It's hard to say which side looked worse in last week's Goldman Sachs show trial. You had the suits from New York, squirming before the Senate inquisitors. And you had the politicians, preening themselves as guardians of financial rectitude — a display far from convincing.
The courts will decide whether Goldman Sachs was guilty of fraud. The main purpose of last week's spectacle was to deflect much of the blame for the crisis from the political class to Wall Street. Yet bankers didn't set the crisis in motion. Washington did.
The genesis of the debacle was a campaign, sustained over many years, to extend homeownership to people who manifestly could not afford it. Last year, the House Committee on Oversight and Government Reform issued the following findings:
"The housing bubble that burst in 2007 and led to a financial crisis can be traced back to federal government intervention in the U.S. housing market intended to help provide homeownership opportunities to more Americans. … Government intervention … created a nexus of vested interests — politicians, lenders and lobbyists — who profited from the 'affordable' housing market and acted to kill reforms. … The ultimate effect was to create a mortgage tsunami that wrought devastation on the American people and economy."
In the late 1990s, Fannie Mae and Freddie Mac — the two government-sponsored mortgage giants — began buying up and guaranteeing subprime mortgages on a vast scale.
By 2008, Fannie and Freddie held or guaranteed $1.6 trillion in dodgy loans, for which the taxpayers are now on the hook. Alarms had been raised earlier, to no effect. Efforts in the Bush administration to rein in the two mortgage giants came to naught.
Sen. Chris Dodd of Connecticut helped derail the reform effort with filibuster threats. Rep. Barney Frank declared Fannie and Freddie perfectly sound. "These two entities — Fannie Mae and Freddie Mac — are not facing any kind of financial crisis," Frank said in 2003. "The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing."
Fannie and Freddie later went bust, with projected losses of more than $380 billion.
Meanwhile, Wall Street had discovered that buying up subprime mortgages and packaging them into bonds was highly profitable, mainly because the ratings agencies — outfits including Moody's and Standard & Poor's — were willing to give these securities their highest rating, triple-A.
The agencies' blessing made possible the dizzying array of subprime-related products — mortgage bonds, collateralized debt obligations and all the rest — derivatives of derivatives of derivatives. "The triple-A ratings gave everyone an excuse to ignore the risks they were running," observed a character in Michael Lewis' account of the crisis, "The Big Short."
Yet the financial reform bill now before the Senate does next to nothing about the ratings agencies, which operate as a government-sanctioned cartel.
Lewis' book is an indictment not only of Wall Street but of the ratings agencies. It's the story of the eccentric characters who smoked out the subprime fraud and set up trades to profit from the coming collapse. How did they do it? They did what you would think ratings agencies are supposed to do. They didn't use mathematical models to judge safety and soundness. They examined the credit quality and underwriting of the loans backing the bonds.
One of them was a one-eyed guy who sat in a room in California, reading publicly available information. He and a few others saw the rot, and it was so obvious that they couldn't understand why the crowd continued to believe the rosy fantasies peddled by Moody's.
Wall Street's excesses sent the markets and the economy off a cliff, but the seeds of the debacle were planted by politicians and richly fertilized by their creations: Fannie and Freddie and the ratings-agency cartel. Now we have the politicians, frantically blaming the bankers for the whole shebang — a story, in other words, that's woefully short of good guys.