The U.S. Financial Crisis: A Misunderstanding of the Top Causes

As I read the daily news, listen to politicians, and chat with my colleagues in the teachers’ lounge, it really seems that almost everyone believes that mortgage defaults and delinquencies are the reason we are in this financial mess characterized by frozen credit markets and downward spiraling stock markets.

To my way of looking at the economic world, saying that rising mortgage payment defaults and delinquencies are the cause of the global financial crisis is tantamount to saying that poor building design was the true cause of the thousands of deaths on 9/11/2001.

To use an often used cliche, rising mortgage payment defaults are simply “the straw that broke the camels back”. Moody’s (Mark Zandi) estimates that all U.S. mortgage losses on existing mortgages will ultimately reach $650B. This $650B of mortgage default is miniscule in relation to the size of our Government’s vast financial resources and to the economy as a whole. It makes no economic sense that a $650B problem would generate an $8 Trillion decrease in financial asset wealth over the last year!

Clearly, there must be a real problem somewhere!

The real cause of the global financial crisis should not be blamed on the mortgage market or the housing crisis, but rather on inadequate regulatory law and the related governmental oversite of our financial institutions. There was no specific law prohibiting financial institutions to amass an alarmingly risky asset to debt ratio. All of the failures of financial institutions are resulting from the firms carrying too much debt (liabilities) relative to their assets (cash & other assets). Marketable securities will always go up and down in price so any firm, especially financial firms, must have a comfortable gap of higher asset values relative to their debt. The financial firms that have failed and are failing did not/do not have a comfortable ratio of asset to debt so when their mortgage related securities fell in value due to the mortgage payment uncertainty, debtors made a run on their collateral and demanded immediate payment from the financial institutions.

So what are the real causes of the financial crisis? Here are my top 6 reasons listed in order of significance. You will notice that the most significant (1-3) are really not specifically related to the housing market or mortgage default increases. Since the mortgage defaults and delinquencies were “the straw that broke the camels” back, I have included them at a lower priority (4-6) of the causes.


  1. Imprecise regulatory law allowed the financial institutions to carry too high a ratio of mortgage-backed securities to collateralized debt.
  2. Banking regulators should have screamed louder earlier regarding the ratio of assets to debt! Although there are many documented attempts from specific people that did warn of this problem it was more a whisper than a scream.
  3. New accounting regulations under Sarbanes Oxley (regulation passed after Enron) are too conservative causing assets like mortgage-related securities to be valued less than their economic value (true worth), which caused the bank debtor run on the bank.
  4. Private lenders (and their CEOs) got greedy either lowering or violating their own lending standards in hopes of making more interest income by loaning to people who were very risk bets.
  5. Households borrowed more than they could afford. Citizens that borrowed need to share the blame with lenders, although I place lenders at a higher standard than borrowers.
  6. New law had been passed several years ago, urging institutions like Fannie Mae to make more loans to lower income households that carried much more risk.

Originally published at Welker’s Wikinomics on Oct 14, 2008 and reproduced here with the author’s permission.

2 Responses to "The U.S. Financial Crisis: A Misunderstanding of the Top Causes"

  1. Anonymous   October 17, 2008 at 11:05 am

    And not a mention of a OTC derivative anywhere Steve?OK, I understand it is easy to missed a few trillion dollars.Long live the shadow banking system !!PS-I agree we need more regulation – of the derivative marketplace NOW. Markets won’t return until this is done.

  2. Guest   February 6, 2009 at 11:03 pm

    repeat after me:The Commodity Futures Modernization Act of 2000The Commodity Futures Modernization Act of 2000The Commodity Futures Modernization Act of 2000