Response to Lucror

This post is intended as a response to an anarcho-capitalist on this website who claimed that homeowners were responsible of the economic collapse of 2007-2008.

Lucror wrote that the financial crisis was "in a nutshell caused by people not paying back their mortgages."

In order to deal with this claim I would like to first take a look at one of the most significant events of the crisis, the 2008 collapse of Lehman Brothers.

From Investopedia.com

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On September 15, 2008, Lehman Brothers filed for bankruptcy. With $639 billion in assets and $619 billion in debt, Lehman's bankruptcy filing was the largest in history, as its assets far surpassed those of previous bankrupt giants such as WorldCom and Enron... Lehman's collapse was a seminal event that greatly intensified the 2008 crisis and contributed to the erosion of close to $10 trillion in market capitalization from global equity markets in October 2008, the biggest monthly decline on record at the time.

Lucror does not explain how he believes homeowners were responsible for this, but let us try and get an accurate picture of the events by placing it in a historical perspective.

Prior to 1999, mergers of investment banks and mortgage companies were illegal under the Glass-Steagall Act. This act was originally passed in 1933 as a result of investigations into the causes of the 1929 stock market crash. However, after the triumph of neo-liberalism in the 1980s, all government barriers to unhindered capitalist extraction of profit were targeted for elimination. This ideological puritanism (quite in line with Lucror's own) led to the 1999 passage of the Gramm–Leach–Bliley Act which eliminated the

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barriers in the market among banking companies, securities companies and insurance companies that prohibited any one institution from acting as any combination of an investment bank, a commercial bank, and an insurance company.1

Gramm-Leach-Bliley was passed with the support of then Secretary of the Treasury Robert Rubin and then Deputy Secretary Larry Summers. Both would profit immensely from Gramm-Leach-Bliley with Rubin going on to take a position on the board of Citigroup, and Summers doing work for D.E. Shaw and Co, making some $5 million in a 16 month period.

Too Big To Fail

With the passage of Gramm-Leach-Bliley the Glass-Steagall act became meaningless. This led to the creation of companies that were "too big to fail" signified by the 2003 and 2004 mergers between Lehman brothers and 5 mortgage lending companies. Housing prices at this time were increasing at a steady and unprecedented rate. Dean Baker writes,

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Government data show that inflation adjusted house prices nationwide were on average essentially unchanged from 1953 to 1995. Rober Shiller constructed a data series going back to 1895, which showed that real house prices had been essentially unchanged for 100 years prior to 1995. By 2002, house prices had risen by nearly 30 percent after adjusting for inflation. Given the long history of stable house prices shown in the government data, and the even longer history in the data series constructed by Shiller, it should have been evident that house prices were being driven by a speculative bubble rather than the fundamentals of the housing market.2

After the merger, Lehman Brothers, like many other investment companies at the time, were now not only giving out mortgages to homeowners, they were also trading in mortgage backed securities. This meant that Lehman Brothers was selling off the rights to collect payments from the mortgages they were selling. This in turn meant that Lehman had no interest in determining whether or not the people they were lending to would be able to make the payments. The people hired by Lehman to appraise the financial status of potential homebuyers were pressured into giving generally high appraisals. Not only that but even more importantly Lehman was incentivized into giving out mortgages to people who they knew could not pay them back. This is because Lehman knew that once the mortgage was given out all it had to was simply trade the mortgage on the market and it would then never see any losses if the homeowner was delinquent with payments. 3

Investment Vehicles

To make matters worse companies like Lehman were also trading in derivatives of the mortgage backed securities meaning that little bits and pieces of each mortgage were owned by multiple shareholders and ownership of the rights to collect payment became hard to pin down. The process of trading these instruments was facilitated by the creation of Collateralized Debt Obligations (CDOs). CDOs were investments packages that included trading of mortgage backed securities along with other assets. Citigroup (the company that Robert Rubin was now chairing) then invented structured investment vehicles, which were companies whose sole assets were CDOs. And if all this wasn’t enough the mortgage backed securities and derivatives were all insured with credit default swaps which were themselves highly profitable investment packages.

With Lehman Brothers and companies like it making record profits from mortgages there was no reason to stop encouraging potential homeowners from taking out risky mortgages. And how was Wall Street able to get away with making these highly risky maneuvers? Because the US government, intoxicated with neoliberal ideology (almost all of it in line with the ideals of anarcho-capitalism) had refused to regulate derivatives markets such as those outlined above.

Well needless to say shit hit the fan. It started with the riskiest of mortgage backed securities, known as subprime mortgages. These were mortgages given to people who had not had thorough background checks done on their financial history and who subsequently had interest rates on their mortgages. Delinquencies on these mortgages began pouring in at an alarming rate leading to large losses in the hedge fund Bear Stearns. Smelling blood Bear Stearn's competitors made moves to drive the prices of subprime mortgages down even further, by July 2007 Bear Stearns filed for bankruptcy.

With the Bear Stearns bankruptcy Lehman Brother's stock fell sharply. Investors, wary of holding their money in a company whose assets were tied so heavily with subprime mortgages, began to pull their liquidity. By early 2008 the company's stock fell by 50%, and by fall of 2008 Lehman had declared bankruptcy. 4 The collapse of Lehman Brothers was a disaster for worldwide capitalism. Governments around the world hard to step in to stop the ensuing chaos with the US federal reserve printing trillions of dollars in an effort to pour liquidity back into its financial companies. Due to popularity of CDOs all investment packages became suspect because it was impossible to know to what extent companies and investments had been exposed to toxic mortgage backed securities.

Blaming the Victim

Wall Street would end up being bailed out after two bailouts and the virtual nationalization of Fannie Mae and Freddie Mac, but what of the homeowners, the ones who Lucror blames for the crisis?

Before the collapse, Wall Street was making a killing off its investment instruments. Lehman Brothers was trading with liquidity worth 30-40x more than the mortgages the investments were originally based on. And while Wall Street was making billions Americans wanted to partake in the profits. This is why they bought homes which they thought would appreciate in value. Yet the people who engaged in these comparatively modest attempts to make money are the ones who are to be blamed by Lucror. The financial experts and the mortgage appraisers whose jobs it was to assess the financial solvency of mortgages are able to escape all blame, and it is the individual homeowners, the ones who sought to share a piece of the Wall Street pie who Lucror reserves his scorn for. This is the logic of victim blaming.

The fact of the matter is that this is a perfect case study in what happens when capitalism is left unregulated. This is the “anarcho-capitalist” paradise which Lucror and people of his ilk would like us to head towards, but whenever we get a taste of this paradise, like in 1929 and 2007, the result is disaster.

  • 1. "Gramm–Leach–Bliley Act." Wikipedia. Wikimedia Foundation. Web. 3 June 2015.
  • 2. Baker, Dean. "The Housing Bubble and the Financial Crisis." The Real-World Economics Review 46 (2008): 73-82. The Real-world Economics Review. Web. 4 June 2015.
  • 3.
    Baker, Dean.
  • 4. "Case Study: The Collapse of Lehman Brothers." Investopedia. 30 Oct. 2008. Web. 4 June 2015.

Posted By

Soapy
Jun 4 2015 01:27

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Sister Ray
Jun 4 2015 08:32

Good stuff, agree with just about all of it. The capitalist wet dream of 'perfectly efficient markets' just doesn't exist- markets left to themselves will inevitably collapse due to their internal contradictions. This is the main role of the state, to prop up markets when they do fail. Right-wing 'libertarians' and AnCaps attack the state, but ultimately without it capitalism could not survive.