The Main Causes of the Housing Crisis and the Financial Meltdown

Previous student question:
For years, I have always believed that some of the government regulation in place has not worked well and has distorted the economy and the financial market.

I also feel the problem of the current weak economy and the on-going housing troubles includes regulatory inadequacy. Is there no regulation in place when it comes to the mortgage industry? If there is, then why did the banking regulators in 2008 look the other way when mortgages were given to people who were unable to afford the loan or unable to understand the fine print? 

My response:

The politicians in charge of executing the banking regulations and in charge of the banking regulators were doing three things that interfered with their ability to enforce a reasonable rule-of-law. One does not find much mention of these activities in the left-leaning, economically-challenged mainstream media. Did you know that a significant number of new mortgages issued during the few years prior to the housing collapse were indirectly sponsored by the government?

1) Those same politicians were accepting political contributions (conflict-of-interest?) from the very mortgage-holding organizations, Fannie Mae and Freddie Mac, two Government-Sponsored Enterprises or GSEs, those politicians were supposed to be regulating. If one checks the facts and follows the money, they will notice that the prominent politicians Chris Dodd (Chairman of the Senate Banking Committee 2007- 2011), Barney Frank (Chairman of the House Financial Services Committee 2007 – 2011), and Barack Obama (Member of the Senate sub-committee on Federal Financial Management 2004 – 2008) were among large recipients of these monies in the mid-2000s.

2) Those same politicians were also insisting that American banks comply with banking laws that used skin color or last names or geographical locations as the criteria for banks to loan mortgage money instead of insisting banks ascertain whether or not these types of new clients were likely to be able to repay the mortgage loan.

3) You are correct that these politicians were looking the other way because they were worrying about whether they were pandering well enough (the real reason for passing ethnic-group membership banking laws) to earn re-election exactly when the voices of many were urging immediate action, because they could clearly see that Fannie Mae and Freddie Mac were near collapse. Do we need new and better banking regulations? Perhaps we do. Do we need better enforcement of the reasonable banking regulations already in place? Of course we do.


Passing new, tough legislation can be spun by a politician to show that the politician is doing something about an obvious problem. On the other hand, simple enforcement of reasonable regulations is not sexy, nor is it helpful to extracting maximum political contributions from those entities being regulated. (See numbers 1 and 2 above.)

The three political activities enumerated above contributed mightily to the financial crisis that we Americans are still mired in. Oh yes, there is always “greed” or the normal capitalistic draw of profit to be made (Adam Smith call this draw, “self-interest”), but that incentive is mostly a constant, while what I cited above is what I see as the primary reasons causing the housing and financial crisis. The notion of profit to be made did not change much and is what it always should be in a capitalistic society.

Making more profit is only a secondary cause of the current housing and financial crisis. But please notice who is mostly blamed — the secondary contributor, i.e., the banks seeking profit, when the primary culprits (greedy politicians) are let off the hook by the left-leaning, economically-challenged mainstream media.



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