From the November 2008 issue of Research Magazine • Subscribe!

Reflections on Finance's 'Revolution'

By now, the snowballing financial crisis has gotten everyone's attention. With the damage approaching $1.4 trillion and counting, it is still too early to weigh definitively the various causes or to foresee the major consequences, but herewith a few observations.

Before Wall Street added its greed and recklessness to the equation, it was Washington that really created this problem. The Community Reinvestment Act of 1977 was the government's response to alleged racial redlining in mortgages. The idea was to expand access to housing to minorities who had lower rates of homeownership -- even though many in those same groups had weaker credit histories.

In 1995, the Clinton Administration significantly toughened enforcement of the Act and lenders were under tremendous pressure to give loans to people with no credit history and insufficient income. Warnings by critics were ignored and politicians like Barney Frank, the current chair of the House Financial Services Committee, championed these loans. Neither he nor former Fannie Mae chairman Franklin Raines has rushed to take responsibility for the massive home foreclosures that have had their greatest impact in the lower-income communities they were trying to help.

Despite the non-financial criteria pushed by government, the mortgage industry went along and sold mortgages to families with insufficient income and no history of responsibly paying debts. Worse, in recent years "no documentation" loans became all the rage. Lenders' recklessness in affirmative-action lending fully matched the spinelessness of their colleagues in college administration. Yet lowering credit standards is no more helpful to the "beneficiaries" than lowering academic standards in college admissions. Both make people in power feel good about themselves, while setting up others for painful, life-altering failures.

Ratings agencies were guilty of malpractice of epic proportions, assigning AAA status to utterly worthless paper. These agencies have long received fees from companies they rate -- a massive conflict of interest. Government regulators should not have allowed this monkey business and Wall Street shouldn't have relied on it. The ratings agencies roughly played the financial equivalent of the CIA prior to 9/11. President Bush, in one of his most foolish acts as president, actually gave the presidential medal of freedom to former CIA director George Tenet. In like fashion, I expect Congress to appoint a Fitch, Moody's or S&P muckety-muck to lead a Congressional investigation into this mess.

Lastly, there is the role of the big Wall Street firms that were buying and selling these infectious asset-backed securities. Former Citi CEO Charles Prince said it best: "As long as the music is playing, you've got to get up and dance."

Capitalists can truly be dopes. I hate to think of all the money Prince and former Merrill CEO Stanley O'Neal were making one quarter at a time. Didn't anyone bother to see that they'd be chair-less when the music would eventually stop? The mindless self-regard of our politicians and myopic conformity of our business leaders will only open the door to destructive demagogues and anti-capitalists.

Gil WeinreichEditorgweinreich@researchmag.com

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