January 27, 2011

FCIC Ignores Critical Role of CRA's and Fed in Financial Market Meltdown

Bruce Yandle

Distinguished Adjunct Fellow

The biggest story the FCIC report missed was that the financial market meltdown had everything to do with the expansion of credit. The report put most of the blame on regulatory failure, while hardly giving Federal Reserve monetary policy a slap on the wrist.

Credit-rating agencies played a critical role in the housing bubble and subsequent collapse, which was discussed in the report. Moody’s, Standard & Poor’s, and Fitch assigned their top credit rating to the new mortgage-backed securities, which were sold to financial institutions worldwide. By siphoning global funds into the U.S. housing market, they helped develop housing into an investment industry.

The fact that the housing crisis was a global phenomenon points to the role of money and finance in the crisis and not solely regulation. The U.S. doesn’t regulate Spain’s or Australia’s housing market.

In the absence of the failure by credit-rating agencies, we would have had a smaller housing bubble in the U.S., and perhaps a more manageable one. In the absence of the Fed’s behavior we would have had a typical housing expansion and credit crunch, a repeat of incidents we have had since WWII, and yet, avoided causing major damage to the U.S. and world economy.

Steps Leading Up to the Crisis:

1. The expansion of housing finance programs under the Clinton and Bush administrations that favored what was then called an "affordable home" program.

2. Monetary action by the Fed that expanded the availability of credit to non-credit worthy recipients – through the various federally assisted housing programs.  The affordable home program was on its way to becoming the sub-prime problem.

3. A home construction boom that responded to the combination of federal housing programs and low cost money.

4. New financial products invented on Wall Street to expand the borrowing of money for home finance and construction, and allowed them to create new kinds of mortgage-backed securities to market to the world.

5. The willingness of credit-rating agencies to assign their highest ratings to a large number of the new mortgage-backed securities when later the securities were found to contain lower quality mortgage components.