"I made a mistake." ~ Alan Greenspan 2008
Throughout the various policy, scholarly, and media debates over the financial crisis the focus has been on a handful of bad actors. Among the culprits are greedy homeowners, lazy underwriters, asleep-at-the-wheel regulators, irresponsible investors, fraudulent appraisers and credit rating agencies, misguided housing policy agencies of government and a range of other individuals and organizations. Missing from virtually all discussions is the critical role that several, broader, and more fundamental contextual factors have played in nurturing these events; factors which promise to create future bubbles and crises if attention is not paid.
Perhaps the most critical factor that has been missing in plain sight is the role of residential racial segregation. As Jacob Rugh and Douglas Massey recently reported in the American Sociological Review, racial segregation is a stronger predictor of the number and rate of foreclosures across US metropolitan areas than creditworthiness, level of subprime lending, home price inflation, coverage by the Community Reinvestment Act and other factors. Because low-income and minority communities were targeted by subprime lenders, it is no surprise that the targets of such high-pressure marketing could be more easily identified in segregated communities, with the foreclosure patterns one inevitable outcome. Fair housing enforcement, consequently, is important for financial services reform in particular as well as equal housing opportunity generally.
A related contextual factor has been the skyrocketing increases in various trajectories of economic inequality. The fact, if not the cause, of such inequalities is widely agreed upon by observers ranging from Mother Jones to the Wall Street Journal. As more families find themselves economically stressed, and falling further behind their neighbors, they become more vulnerable to exploitative home refinancing schemes which, again, lead directly to foreclosures. Strengthening the role of unions, rebuilding the social safety net, and restoring the middle class, therefore, also constitute essential steps toward financial services reform.
An ideological commitment to the false notion that markets are self-correcting led financial institutions and regulators down the same path. Even Alan Greenspan, a protégé of Ayn Rand and longtime Chair of the Federal Reserve Board, admitted before the House Oversight Committee in 2008 that his view of how the world worked was wrong. Greenspan testified that "I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms." Committee Chair Henry Waxman followed, "In other words, you found that your view of the world, your ideology, was not right, it was not working." Greenspan replied, "Absolutely, precisely."
But the notion that all goods and services are and should be distributed via voluntary decisions on the part of individual buyers and sellers in a free market where entrepreneurs are properly driven to maximize private returns to stockholders remains an article of faith, but faith that has proven unfounded. Some observers have noted the blind faith in free markets as part of the problem, but only to support a call for stronger regulation. Rarely does any "serious" student of financial services question the role of private capital accumulation as the appropriate, ultimate objective of our economic system or propose alternative structural approaches to prosperity. Nowhere has anyone suggested, for example, that the state-owned Bank of North Dakota which has been successfully financing industry, agriculture, finance, education, and more since 1919 might have any lessons for us today.
Of course this ideological perspective does not appear out of thin air. The nation's elite (and not so elite) business and law schools, which train - and socialize- the leaders of our nation's financial institutions and their regulatory agencies, preach this gospel. And the minions learn it well. Among the consequences is the revolving door between industry and regulatory offices. A firm hiatus between leaving a regulatory agency and joining one of the regulated would be one step in the right direction.
A related contextual factor is the political power of the nation's financiers. Industry lobbyists do not always get their way in the legislative process, but they are well prepared to continue the more opaque battle in the rule-writing process. As the Wall Street Journal reported, months before the Dodd Frank Wall Street Reform and Consumer Protection Act was signed into law, but in anticipation of legislation along those lines, lobbyists were working closely with agency staff to write the regulations. No doubt some of what the industry lost in the law will be regained in the regulation-writing process. And some in Congress are already considering legislation to repeal the law itself. The political power of the industry is occasionally noted but, again, primarily to demonstrate the need for stronger regulation of the industry rather than broader political changes. Yet absent a broader context of campaign finance reform, reforming the nation's financial institutions will be a far more difficult task.
Perhaps the most challenging force is represented by global capital. As the eminent geographer David Harvey argued in his recent book The Enigma of Capital, what we are experiencing is a crisis of capitalism, not a crisis of regulation. The unsustainable demand for permanent private returns on capital made mortgage-backed securities an attractive outlet for surplus capital, at least until the bubble burst. But failing to reign in the power of global capital is to invite more frequent and more severe booms and busts.
These contextual factors present far more fundamental and problematic challenges to the nation's economy and overall well being than whether or not we figure out how to resolve the too-big-to-fail problem, regulate derivatives, or determine which financial products should be banned. Technical fixes are clearly part of the solution. But bringing a strong dose of democracy to our economy should be the first order of business.
Gregory D. Squires is Professor of Sociology and Public Policy and Public Administration at George Washington University. An earlier version of this article was published in The American Banker on February 11, 2011.