in a sense, in collusion with the markets.

There are a lot of places to direct blame, so allocate as you see fit. This is a complicated problem, as are the solutions. So before we decide to nail one group, institution, or idea to the cross, let’s make sure we have a full understanding of the problem and the consequences. Only then can we have a good idea of where to send the angry mob, and how to clean up this mess.

But this just one man’s opinion. What do you think?

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