Root Causes of Financial Crisis Are Many

Wednesday, 20 Jan 2010 08:37 AM

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As a general rule, diagnosis should precede treatment. But last week, we saw in both the legislative and executive branches examples of the "treatment before diagnosis" mentality.

In Congress, the first hearings of the congressionally created Financial Crisis Inquiry Commission took place under the chairmanship of Phil Angelides, former California treasurer and former chairman of the California Democratic Party.

A law mandated the commission and stipulated that it report to Congress by December 2010, "with a series of conclusions about what occurred, and recommendations as to how to avoid future market breakdowns." (Disclosure: I provide professional advice to some financial institutions.)

Angelides led off his first hearing, at which he had called the CEOs of some of the leading New York banks with a demand that they accept blame for the financial crisis, saying he was "troubled by their inability to take responsibility."

With the chairman having decided on the first day that the bankers were responsible for the financial meltdown, what is the point of the commission? Can't they even bother to fake an intent to carry out their responsibilities as the law requires?

Even weirder, the Democratic leadership has made it clear that they plan to pass their financial re-regulation act before the November elections — even though they legally call for recommended changes from the commission to be reported back to them after the election, in December.

Sadly, Angelides' kangaroo-court attitude does not seem to be an aberration.

On Saturday, the president, in the words of The Washington Post, "unleashed a verbal barrage against the nation's largest banks, accusing them of wanton selfishness by refusing to accept new regulations he and his party are proposing, and for fighting a new tax that Obama wants to impose."

The president proposes enacting "The Financial Crisis Responsibility Fee," which is a $90-billion tax leveled against the 50 largest banks that, according to the Post, "Obama called responsible for pushing the nation into economic crisis. By paying the tax, the nation's largest banks would settle their debt to taxpayers."

That the bank paid back, with interest, the money loaned to them by the taxpayers does not excuse them from this new tax.

Note that not only is the president, like the commission chairman, assuming they know the cause that the commission the president signed into law is assigned to find out. But also, this new tax would establish a precedent that any person or business can be taxed or fined for any harm that Congress thinks they did to the economy.

On this theory, everyone who contributed to the real estate and stock market bubble, the breaking of which "caused" the crisis, could be taxed for the "effects" of their economic conduct.

Under that theory, everyone who bought real estate or a stock after, say, 2005, should be taxed for their crime against society.

Perhaps the Democrats would apply this theory to education. They could tax the teachers' unions and their members for "causing" generations of ill-educated children.

But beyond such foolishness, the fundamental danger of this mentality is that if they are wrong that, basically, the banks caused the crisis, then their remedies in the form of new regulations and taxes may not make the economy safer.

Rather, they may needlessly encumber and tax our financial institutions and drive financial business to unregulated Asia — and with it, our future prosperity.

Their theory is that greedy, insufficiently regulated bankers went money mad, making bad loans, gambling with their depositors' money, and thereby destroyed not only their own banks but the nation's and the world's economy.

It's a simple and time-tested method: Characterize human actions as sins, and respond to sin with punishment. That is how the Spanish Inquisition dealt with heresy, and why primitive societies made human sacrifices to propitiate their gods.

Unfortunately, such punishments didn't end free thinking or the droughts that the primitives thought were evidence of their sin against their gods. And punishing the human desire to acquire will not make us healthy, wealthy, and wise.

There are other, more plausible theories of what caused the economic crisis.

Larry Summers, now the president's top economic adviser, gave a brilliant speech in Mumbai in March 2006 in which he pointed out that the account imbalances in the world — caused by China's and other's excess savings being loaned to the U.S., and not corrected by letting exchange rates find their natural levels, and the U.S.'s lack of savings and excessive borrowing — would cause severe recession in the near future.

This trade and capital imbalance problem, many experts believe, was compounded by the Federal Reserve policy of keeping interests rates too low too long after Sept. 11.

Between those two phenomena, America was awash in a sea of cheap money that resulted in asset bubbles, excessive debt and the inevitable petty corruptions that attend bubbles.

Add to these ill-considered government policies the congressional bipartisan pressure on banks to make bad subprime loans, and you may be approaching a better explanation for what caused the crisis.

Three quarters of a century on, serious economists are still vigorously debating the causes for the Great Depression and its persistence.

Wouldn't it be wise to spend at least a few months trying to find out the real causes of our current economic crisis before committing major surgery on a financial system that has over the last century permitted the United States to become the greatest economic engine in human history?

© Creators Syndicate Inc.

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