The Cause of the Crisis Jared M. Ladden HMN 679HB Special Honors in the Department of Humanities The University of Texas at Austin -------------------[First Reader’s Signature] --------------- Professor Brian Roberts Department of Government Supervising Professor -------------------[Second Reader’s Signature] --------------- Professor Robert Prentice Department Chair: Business, Government, and Society Second Reader “The perception of reality is often realer than reality itself” - Unknown The Cause of the Crisis 2 Table of Contents Table of Contents………………………………………………………...2 Introduction: September 15, 2008 …………………….…………………3 Chapter 1: 1929 vs. 2008 ……………………………………….……….5 Chapter 2: Pointed Fingers………………………………………………7 Chapter 3: The Product………………………………………………….8 Chapter 4: The Insurer………………………………………………….13 Chapter 5: The American Dream…………………….………………….16 Chapter 6: The FHA …………………………………………………….20 Chapter 7: Degrading the System………………………………………. 23 Chapter 8: The American Consumer…………………………………….31 Chapter 9: The Mortgage Broker……………………………………….38 Chapter 10: The Investment Banker…………….……………………….48 Conclusion: A Lack of Ethics …………………………………………... 63 Bibliography……………………………………………………………...67 Vita ………………………………………………………………………76 The Cause of the Crisis 3 Introduction: September 15, 2008 “Anyone who says we’re in a recession, or heading into one – especially the worst one since the Great Depression – is making up his own private definition of ‘recession’.” –Donald Luskin, The Washington Post – Sept.14, 2008 September 15, 2008. A sea of 28,600 cardboard-boxes filled with plants, paperweights, and coffee mugs, floods New York City’s 7th Avenue. These 28,600 boxes are carried by previous Lehman Brothers’ employees, as they filter out of the bank’s $700-million New York headquarters. Surprisingly, this quantity of jobless Lehman employees is one of the smallest figures in the following story. In fact, the boxes would each need to contain $21,643,356 to match Lehman’s $619 billion’ worth of debt when it declared bankruptcy on September 15, 2008. Lehman Brothers was only the 4th largest U.S. investment bank at the time. Therefore, their mammoth debt-pile only accounted for 16.2% of the “$10 trillion-dollars’ worth of market capital erosion” caused by the 2008 crisis (“The Collapse of Lehman Brothers”, 2017). The astronomical losses incurred by the banks led to sizeable losses for Americans as well. The Federal Reserve Bank of San Francisco estimates that the Subprime Mortgage Crisis cost every American a “lifetime present-value income loss” of roughly $70,000 (FRBSF, 2017). Based on these appalling metrics, it should come as no surprise that countless historians have sought to calculate the true cost of the crisis. Enormous corporations deemed too big to fail crumbled into dust. Global financial markets joined them, as the Dow Jones Index plunged 500 points in its worst nose-dive since the terrorist attacks of September 11, 2001. The Cause of the Crisis 4 The fiscal decay of the crisis has been calculated by countless economists, all of whom have revealed how they reached their respective values of damage. Yet, despite these calculations, there is one number far more intriguing than any other. This number represents the quantity of American executives sentenced to jail for their involvement. While the actions of bankers, insurers, and mortgage brokers should have rewarded countless unethical players jail-time, the number of American executives sentenced to jail is one (Noonan et al., 2018). This number is represented solely by Kareem Serageldin, the former Head of Structured Credit at Credit Suisse. Serageldin openly stated that he was “ready to pay [his] debt to society,” and has since served time for his role in the Subprime Mortgage Crisis. If the estimated values of ruin are so large, how is it possible that only one American executive was issued a mere thirty-month-sentence? Even the judge on trial said Serageldin’s actions were “a small piece of an overall, evil climate within [Credit Suisse] and many other banks” (Abrams and Lattman, 2014). It is clear that Serageldin could not have caused the entire crisis on his own—not without the help of American consumers, Congress, investment banks, insurers, and the numerous mortgage brokers who helped destroy the U.S. economy. Despite the actions of countless bad actors, much of the unethical behavior displayed was not deemed “illegal.” Unearthing the true costs of the crisis was rather simple, for it was extracted from financial statements, bankruptcy filings, and balance sheets. However, the true cause of the crisis still remains one of the largest financial ambiguities in American history. Eleven years later, no one is in prison, most corporations involved still exist, and a consensus on the true underlying cause has not been reached. If no one is still in custody The Cause of the Crisis 5 for their involvement, it is clear that neither one person, nor a group of people are solely responsible. Yet the unanswered question still lies eerily on the table. If not one product, individual, organization, corporation, or even a specific combination of them has been universally deemed responsible, what truly caused the 2008 Subprime Mortgage Crisis? Chapter One: 1929 vs. 2008 “There is no cause to worry. The high tide of prosperity will continue.” –Andrew W. Mellon, Secretary of the U.S. Treasury–September, 1929. The Great Depression of the 1930s negatively influenced multiple aspects of the American economy. Unemployment rose to twenty-five percent, homelessness spiked across the country, international trade declined by sixty percent, and the stock market needed twenty-five years to recover (The Balance, 2019). Despite the devastation caused by America’s first recession, “the Great Depression [most likely] does not even qualify as a financial crisis,” for there were few financial institutions at the time and they were not yet as influential as they are now (Wallison 4). In addition to the lack of financial institutions, the causes of the Great Depression have been agreed upon as combination of global economic issues. In particular, decreased international lending and tariffs, the gold standard, World War I, and the market crash of 1929 have all been deemed contributing factors (Brittanica, 2012). These isolated causes of the Great Depression strongly contradict the variety of fingers pointed every direction following the Subprime Mortgage Crisis. The Cause of the Crisis 6 The Great Depression stemmed directly from a period of rapid consumerism, known as the “Roaring 20s.” Throughout this decade, “the nation’s wealth more than doubled,” setting the stage for a drastic economic downturn (“Great Depression History”, 2009). Enthusiastic consumer spending finally plateaued on October 25, 1929. On this date, later coined “Black Thursday,” 12.9-million, overpriced shares were sold in bulk, as anxious shareholders became fearful of their investments (Great Depression History, 2009). Five days later, “Black Tuesday” emerged along with a 16-million share selloff. The second market collapse sparked a series of bank runs throughout the nation, ultimately creating a public confidence crisis. America’s economic self-esteem was not restored until Roosevelt and his “fireside chats” revived the nation’s spirit (“Great Depression History”, 2009). The ten-year chronology of the Great Depression is a simple narrative to follow. A rapid, nine-year period of economic growth, fueled by mass consumerism, eventually led to an inevitable stock market peak and crash in October of 1929. An additional market crash occurred five days later, causing widespread bank runs that demoralized the economy. Sentiments of fear and greed perfectly intersected within America’s financial markets and chaos ensued. The Great Depression of 1930 and the Subprime Mortgage Crisis are different for many reasons. However, out of all the details intertwined within each story, the largest dissimilarity is the agreement on direct causes. President Herbert Hoover claimed in his 1952 memoirs that “without the war there would have been no depression of such dimensions” (Hoover 2). In addition to World War I, many have acknowledged that the The Cause of the Crisis 7 “Roaring 20s” created a consumerism monster, fluffing the nation for collapse at the end of a prosperous era. The 2000s were at times exciting, encompassing a new digital age and the internet, but the start of the century was far from “roaring.” In fact, its onset was highlighted by fear from September 11, 2001 and an expensive war in Iraq, again leaving many searching for 2008’s true catalyst. Chapter Two: Pointed Fingers “Mankind does not reflect upon questions of economic and social organization until compelled to do so by the sharp pressure of some practical emergency.” –R.H. Tawney, Religion and the Rise of Capitalism Fingers have been pointed in every possible direction at those, and by those, deemed responsible for the 2008 Subprime Mortgage Crisis. The extensive culprit list includes, but is not limited to, investment bankers, ratings agencies, mortgage brokers, American consumers, U.S. Congress, and more. The assessment of these culprits will help determine who is most directly correlated to the biggest economic catastrophe since the Great Depression. Whom these fingers belong to and their direction of blame must be assessed with proper diligence and consideration. Prior to delving into this culprit list, the importance of isolating the causes of an eleven-year-old event must be addressed.