Who's Really At Fault

I've been doing quite a bit of reading recently, mostly books about the recent American economic downturn. As is expected, each author tries to determine the causes of the fall and the guilty parties who allowed malfeasance or tried to pull the US financial system apart. The list of guilty parties is quite long: greedy bankers, deceptive borrowers, inept credit ratings, government ignorance and so on.

However, I put the blame for economic crash on those and countless others. In sum, everyone is to blame for a rather simple reason - no one did enough to learn what was actually going on and that a bubble was expanding. People simply became joyfully ignorant at what was actually going on with the economy and financial system. The fault can follow the path of the toxic assets that polluted the system.

First, loan originators looked to find borrowers to buy houses without regard for their ultimate ability to afford those houses. They didn't do the necessary research to learn that the loans couldn't be paid off, only hoping that prices would continue to rise. The borrowers they found to purchase homes did so without understanding the contracts they were signing. They didn't do the necessary research to learn what they were agreeing to, only thinking they were getting a great deal and that they could continue to pull more money out of their homes. The loan originators then quickly sold off the loans to banks to form asset-backed securities. The banks which purchased these loans did so without determining whether they would continue to be serviced over their life-span. Again they did not do the necessary research. Shortly after their purchase, the loans were usually pooled together into larger and larger bonds.

Once these bonds were put together, they were taken to ratings agencies. These agencies were responsible for determining the creditworthiness of the new bonds, however, they lacked the knowledge of the assets they were rating. The agencies did not do the necessary research to understand the bonds and accurately rate them. Instead, seeking higher payments, they often slapped inflated ratings to the bonds and sent them on their way. Once these bonds were rated, they were then sold to investors (often foreign banks, pension funds, etc.) or held by the banks. Again, these investors did not do the necessary research to understand what they purchased, and instead were fully dependent on the ratings from the agencies. They did not do their own research.

In the end, the bonds fell apart as home buyers became unable to pay their mortgages. Their payments often adjusted upwards catching many of them off-guard because they did not understand their contracts. The banks and investors then began to take losses as their investments slowly stopped paying their necessary interest. Once this happened, they stopped purchasing new loans which brought new loan issuance to a halt, bankrupting the loan originators.

Ultimately, the government had to step in and bank-stop a large number of institutions in order to protect the whole financial system. This occurred at great loss to taxpayers. Again, the government did not intervene until the problem was too great. Believing that home ownership was good for the country, government agencies and legislators acted to allow the bubble to continue expanding until it popped. Again, they failed to realize the consequences of its actions.

On the whole, the economic downturn was everyone's fault. People simply did not understand what they were agreeing to, who they were loaning money to, ratings they placed on securities, what they were buying or the actions they were encouraging. If greater due diligence was done, or consequences considered before action, the great recession could have been avoided.