the root cause of the financial collapse on the front end was the housing bubble, and on the back end, the root cause was the 40-to-1 leverage ratios hidden away in securitized debt and the shadow financial system which came crashing down when housing prices turned downward to end the bubble

a bubble occurs if everybody expects, and expects future buyers to expect, that future prices will increase above that otherwise determined by the fundamentals of supply and demand

contrary to popular belief, a bubble does not require credit, or even fiat money to exist, and could occur on a gold or barter standard, fueled by income or savings instead of debt, however, "innovative financing" based on 40-to-1 leverage ratios can expand a relatively harmless, correctable bubble into a financial collapse like the current one

every dollar of default at the homeowner level is multipled by 40 throughout the system wherever the toxic debt exists, which caused panic and a dramatic contraction of credit as $2-4B of wealth evaporated from homeowners and shook the financial system to its knees

blaming individual home buyers for the crisis is nonsense - expectations of rising house prices were pervasive and decisions to seek the high investment returns were rational and no different than other investments <i>in light of a government policy dictated by the private housing sector through lobbyists, including those with Fannie Mae and Freddie Mac, that specifically denied the bubble, encouraging it instead with low interest rates and expanding it dramatically through deregulation of the financial industry</i>

the lax qualification standards for loans, low teaser rates with exploding resets and reams of outrageous fees and commissions for nothing in return were all <i>supply side phenomena - not demand side - designed to redistribute bubble-driven profits away from homeowners to the financial and real estate sector</i>

blaming the buyers for purchasing homes under these conditions as "too good to be true" is mistaken because it was pervasive as accepted practice and obviously was true, even without the hard sell - that many new homeowners could not be wrong no matter the terms and conditions <i>which despite how egregious, could have been largely offset had housing prices continued to rise</i>

when the bubble burst with declining prices is when the unraveling began, but just because some homeowners were leveraged out on a knife edge of risk when prices turned downwards doesn't mean it was their fault - the people that sold it to them multiplied out that risk by forty-fold and in that context are forty times as guilty, or even more given that near the end, denials of the bubble turned to "who could have known" flat out lies

You make many good points. But if I borrow money, I alone am responsible for paying it back. A homeowner who takes on debt beyond his ability to pay cannot escape blame.

Isn't that exactly his point? What applies to the homeowner applies to EVERYONE who handled the mortgage afterwards, who then treated it as an asset to borrow money on without maintaining sufficient reserves in case something went sour, and who wound up multiplying it out ever how many times you care to name (various sources give the leveraging rates at 30 to 1, 33 to 1, and in the first post here, 40 to 1). I will agree with all those who say that each of us should maintain an emergency fund (a reserve) for our own lives. What is good, common sense for the individual is equally good, common sense for corporate America. I will insist that if you want to hold the original borrower to such an absolute and strict standard you must also apply that same absolute and strict standard to all the subsequent borrowers.

Except these weren't standard mortgages. I used one as a bridge loan for my wife's business. I have a minor in Econ and have done a fair amount of investing for a good 20 years including succesful options trading and short selling.

And _I_ and my wife (who has a masters) had a tough time sorting out what was and was not in the mtg even with the help of our accountant. It took us 3 go-rounds with the kid that was selling us the mtg before all the paperwork was squared away (and this was our 6th RE transaction/refinance).

IOW this was harder than figuring out the value of covered Put options.

But the kid selling them was just working through the local community college. And clearly he was selling these by script to people who didn't have close to the education and experience we had.

In the stock market to trade in options both the buyer and the broker are REQUIRED BY LAW to certify that the buyer is a "expert trader" - and if a broker makes that claim fallaciously, hsi personal and borker's liability is on the line.

Yet deals far more complex than that were being sold as just normal mortgages by poorly educated sales people to poorly educated buyers with no similar protections.

Now who's fault is it?

but Carpe Diem

Either people take responsibility for their OWN actions or they do the 'scape goat' thing.

From the rest of your post, you seem to follow the 'If I don't understand it I don't do it.' Why do you wish to apply a different standard to other people?

Either people are adults and left to be so and responsible for their own actions and deeds, or they are children who should be taken care of. When things and life go well, the first view seems to be prevalent, when they turn against one, the second shows up more and more, across the board.

I'm only addressing the loan situations. Not the overall market ills. That had more to do with greed and short term views and not looking long term, ALL a common human falacy.

So you don't think Fraud should be a chargable offense right?

From the rest of your post, you seem to follow the 'If I don't understand it I don't do it.' Why do you wish to apply a different standard to other people?

I don't apply a different standard. But when the sales person convinces someone they understand it, but underlying that understanding is fraud, then I don't hold the victim of the fraud to "Seize the Day" (Don't use latin if you don't know what it means. It makes you look silly. Carpe Diem means Seize the Day, Caveat Emptor means Buyer Beware).

I'm only addressing the loan situations. Not the overall market ills

The loan situation you are addressing is a tiny fraction of the problem.

Wrenn:

The loan situation was a direct result of the market place. The market ills resulted from the market's lackadasical, irresponsible, and unethical approach to packing loans into subprime CDO and the selling of CDS to achieve a higher rating.

Barry:

Been reading your posts and they are spot-on. Thanks for engaging in an area I have trouble addressing.

Equal and abundant measures of greed and ignorance are essential for a con like this to work as well as it has. For every con there must be a mark. Like all pyramid scams for every front end winner there will be dozens and dozens of back end losers. This game has been so wildly popular that it simply ran out of suckers.

The tried and true top water baits continue to work. Spinner Baits like "The Free Lunch", and "Something for Nothing", have been particularly productive over the last eight years. As Mordecai Jones, (played by George C. Scott) revealed to his budding apprentice in the classic "The Flim-Flam man", " You can never cheat an honest man."

The Repub recession was caused by years of trickle down economics.

They have been at war with the middle class and poor . They literally destroyed the guys who buy the stuff. Now that they killed the customers and sent them into the poorhouse the economy has gone into the toilet. Oh sure the mortgage mess helped get the ball rolling but trickle down is the real culprit here. Notice only one class has done well up until a week or so ago. The billionaires did well until Mr Joe Sixpack couldnt pay his bills any longer. Now everyone is destroyed. As soon as I saw Bush employing Reagans trickle down economics I knew his was coming. Well, its here folks. Hope you did well with those tax cuts to the wealthy.

blaming individual home buyers for the crisis is nonsense - expectations of rising house prices were pervasive and decisions to seek the high investment returns were rational and no different than other investments

There was an aweful lot of stupidity going around, but that is no excuse. Arguably, the only person that really could know whether or not the mortgage was realistic is the prospective homeowner. Yes, it wasn't right that banks made it easier for the customer to bet that their career would rise meteorically, or that they would win the lottery, but in the end, the buyer is the one that took the decision to purchase an overpriced home in stead of renting or buying something affordable.

I don't see any reason why irresponsible homeowners should get a pass. Arguably, the guys that repackaged the mortgages on Wall Street are the least culpable in all of this, because they couldn't know just how unrealistic these mortgage payments were. The two people that had the highest degree of culpability are the buyer and, to a lesser degree, the real estate agent. The banks that overestimated the creditworthiness of the buyers were too credulous and in most cases they must share part of the blame too, but surely less.

The systematic overestimate of creditworthiness certainly was a failing of the financial system, rooted in optimism, exceptionalism and greed. They did create an asset bubble that was apparent for all to see starting from the late nineties (irrational exhuberance time). The expansion of leverage, which turned a simple deflation into a global implosion, was caused by the same factors, and should have been curtailed after LTCM showed that even the smartest guys had really no idea what they were doing when they balanced risks in multi-billion dollar portfolios.

Blame the financial sector for building a house out of tinder, and weatherproofing it with oil. But the people playing with matches were the buyers and their agents. There's no reason why they shouldn't get burned.

Where fiat money systems play into it is that in such systems, creation of debt can be made to look like growth, which in turn creates a disincentive for policy makers to hinder debt creation beyond reasonable levels, especially when those policy makers are answerable to an electorate who is undereducated as to the difference and prefer short term instant gratification to long view planning.

When even the pols who claim to believe in regulation for its own sake get into mantras like "It's the economy, stupid", they can become disinclined to regulate anything that gives the appearance of a healthy economy even when the fundamentals start to crack.

Barry, you can't absolve the borrowers, that is, if justice is a concern to you. But I see that you are an economist and not a jurist. Most of the borrowers lied on their application, and while they may have done this at the behest of unscrupulous real estate and loan agents, they played their part with their eyes open. I know how NIV (no income verification) stated income loans work. I used to originate them back in the early 90s. Income is verified by the borrower’s statement and it not verified with conventional supporting documents such as tax returns, bank statements, w2's ect. There are other variations of these loans but I’m not going to mention them because of time restraints.

There is plenty of blame to go around here as there are many players involved. Plenty.

As far a root causes go, I don't know how you can blanketly imply there are no root causes or that the same is a myth. That is simply not true. As an economist (a scientist) I would think you would understand the principles of cause and effect, it's an element of supply and demand.

I would say that one of the root causes of our current financial meltdown is an unwillingness of persons to be honest with themselves and the people they engage.

Barry,

You correctly state that a financial bubble does not require credit, but in this case it is a big factor.

You correctly state that fiat money is not cause all bubble, but here is was a catilyst.

You are correct that bubbles occur even in systems with a gold standard (are there of these left?), However, fiat money nearly always creates inflation over the long term. It certainly did here in the US.

You are correct that 40 to 1 leverage rations can expand bubbles, but as with the other points where you are correct, you can’t justifiably use the argument that while none of these in themselves are required that makes them a “myth”, that they are not “root causes”. All of these thing played a part .

You don’t mention the rating agencies moody’s, Standard and Poor’s et al who rated the largest portion of these junk bonds as Triple A. Would culpability on their part be a myth too?

However, the common denomitator is bankers.

Bankers supported Baroque Nigeria, when he fed ACORN with federali money to the unheard of tune of $800,000, as ACORN was then bribed by bankers, to get housing credit limits for American citizens they otherwisewho would not qualify for, but wait!

Being the forever loving blood suckers they are, bankers decided to play the latest stock market instrument, Hedged Monte-Carlo, void of making a red cent, but why should tha matter, for any way you toss this either up or down, bankers bring home the moola, but wait!

Bankers then needed to turn this into a win, win, win, win by bribing Congress. Willie Brown tries to spin it in a posssitive direction, "Somebody must have double-crossed her on the first vote. There's no way [Congresswoman] Nancy [Pelosi] would have gone out there with that proposal without having taken a vote count.

I know there are a lot of complaints, about all the breaks, and other goodies called enhancements that went into the final [banker's] package, but that's just how things get done," for bankers. [10/5/08, San Francisco Chronicle]

With multitrillions evaporating out of the world's economy, is there any wonder nations are trying to appease bankers? If Abraham Lincoln was gunned down at the order and under the pay of bankers, then what would be a factor to stop them today, as October Surprise revealed gold digging bankers April 2009, as inflation spirals out of control?

What governement, on any level, will be able to survive?