What We Didn’t Learn From the Bear Stearns Collapse
Sifting though the conventional wisdom 10 years later.
Bloomberg, March 19, 2018
This weekend marked the 10th anniversary of the collapse of Bear Stearns Cos. The proximate cause of the disaster was a combination of excessive, subprime mortgage-concentrated leverage and poor risk controls. But the overall economic, monetary and regulatory environment were the broader reasons.
On this anniversary, it is worthwhile to review what happened and what lessons were and were not learned. Let’s begin by looking at some of the broadest factors in effect during the pre-crisis era and how they contributed to the collapse.
Lenders made it easy, especially the non-bank underwriters who were not constrained by either Federal Reserve or Federal Deposit Insurance Corp. rules and regulations. Speaking of which:
• Deregulation: The prior few decades were an era of radical deregulation. The Commodity Futures Modernization Act of 2000 allowed derivatives to be treated unlike any other financial instrument: no exchange need, no reserve requirements and no disclosures necessary. The Securities and Exchange Commission’s Net Capital Rule (Rule 15c3-1), which limited investment bank leverage since 1975, was overturned. Glass-Steagall, which separated investing and savings banks, was repealed. The federal preemption of state anti-predatory lending laws also contributed.
• Bad economic theory: Greenspan’s “oops” moment came when he told Congress he found a flaw in his idea that bank executives would never do anything that would hurt the reputations, never mind the survival, of their institutions. This was a basis (perhaps excuse is better word) for the now-laughable belief that banks could self-regulate. The reason was a stronger force existed, namely:
• Incentives: This may be one of the fundamental laws of economics: Incentives matter. From “I’ll be gone bonuses” based on trades that blew up long after employees have left the firm, to the run-of-the-mill emphasis on short-term company stock movements (see this, this and this), the incentive system was utterly misaligned. It still is.
Perhaps the most startling lessons from the crisis are those that stubbornly refuse to be learned. There is a long and not very distinguished list of what did not cause the meltdown. Some of these explanations are tortured examples of cognitive dissonance: a stubborn refusal to accept a fact that directly contradicts a belief system or ideology in which you have invested a lot of time, effort and energy. Other factors are what I called “The Big Lie” — a false narrative blaming people and issues that had nothing to do with the crisis, but make for convenient scapegoats.
Let’s state this unequivocally: Poor brown and black people did not cause the financial crisis. There have been numerous attempts to claim they did, but each is so easily dispatched as to be laughable:
• Community Reinvestment Act (CRA): This 1970s anti-redlining legislation is a favorite boogeyman of critics. But as we noted previously, had the CRA been the cause of the crisis, home sales and prices in urban, minority communities would have led the national home market higher, then led the nation in foreclosures. This is not what happened. Instead, inland California, Las Vegas, Arizona and South Florida were initially the biggest gainers and ultimately experienced the biggest losses in the housing debacle. To say nothing of the fact that much of the rest of the world experienced an even greater housing boom and bust.
You can blame the CRA, but only if that acronym stands for Credit Rating Agencies.
• Fannie Mae/Freddie Mac: The other favorite boogeyman is these two government-sponsored agencies. Many pro-deregulation commentators refuse to accept their own roles in the crisis, and casting about for others to blame, found easy marks in these two.
Not that they were blameless: They were poorly run, sloppy finance firms that were notoriously mismanaged (my firm was short the GSEs pre-crisis). But that does not mean they were a significant causal factor. Even Greenspan admitted they were no more or less responsible for the crisis than any other big and poorly run bank.