Playing the blame game

Playing the blame game

Chances are you can't succinctly express your views on that complex question. But the American public will settle on one of four catch phrases over the next several months. Whatever bit of conventional wisdom wins out will have an impact on the economy. The contenders are as follows.

Free markets ran amok. The broad deregulatory trend of the past 30 years finally went too far.

Financial geniuses cooked up new ways to buy, slice, dice, reconstitute, and sell mortgages as novel securities that no one really understood but that investors were willing to buy because rating agencies - clueless, conflicted, and unregulated - said they were solid. Mortgage brokers were permitted to confuse and deceive prospects.

Supposedly stabilizing the whole system was a multitrillion-dollar market in credit default swaps that was totally unregulated. When government fails to police the financial sector strictly, that is what happens.

If this version wins out, watch for heavy new regulation of risk markets and financial institutions - leading to reduced innovation, profitability, and market values in the sector.

Greenspan did it. In the late 1990s, when former Federal Reserve chairman Alan Greenspan knew that stock prices were irrational, he failed to put the brakes on, and then, trying to rescue the economy after the resulting market bust from 2000 to 2002, he cut interest rates too far too fast. Credit became insanely easy throughout the economy, and everybody but him could see it.

He even reassured the nation that there wasn't a housing bubble, and such words from the maestro emboldened hapless homebuyers to continue down their doomed path of paying and borrowing ever more money.

When one person gains so much influence over the financial system and screws up, the result is disaster. Expect little structural change but intense new congressional and media scrutiny of the Fed if this explanation triumphs.

Bill Clinton spawned the subprime epidemic. To gain favor with the lower-income voters who are an important part of their base, the Democrats heavily revised the Community Reinvestment Act in 1995 and took other measures that virtually forced lenders to give mortgages to subprime borrowers.

Remember the outcry over redlining, the practice of refusing to lend for homebuying in certain neighborhoods? Congress sure fixed that, and now those neighborhoods are the hot zones of the foreclosure crisis. Banks that refused to lend to those borrowers weren't evil, they were prudent - until Clinton and Congress made that illegal.

Even if Democrats have come to believe this now, they will be hard pressed to narrow the scope of homeownership. So expect little change.