Made mistakes. American politicians, central banks and regulators were just as eager as speculators to expand the housing bubble. They just had a bigger pump.
The US Federal Reserve lowered interest rates from 6.5 percent to 1 percent between 2001 and 2003, and housing prices soared. Starting in 1995, the government threatened banks and thrifts with regulations and legal challenges if they did not extend more loans to poor neighbourhoods and a government‐sponsored company such as Fannie Mae used its state guarantees to purchase more risky loans and expand the sub‐prime market.
Is the solution to the crisis really to give more power to people and institutions that contributed to bringing it about?
The problem with regulation is that it is always a response to the last crisis. Generals fight the last war and always try to avoid the mistakes made then. So we get new rules that target the mistakes that everybody already knows they must avoid. The next possible crisis and its causes are so far unknown, and our regulations may have no effect or even make them worse.
After the exposure of accounting scandals in companies such as Enron, we have seen more drastic accounting regulations. We all wanted to avoid another Enron. “Fair value accounting” was one of the results, which means that financial institutions had to mark their assets to market. If a bank has mortgage‐backed securities for sale, their value is registered as the price it could get if it sold them on the market today, rather than taking historic prices into account.
It sounds reasonable, but the problem is that when there is panic in the market, no liquidity and no buyers, that price is very low. So suddenly all institutions see the value of their assets drop at the same time. If they sell to make up for the loss, the prices fall even more, and accountants keep marking down assets. The result is that a bank or thrift that looked very stable a few days ago can suddenly turn out to be insolvent, at least on paper.
William Isaac, who used to be chairman of the Federal Deposit Insurance Corporation, has said that if fair value accounting was in place in the 1980s, all the big banks in the US would have collapsed and the recession might have become a depression.