Does Bethany McLean Know Who Are The Real Financial Villains?

Bethany McLean is out with a new op-ed at The New York Times where she introduces readers to "the real financial villain." Is it Goldman Sachs? Is it the rating agencies? Is it the big banks that were duped by the first two actors?

Goldman Sachs, ACA Capital, IKB Deutsche Industriebank and even the rating agencies never had any duty to protect us from their greed. There was one entity that did — our government.

Bethany's conclusion of who is to blame is sound. Unfortunately, her reasoning for why the government is to blame, is not. Let's look at the claims she makes point-by-point. Bethany again:

But it was the purported regulators, including the Office of the Comptroller of the Currency and the Office of Thrift Supervision, that used their power not to protect, but rather to prevent predatory lending laws. The Federal Reserve, which could have cracked down on lending practices at any time, did next to nothing, thereby putting us at risk as both consumers and taxpayers. All of these regulators, along with the S.E.C., failed to look at the bad loans that were moving through the nation’s banking system, even though there were plentiful warnings about them.

Bethany's complaint here is arbitrary. "Predatory lending" is a scare-term with no scientific basis or absolute definition.

You think offering someone a $500,000 home mortgage loan with a 10% interest rate when they only make $20,000 a year is "predatory." I think the bank that would make such a loan is stupid because banks make money on credit spreads between deposited money and loaned money, not on foreclosing on homes and having to pay maintenance teams, real estate brokers and auction fees, ultimately to write down the sold property as a loss.

But either way, who is the United States Congress or any other federal or state regulator to tell somebody that they can't afford something and therefore they won't be allowed to take out a loan? And who are these regulators to tell a bank that they're only going to lose money on such a silly transaction and therefore they can't make such a loan?

They're nobody, that's who. I don't believe governments have any proper role but so far as people have agreed over the years that they do, the justification for government is that it is supposed to protect individuals and their property from theft, assault and murder.

Notice that "financial loss accrued through careless borrowing/lending practices" is not on that list.

Bethany then claims that this disinterest by regulators in policing these practices put "us" as consumers and taxpayers at risk.

That isn't correct, either. I as a consumer am not at risk of careless borrowing/lending practices if I don't participate in them. And I as a taxpayer am not at risk if the government doesn't bail out a bunch of slimeball bankers and then pass me the bill. Which, ultimately, it did-- but I pay the price not because some bad loans were made, but because the government decided to make me responsible for those decisions!

More important, it was Congress that sat by idly as consumer advocates warned that people were getting loans they’d never be able to pay back. It was Congress that refused to regulate derivatives, despite ample evidence dating back to 1994 of the dangers they posed. It was Congress that repealed the Glass-Steagall Act, which separated investment and commercial banking, yet failed to update the fraying regulatory system.

Again, the question is, "What danger do risky loans/the use of derivatives pose to anybody but those who use them, so long as the government doesn't subsequently bail these actors out and stick unrelated parties with the bill?"

Bethany seems to take government intervention as inevitable. But that appears to be a problem with the political system, not the financial system.

I feel like I am repeating myself here but, in regards to Glass-Steagall, "What need is there to separate investment and commercial banking within an institution, if no one but the institution and those that voluntarily exchange with it are the ones to pay the penalty of risky or unethical business practices?"

It was Congress that spread the politically convenient gospel of home ownership, despite data and testimony showing that much of what was going on had little to do with putting people in homes. And it’s Congress that has been either unwilling or unable to put in place rules that have a shot at making things better. The financial crisis began almost three years ago and it’s still not clear if we’ll have meaningful new legislation. In fact, Senate Republicans on Monday voted to block floor debate on the latest attempt at a reform bill.

Rules that "have a shot at making things better" are not the same as "rules that will make things better." One involves probability, the other certainty. Bethany's take seems to be that any gamble is "worth" taking at this point which is apparently why she criticizes Republicans at the end of the paragraph for stalling the latest regulation bill. (It's a regulation bill, not a "reform" bill, another scare-word that is in this case used to make opponents of the bill look like regressive, overly conservative monkeys.)

Missing from Bethany's discussion entirely is WHY banks were making increasingly risky loans at the point in time they were making them. Look at the timeline-- Glass-Steagall repealed with Gramm-Leach-Bliley Act of 1999, housing bubble 2003-2007. Why did it take the banks a full four years after they were able to recombine their investment and commercial banking arms to start a housing bonanza? If the derivative danger was known in 1994, why did it not blow up until 2007? And how significant to this whole story is the fact that Alan Greenspan reduced the Federal Funds target to 1% in 2003?

Bethany McLean is a great writer and an outstanding journalist. Her work on uncovering the extent of the Enron fraud and her depiction of the deranged personalities of the participants was thorough and insightful. Unfortunately, she doesn't understand business cycle theory and fails to see the role federal government and Federal Reserve stimulus policies play in creating the boom-- and the bust. As a result, she misses the cause of all the financial chicanery she writes about, just as she was confused about the ultimate cause of the rise and fall of Enron.

The reality is that the Boom is the Bust and no amount of bailouts or stimulus can change that reality. People were going to lose money because they had to-- the wealth was an illusion in the first place. Now, thanks to the near-ZIRP of the Fed and the bailouts and stimulus efforts of the federal government, when the next crisis comes, people will be out their share of the cost of the bailout PLUS all the wealth they would've lost the first time around (plus more, because the extent of their wealth which is illusory will have grown).

Contrary to Bethany's narrative of the depression, the greatest damage that was done to American taxpayers in the aftermath of the first wave of this global economic depression was the massive, government-engineered bailouts and stimulus efforts. These were financial burdens foisted on taxpayers and dollar-holders without their consent. Ultimately, these burdens will prove to be much more financially destructive to individual Americans and individual holders of US dollars than the collapse of the major commercial and investment banks would have been at the time. And the worst part is that these are burdens that will largely be shouldered by parties that were not responsible for the mess while the real villains of the financial crisis -- the Federal Government, the Federal Reserve and the starry-eyed shoulda-been-failures of the Wall Street world -- will walk away largely unscathed, again.

Oh, and they'll all be chuckling as they walk down the street counting your money.