What caused the financial crisis? The Big Lie goes viral.
Barry Ritholtz
Washington Post
November 5 2011


I have a fairly simple approach to investing: Start with data and objective evidence to determine the dominant elements driving the market action right now. Figure out what objective reality is beneath all of the noise. Use that information to try to make intelligent investing decisions.

But then, I’m an investor focused on preserving capital and managing risk. I’m not out to win the next election or drive the debate. For those who are, facts and data matter much less than a narrative that supports their interests.

One group has been especially vocal about shaping a new narrative of the credit crisis and economic collapse: those whose bad judgment and failed philosophy helped cause the crisis.

Rather than admit the error of their ways — Repent! — these people are engaged in an active campaign to rewrite history. They are not, of course, exonerated in doing so. And beyond that, they damage the process of repairing what was broken. They muddy the waters when it comes to holding guilty parties responsible. They prevent measures from being put into place to prevent another crisis.

Here is the surprising takeaway: They are winning. Thanks to the endless repetition of the Big Lie.

A Big Lie is so colossal that no one would believe that someone could have the impudence to distort the truth so infamously. There are many examples: Claims that Earth is not warming, or that evolution is not the best thesis we have for how humans developed. Those opposed to stimulus spending have gone so far as to claim that the infrastructure of the United States is just fine, Grade A (not D, as the we discussed last month), and needs little repair.

Wall Street has its own version: Its Big Lie is that banks and investment houses are merely victims of the crash. You see, the entire boom and bust was caused by misguided government policies. It was not irresponsible lending or derivative or excess leverage or misguided compensation packages, but rather long-standing housing policies that were at fault.

Indeed, the arguments these folks make fail to withstand even casual scrutiny. But that has not stopped people who should know better from repeating them.

The Big Lie made a surprise appearance Tuesday when New York Mayor Michael Bloomberg, responding to a question about Occupy Wall Street, stunned observers by exonerating Wall Street: “It was not the banks that created the mortgage crisis. It was, plain and simple, Congress who forced everybody to go and give mortgages to people who were on the cusp.”

What made his comments so stunning is that he built Bloomberg Data Services on the notion that data are what matter most to investors. The terminals are found on nearly 400,000 trading desks around the world, at a cost of $1,500 a month. (Do the math — that’s over half a billion dollars a month.) Perhaps the fact that Wall Street was the source of his vast wealth biased him. But the key principle of the business that made the mayor a billionaire is that fund managers, economists, researchers and traders should ignore the squishy narrative and, instead, focus on facts. Yet he ignored his own principles to repeat statements he should have known were false.

Why are people trying to rewrite the history of the crisis? Some are simply trying to save face. Interest groups who advocate for deregulation of the finance sector would prefer that deregulation not receive any blame for the crisis.

Some stand to profit from the status quo: Banks present a systemic risk to the economy, and reducing that risk by lowering their leverage and increasing capital requirements also lowers profitability. Others are hired guns, doing the bidding of bosses on Wall Street.

They all suffer cognitive dissonance — the intellectual crisis that occurs when a failed belief system or philosophy is confronted with proof of its implausibility.

And what about those facts? To be clear, no single issue was the cause. Our economy is a complex and intricate system. What caused the crisis? Look:

1. Fed Chair Alan Greenspan dropped rates to 1 percent — levels not seen for half a century — and kept them there for an unprecedentedly long period. This caused a spiral in anything priced in dollars (i.e., oil, gold) or credit (i.e., housing) or liquidity driven (i.e., stocks).

2. Low rates meant asset managers could no longer get decent yields from municipal bonds or Treasurys. Instead, they turned to high-yield mortgage-backed securities. Nearly all of them failed to do adequate due diligence before buying them, did not understand these instruments or the risk involved. They violated one of the most important rules of investing: Know what you own.

3. Fund managers made this error because they relied on the credit ratings agencies — Moody’s, S&P and Fitch. They had placed an AAA rating on these junk securities, claiming they were as safe as U.S. Treasurys.

4. Derivatives had become a uniquely unregulated financial instrument. They are exempt from all oversight, counter-party disclosure, exchange listing requirements, state insurance supervision and, most important, reserve requirements. This allowed AIG to write $3 trillion in derivatives while reserving precisely zero dollars against future claims.

5.  The Securities and Exchange Commission changed the leverage rules for just five Wall Street banks in 2004. The “Bear Stearns exemption” replaced the 1977 net capitalization rule’s 12-to-1 leverage limit. In its place, it allowed unlimited leverage for Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns. These banks ramped leverage to 20-, 30-, even 40-to-1. Extreme leverage leaves very little room for error.

6. Wall Street’s compensation system was skewed toward short-term performance. It gives traders lots of upside and none of the downside. This creates incentives to take excessive risks.

7.  The demand for higher-yielding paper led Wall Street to begin bundling mortgages. The highest yielding were subprime mortgages. This market was dominated by non-bank originators exempt from most regulations. The Fed could have supervised them, but Greenspan did not.

8.  These mortgage originators’ lend-to-sell-to-securitizers model had them holding mortgages for a very short period. This allowed them to get creative with underwriting standards, abdicating traditional lending metrics such as income, credit rating, debt-service history and loan-to-value.

9.  “Innovative” mortgage products were developed to reach more subprime borrowers. These include 2/28 adjustable-rate mortgages, interest-only loans, piggy-bank mortgages (simultaneous underlying mortgage and home-equity lines) and the notorious negative amortization loans (borrower’s indebtedness goes up each month). These mortgages defaulted in vastly disproportionate numbers to traditional 30-year fixed mortgages.

10. To keep up with these newfangled originators, traditional banks developed automated underwriting systems. The software was gamed by employees paid on loan volume, not quality.

11. Glass-Steagall legislation, which kept Wall Street and Main Street banks walled off from each other, was repealed in 1998. This allowed FDIC-insured banks, whose deposits were guaranteed by the government, to engage in highly risky business. It also allowed the banks to bulk up, becoming bigger, more complex and unwieldy.

12. Many states had anti-predatory lending laws on their books (along with lower defaults and foreclosure rates). In 2004, the Office of the Comptroller of the Currency federally preempted state laws regulating mortgage credit and national banks. Following this change, national lenders sold increasingly risky loan products in those states. Shortly after, their default and foreclosure rates skyrocketed.

Bloomberg was partially correct: Congress did radically deregulate the financial sector, doing away with many of the protections that had worked for decades. Congress allowed Wall Street to self-regulate, and the Fed the turned a blind eye to bank abuses.

The previous Big Lie — the discredited belief that free markets require no adult supervision — is the reason people have created a new false narrative.

Now it’s time for the Big Truth.

Category: Bailouts, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

34 Responses to “What caused the financial crisis? The Big Lie goes viral.”

  1. onwee says:

    It’s just as big a lie to say it’s all about “banksters,” and BTW the notion that free markets mean NO regulation is a lie told only by the left. Nobody on the right that I have heard (feel free to find one but it’s not a common thought) says zero regulation is what they mean by free markets. As little regulation as possible to be orderly so that markets can function well is what free market believers believe in. No dysfunctional, misguided, politically driven, market ignorant laws is another way of saying that. There will always be yin and yang based on knowledge, analysis and world view, but zero regulation is not part of the spectrum, so it’s funny how often it’s declared to be…by the left. Talk about a straw man.

    As to the cause of the crash, here are the parties that share the blame: bankers, mortgage brokers, regulators, borrowers, rating agencies, and politicians who believed good public policy was maximizing home ownership among the marginal buyers. Until everybody accepts the truth of the whole list, we’ll all be telling lies of various sizes to each other.


    BR: Who said it was just the banksters? See Who is to Blame, 1-25

  2. tonymc says:

    The simple truth about this is that government was the cause and the responsible overseer for every single point you bring up. Government required each bank to lend irresponsibly. Liberalism, socialism and the inherent borrowing caused the catastrophe. Big government meddling and irresponsible borrowing caused all the problems and is still driving bad behavior. The amazing thing is that government continues to borrow and use the money to incentivize things like having babies, layoffs and special interest lobbies. Government incentives destruction.

  3. Winston Munn says:

    Reagan: What’s that?
    Father Karras: It’s data.
    Reagan: You keep that away from me. Oh, it burns! It burns!

  4. VennData says:

    Add to that the “Reagan Myth”

    From and his cowardly retreat from Lebanon (that set us up for a generation of terror to his pseudo free-market tariffs and trade restrictions and “tax cuts” that were actually, annual tax HIKES on workers and small business…


    … and of course – worst of all – the ‘Reagan Coalition” that the GOP used .. dangling flag burning, abortion, guns, POW’s and anything else they could exploit to keep their “Big Tent” a “Big Emotional Voting Prison.”

  5. KeithOK says:

    It doesn’t take long for the Big Lie to show it’s face in the comments.

    “Government required each bank to lend irresponsibly.”

    Why other with facts and data, or even reality, when you find a nice fiction that better matches what you want to believe.

  6. wunsacon says:

    tonymc, the government did not force Hudson City to lend. The government didn’t force anyone to make bad loans. That’s you and the bank shysters making excuses. At least the banks do it for rational reasons, to continue the confidence game. Are you a banker. If not, what’s your excuse?

  7. ilsm says:

    The big lies (CRA, SS cannot be paid on the backs of youth, war is peace etc, etc.) are red herring appealing to ideologies common to the GOtea party base.

    What happens when the divide and conquer propaganda stops working?

    Occupy St Louis!

  8. Global Eyes says:

    If The Big Lie is an apt condensation of Bailout Nation, what constitutes
    The Big Truth might be a one-sentence mantra that will ignite public concern.

  9. famattjr says:


    And it just continues. Column in Examiner does not have one fact, figure or chart relevant to the headline.

  10. mrmike23 says:

    Barry…I only want ask you, if you are so prescient, where was your outrage when this was all happening? As they say, hindsight is 20/20.

  11. [...] What caused the financial crisis? The Big Lie goes viral. (ritholtz.com) [...]

  12. louis says:

    I give up BR, some people just cannot get this.

    Bailout Nation is now Underwater Nation.

    Follow the money peeps.

  13. Sechel says:

    You raise many valid points, but the greed argument must be put in the context of the ultra-low interest rate environment of the Greenspan Era. Funds have a certain minimum return they need, and when the Fed lowers the “risk less” rate of return investors are forced to take on extra risk in the hopes of attaining it. If rates were higher heading into the subprime crisis the money funding it might have gone elsewhere. Ironically Ben Bernanke is attempting to cure the hang-over by handing out more boos.

  14. MaxMax says:

    Thank you, Barry, but I fear you`re fighting a losing battle against the Newspeakers.

  15. BusSchDean says:

    tonymc: Your claims are simple but they lack support (a close relative to truth). Witch hunts and simplistic labels went out with McCarthyism.

    If you believe in Adam Smith’s capitalism (given your rant I presume that to be the case) then no competitor can be too big to fail, barriers of entry need to be kept low, and good information needs to flow freely. In short, markets do need to be regulated to maintain their integrity. Otherwise powerful competitors begin to shape the outcome, competition goes to hell, and buyers lose. Smith did not describe a market system and the “invisible hand” because he trusted businesses. Not at all. Competition would keep self-interested-driven businesses in line. The gov’t deregulated the market with strong encouragement from the financial sector. The data shows a great deal of sub-prime mortgage activity independent of Freddie and Fannie (though they too furthered the problem). The banks did ignore, hide, and otherwise shift risk only to be saved with taxpayer money. The gov’t, the Fed, the rating agencies, mortgage generators, and buyers of mortgage all fed the bubble. Barry’s point was simply that the Mayor, someone whose listened to, was ignoring the data. If you want to make a strong counter-argument all you have to do is show a convincing analysis; the data is available.

  16. Sechel says:

    Another point. Greed has always existed and it will continue to do so. Something got out of hand. It’s absurd to say the banks are victims in all this but we’ve had since the Carter administration a move toward deregulation starting with the transportation industry. We have a system in place in the United States where capital is not necessarily allocated in a way conducive to risk(e.g. Federal Reserve lending, FDIC insured deposits etc), so we’re forced to try to ensure safety via additional regulation of the industries fortunate enough to get this benefit. Regulators will always miss things, they won’t spot dangerous new trends and they are subject to lobbying and pressure from all directions, and when you make regulators weak and don’t adopt principles based regulation approach, you’re asking for the system to be gamed along with massive systemic risk being created. In short there’s pros and cons to a free market based regulation and the use of regulators, but it’s not an all or none approach. What we seem to have now is perhaps the worst of both(banks that get access to subsidized borrowing rates and regulators that are made ineffective by the successful lobbying of those same institutions)

  17. MacroEconomist says:

    Barry, I fear it’s a losing battle. When you get comments like @onwee, I just shake my head.

    Yea sure, it’s not just about regulation, it’s about enforcement of those regulations. But in order to enforce something, you need sufficient manpower to do so.

    Who gutted the SEC?
    Who gutted the Depaterment of Energy?
    Who are the biggest lobbies in Washington and what was their role in the crisis?

    The “straw man” isn’t the debate against Republicans vs. Democrats. It’s about how big business has stolen this country.

  18. MacroEconomist says:

    @mrmike23, you are a moron. I have been reading Big Picture for 6 years now. BR has called this from the beginning.

    Where WERE YOU?

  19. Winston Munn says:


    From the NYT article you linked – this should be the new national motto: “‘You tend to be more discerning when you have to eat your losses,’ said Denis J. Salamone, the bank’s chief operating officer.”

  20. adammarley says:

    As little regulation as possible to be orderly so that markets can function well is what free market believers believe in. No dysfunctional, misguided, politically driven, market ignorant laws is another way of saying that. There will always be yin and yang based on knowledge, analysis and world view, but zero regulation is not part of the spectrum, so it’s funny how often it’s declared to be…by the left. Talk about a straw man.

  21. Deborah says:

    All good points, but I would suggest that before regulations were weakened and repealed we were still in a position where we were going to have big trouble. We just have much bigger trouble and it came sooner.

    Things that were working or seemed to be working were dependent on a ponzi population model and the rate of increase in population has declined to the point that even without the irresponsible behaviour of so many groups on so many level, serious problems would have started to be apparent.

    Also, the largest and most politically powerful demographic group, the baby boomers, were rescued from excessive debt loads by inflation and yet many still completely failed to manage their resources to prepare themselves for retirement. Many simply borrowed more. This group had the opportunity to purchase homes and then see wages increase considerably relative to what they borrowed. They also had the opportunity to refinance debt at lower rates as Greenspan stepped down rates over a 20 year period.

    I believe that this truly masked that the lending laws as they existed DON”T work in an environment of relatively flat wages or low wage increases and that 30 year mortgages are a disaster for the financial health of the long term economy, especially as interest rates have decline and people have borrowed up to a fixed percent of income that has remained constant when it too ought to have declined with declining interest rates.

    Another thing that is grossly flawed in all this theory and myths of how the financial world works is that we have this theory that the money we have invested will grow at the rate of inflation and currently most pension plans are using a grossly unsustainable rate of return in terms of accounting for their ability to pay obligations. That is one problem, but a problem never looked at is that governments are also expected to be paying pensions that have increases for inflation built into the obligations, but they have no money invested to cover these increases, indeed, because of the gross levels of borrowing, they are essentially paying out “at both ends,” for those that have private pensions through the return on treasury bills and for those dependent on government pensions, both public pensions and social security. The government has so grossly shifted the demand curve for money, well, what would it look like if moneys for government pensions were separate and required to “work” to provide for these immense promises? With government pension obligations it should be the largest player in seeking return on investments whereas it is currently the largest provider of return on investment.

    This is just another financial crisis and it is hidden in the housing bubble financial crisis.

    It would be so interesting to be able to study the financial beliefs and policies that have developed since the 1930s depression a hundred years from now because I think in hind sight our great, great, great, great grand children will think that we were not so financially sophisticated to not see the degree to which are beliefs developed around ponzi population growth because we utterly lacked the foresight to see the problems with declining population growth and to adjust our policies accordingly.

  22. denim says:

    Deja Vu all over again….when the time is ripe for the harvest.

    “The evidence thus far indicates, tends to show that men upon whom fortune has smiled beneficently and who possessed great financial power and great governmental power undertook to nullify the laws of man and the laws of God for the purpose of gaining what history will call a very temporary political advantage,” Ervin said. [that would be Senator Sam Ervin of North Carolina, at the Watergate hearings]. The fine Senator went on to quote Paul in Galatians 6: “Be not deceived; God is not mocked: for whatsoever a man soweth, that shall he also reap.” He had to gavel down the applause….
    UPI story in the Sarasota Herald-Tribune – Jul 19, 1973

  23. Peter Davies says:

    A great article BR. Its content needs to be promulgated far and wide as an anitidote to the extreme right wing/religious nutters who are now so prominent in the media. These people are not freedom-loving capitalists. They are corporatists trying to hijack capitalism. The only freedom they truly expouse is the freedom to do what they want including limiting the freedom of others.

  24. victor says:

    Barron’s Abelson incessantly warned us about the looming sub-prime crisis but frankly when someone like Greenspan dismissed the notion and a Ben Stein would chime in with same arguments, who were we to believe at the time? I guess we were all duped? I read that when John Paulson’s hedge fund made that one big killing a Merrill Lynch fund registered almost an identical loss; one bet, two parties? cannibalization anybody? Zero sum game less friction losses (that’s us, the unwashed)

    “Once again, real life is not a casino with simple bets. This is the error that helps the banking system go bust with an astonishing regularity”.

    By Nassim Nicholas Taleb

  25. DeDude says:

    There were all kinds of credit driven bubbles in all kinds of assets, and they happened in most of the western industrialized countries. Residential real estate, commercial real estate, credit card financed consumption – in US, Spain, Ireland, etc. It was all about credit driven “consumption” and it was all driven by those peddling (and profiting from) easy loans. To suggest that some US specific government policy regarding home ownership was responsible, is a clear sign of having missed the big picture (or of pimping for the 1%). The huge burst in credit was created by financial innovation (allowing banks to do the equivalent of printing their own money) and Central bankers desperately trying to save economies that were stalling for a lack of fuel (fuel = increased income for consumers), due to structural flaws in their capitalist economies. The only thing government can be held responsible for is its failure to institute laws and regulations that prevented the top 1% from blowing a huge credit bubble and using it to rob the 99% of their money and of a functioning economy for decades to come. Allowing something as simple as finance (distributing savings to invest in productive businesses) to become 1/3 of our economy is a crime of inefficiency.

  26. q7 says:

    All good points Barry.

    However, I don’t think there would have been a housing caused financial crisis if banks had simply behaved as prudently as mine did in the early 1980s when I applied for a mortgage:

    20% down and a copy of your paycheck.

  27. Sechel says:

    Over the past decade so many safe guards have been remove from the financial system that nobody trusts it anymore. I believe MF global to be a game changer. While all the details are still not known the news suggests that MF Global was able via rehypothecation leverage client assets to purchase sovereign debt. Just like in Lehman people who thought they could trust access to their funds are finding out they may be unsecured creditors. You also had regulators not being dilligent or early enough to ensure the firm had sufficient net assets to cover the loans or to ensure that customer accounts were properly segregated. It all comes down to regulators being more responsive to the entities they regulate than the ultimate customers of those institutions. And it’s not just MF Global and the CFTC (which is actually run by regulators who seem to want do the right thing(Gensler & Chilton) but the Fed reserve itself who thinks nothing about transferring swaps from BAC parent to the regulated entity under the supervision of the FDIC which exposes tax payers and also puts at risk lenders who thought they were investing with a higher credit(the regulated part of BAC)

  28. [...] Wall Street is the victim, not the cause of the recession. (See here) [...]

  29. Defining Quality says:

    Here’s the Big Truth.
    Corruption in government is the cause and we all know it but no one has any idea how to stop it.
    The corruption goes on unabated!!!!!!!!!!!

  30. [...] don’t know about you but I find Barry Ritholtz’s explanation for the financial crisis as good as any. In his explication it was caused by a combination of [...]

  31. unfavorableodds says:

    Barry’s 12-point list is pretty much spot on, except for one extremely glaring mistake that he repeats over and over like Bloomberg and Republicans do with the CRA. Prior to the SEC rule change in 2004, leverage ratios of investment banks were HIGHER than after the rule change. Leverage ratios were consistently higher in the glorious 1990s than they were from 2004 to 2007. This is not information from some deregulation partisan hack. It’s from guys like Stiglitz, Alan Blinder and Andrew Lo!

    Besides that, the rule change was in response to the Basel Accords negotiated in the 1990s. Prior to the rule change, international brokerage firms had much higher leverage ratios that U.S. broker dealers.

    I’ll repeat, the rest of Barry’s list is spot on, particularly where he shoots down the “Congress made me” crap. But to say that the 2004 rule change allowed banks to behave in a way that they hadn’t before is not supported by the facts. It’s like Barry is trying to create a false narrative.

    It does, however, provide a nifty scapegoat.

  32. [...] There are some other false narratives going on about the financial meltdown of 2008.  They are basically that “Wall Street is a victim” and “the government forced banks to loan money to poor people who couldn’t pay it back.”  Of course, these narratives are patently false, and in a recent Op-Ed piece in the Washington Post earlier this month, money manager Barry Ritholtz eloquently makes this case.  He said, “Indeed, the arguments these folks make fail to withstand even casual scrutiny. But that has not stopped people who should know better from repeating them.  The Big Lie made a surprise appearance Tuesday when New York Mayor Michael Bloomberg, responding to a question about Occupy Wall Street, stunned observers by exonerating Wall Street: “It was not the banks that created the mortgage crisis. It was plain and simple, Congress who forced everybody to go and give mortgages to people who were on the cusp.”  (Click here to read the complete Ritholtz article–it’s great!!) [...]