Five Truths about the Banking Crisis

The first truth to understand about the banking crisis is that people don’t want you to understand it. You are supposed to trust in the judgments of the experts and give them whatever they are asking for, no matter what the cost or consequences. Just ignore the fact that many of these people are the same experts that failed to foresee or to prevent the problem in the first place.

Henry Paulson, the former treasury secretary, is one such expert. Throughout 2007 and most of 2008, he assured the public that the economy was strong, any subprime mortgage fallout was contained, the banking system was safe, and that there were no plans to recapitalize or rescue Fannie and Freddie.

Then, last September when multiple financial institutions were on the brink of collapse, he naturally took responsibility for his errors in judgment and inaction and resigned, right? Well, no. Actually he requested $700B more with virtually unlimited authority.

Of course it wasn’t exactly a request. Give me $700B right now or you get a massive financial collapse and the Second Great Depression. It almost sounds like a scheme cooked up by Dr. Evil. Did Paulson have some kind of doomsday device that he was ready to activate? Was the country really facing a financial meltdown?

We will answer that shortly and the answer may surprise you. Lets move on to Truth #2. This entire crisis was caused by widespread mismanagement throughout the financial industry.

Banks that loan money to borrowers who can’t repay don’t stay in business for very long -- or at least they’re not supposed to. The same is true for investment managers that exchange good money for bad paper.

This may seem obvious, but there are still far too many weakly written articles that blame the financial failures on the bad economy or the weak housing market -- as if banks couldn’t possible imagine that the economy might slow at some point.

Similarly, pointing the finger at credit rating firms or government regulators or auditors also misses the mark. Yes, all of these parties should have acted earlier to help prevent the crisis. But the situation wouldn’t even exist if not for the widespread irresponsibility of the people we trust to manage the world’s money.

Once the blame is assigned correctly, the ethics of the situation become very clear. Management needs to go, and the institutions they ran into the ground deserve to fail. But we can’t have hundreds of banks and financial institutions fail, right? Wouldn’t the economy drown in a sea of bankruptcies?