The Politics of Blame

With the presidential election only a few weeks away, and our economy in a shambles, it's not surprising that fingers are pointing in all directions.

Republicans want to put the blame on the failure of Fannie Mae and Freddie Mac, and would like you to believe that John McCain led the charge to institute reforms that could have avoided all this.

I'll give McCain credit for advocating more oversight of Fannie/Freddie. The problems and abuses at Fannie/Freddie had been known for more than 20 years, and no action had been taken under either Democratic or Republican administrations. Sen. Chuck Hagel introduced the Federal Housing Enterprise Regulatory Reform Act of 2005 (S.190) on January 26, 2005. McCain didn't author the bill, but did sign on as cosponsor in May, 2006, after a damaging federal report on accounting practices at Fannie Mae was released. Better late than never.

But accounting wasn't at the heart of the problems at Fannie/Freddie, and they are only part of the cause of the financial crisis.

McCain's was quick to point a finger at the "greed that caused the crisis on Wall Street," and I agree with him. I'd be more impressed, however, if he acknowledged his own responsibility for the lack of oversight of our financial system.

In an article in Barron's (a Wall Street Journal Publication) last week, "A Memo Found in the Street", Barry Ritholtz points his finger back:

We on Wall Street feel somewhat compelled to take at least some responsibility. We used excessive leverage, failed to maintain adequate capital, engaged in reckless speculation, created new complex derivatives. We focused on short-term profits at the expense of sustainability. We not only undermined our own firms, we destabilized the financial sector and roiled the global economy, to boot. And we got huge bonuses.

But here's a news flash for you, D.C.: We could not have done it without you. We may be drunks, but you were our enablers: Your legislative, executive, and administrative decisions made possible all that we did. Our recklessness would not have reached its soaring heights but for your governmental incompetence.

Ritholtz provides a list that includes misguided policies at the Federal Reserve, relaxed guidelines at the SEC, and key pieces of legislation and regulatory change. His description of three key regulatory changes:

1999: The Financial Services Modernization Act (also known as Gramm-Leach-Bliley) repealed Glass-Steagall, a law that had separated the commercial-banking industry from Wall Street, and the two industries, plus insurance, came together again. Banks became bigger, clumsier, and hard to manage. Apparently, risk-management became all but impossible, even as banks had greater access to larger pools of capital.

2000: The Commodities Futures Modernization Act defined financial commodities such as "interest rates, currency prices, and stock indexes" as "excluded commodities." They could trade off the futures exchanges, with minimal oversight by the Commodity Futures Trading Commission. Neither the Securities and Exchange Commission, nor the Federal Reserve, nor any state insurance regulators had the ability to supervise or regulate the writing of credit-default swaps by hedge funds, investment banks or insurance companies.

2004: The SEC waived its leverage rules. Previously, broker/dealer net-capital rules limited firms to a maximum debt-to-net-capital ratio of 12 to 1. This 2004 exemption allowed them to exceed this leverage rule. Only five firms -- Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Stearns and Morgan Stanley -- were granted this exemption; they promptly levered up 20, 30 and even 40 to 1.

I've written in the past about the role of deregulation (Fundamentally Unsound) in creating the turmoil in financial markets, the lack of SEC oversight, and the connection of Gramm-Leach-Bliley to the financial problems we face today. So the key role of McCain's economic advisor and (former) campaign co-chair, Sen. Phil Gramm, came as no surprise.

While I don't buy Ritholtz's excuse for Wall Street, he's right about one thing: this could not have happened without the support of those in Washington, D.C., including self-described "deregulator," John McCain and Phil "mental recession" Gramm.

Wall Street may be to blame, but I don't have to make a decision about Wall Street in a few weeks. I just have to decide who I believe should lead our country as President...and it isn't John McCain.


Next: More about the Commodities Futures Modernization Act of 2000 and "financial weapons of mass destructions."