The Credit Society: Historical and Social Trends that Led to the Economic Crisis of the Late 2000’s

For the course Globalized Capitalism with Robin Blackburn at the New School for Social Research

INTRODUCTION:

As the recent credit crunch and current recession attest, American social trends have not kept pace with the economic requirements of capitalism and we have walked blindly into financial distress.  It is an unfortunate state of affairs, indeed; we have neglected a common sense approach to financial prudence, allowing trusted institutions to gamble wildly with our collective economic well-being.  Therefore, this paper asks this question: what reforms of public and personal economic behavior can alleviate the private and national distress spawned by the current economic crisis, and, moreover, provide some assurance that we can prevent a recurrence?  The true problem of the 21^st century may prove to be a matter of deciding to reform the management and theory of financial practices in the United States to avoid future investments from coming up short, perhaps embracing systems of trade that better support local economies, and regulating the cooperation of corporations.

This paper confronts today’s recession as equally a problem of irresponsible practices within the financial sector as it is a problem of the financial imprudence of the public.  In the wake of the recent credit crunch and subprime mortgage crisis, the United States, along with much of the world, must reexamine the practices of our banks, investors, creditors, and corporations, all which contributed to the state of our current recession.  Moreover, we must examine the contribution of common credit holders and consumers, whose excessive spending and unaffordable debt accumulation solidified the financial crisis of the middle classes.  The urgency of the situation begs us to question what appears to be a veneration of consumption within our society, and the historical implications of the social function of consumption, which may have overridden a more prudent logic of investment and credit on the part of the American consumer.  The purpose of this paper is to explore these questions and examine the possibilities for installing financial protections while promoting growth for investors.  Moreover, this paper will explore possibilities for systemic change, which could be the next necessary step in the conversation between the financial sector and the federal government.

Certainly, the scope of this paper is unfortunately insufficient to adequately examine the trends and data it hopes to understand.  Moreover, this paper suffers from numerous other deficiencies, in particular, a noticeably weak exploration of vital international data and perspectives, which only serves the detriment of the ultimate goals of the paper.  However, deficiencies aside, it is the author’s hope that the intentions of this paper will be valid nonetheless, and perhaps will contribute a different understanding than has been voiced in recent times.  This is, perhaps, too much to hope for, but nonetheless, I will try!

The Structure of the Current Problem

(The Subprime Mortgage Crisis and Modern Financing Practices)

The problem of the current economic crisis is a problem of financial handling.  According to a 2008 report on subprime mortgage performance published by representatives from the Federal Reserves, “A subprime mortgage is one made to a borrower with a poor credit history (e.g., a FICO score below 620) and/or with a high leverage (as measured by either the debt-to-income ratio or the loan-to-value ratio).”[i] In theory, these types of loans intend to extend access to financial aid to normally ineligible borrowers.  However, in the case of subprime loans and mortgages, the potential (and eventual) detriment often far outweighs the benefits.  Disaster, in hindsight (as always), seems to have been inevitable.

In a comparison between the delinquency rate for fixed and adjustable rate prime and subprime mortgages, the disparity is astounding.  For a fixed rate prime mortgage in 2008, the delinquency rate was about 1.11%, and about 5.43% at the adjustable rate, whereas the fixed rate subprime delinquency was about 8.73%, and the adjustable rate a whopping 24.11%.[ii] According to CNN analyst Les Christie, by May 2010, the overall delinquency rate on all mortgage payments reached 10.06%, with 4.63% foreclosed.  Of the mortgage types within the 10%, 6.17% of fixed rate prime mortgages went delinquent, along with 13.52% of adjustable prime mortgages.  Subprime fixed rate mortgages went delinquent at 25.69%, and the adjustable went at 29.09%.  According to Christie, the rates are ballooned in part due to delinquent borrowers whose homes were not foreclosed in order to permit their continuation in the system, and prevent repossession during the recession, otherwise lenders would not recoup even a small percentage of their losses from the borrowers.[iii] Clearly, the adjustable rates pose the most risk regardless of borrower qualification; nonetheless, lenders were still willing to give loans that carried the highest risk to borrowers who stood the greatest risk.  After the value of investments plummeted and interest rates soared with the decline of house sale prices in the mid-2000’s, the number of sellers outnumbered the buyers in the housing market, leading to a rise on loan and mortgage repayment delinquencies and defaults.  As a result, financers tightened credit and left investors to sink or swim.

The crisis was not restricted to homeowners, however, as student and automotive loans were similarly affected, amongst other industries.  The College Board and Department of Education, for example, reported in 2008 that nearly one fifth of student loans, seen numerically as 238,000 out of 3.4 million, borrowed that year would eventually default.[iv] Such a problem was earlier predicted in a Project on Student Debt study,[v] which noted the 8% increase in student debt from 2005 to 2006, while, in contrast, the offered starting salaries of graduating seniors rose only 4%, indicating early on that income would eventually fall short of loan repayment.  According to the New York Times, by 2008 (no information for 2009 or 2010 is available yet) the student default rate was at 7%, up from 5.2% in 2006.  The Times also notes that included in the total are the debts incurred by students attending for-profit institutions, which increasingly offer loans more readily to students who may not be able to afford repayment, which has left for-profit educated students with higher debt percentage after graduation than non-for-profit educated students.[vi] Awareness of this concern has led lawmakers to seek regulation of recruitment practices and loan approval, in addition to suggesting that schools with the highest debt per capita should provide programs with higher employment opportunities to maintain access to future federal aid.[vii]

The parallels between the situation of student loans and subprime mortgages portray a combination of misunderstanding and misrepresentations of (and perhaps, lackadaisical attitude toward) the financial practices involved in borrowing—much of which is evidenced in the seeming atmosphere of surprise that permeated both the media and public venues after the price bubble burst.  Were we so unaware of the risks involved?  Or was sheer overconfidence blinding ordinary prudence?  Why were lenders willing to take such a risk with subprime borrowers, and why were borrowers eager, willing, or at least, resigned to accept such risk?  About this time, numerous explanations for the problem abounded on the airwaves and in print, but none could pinpoint a cause or suggest how we may have foreseen the extent of the “muddle” of our “delicate machine,” to borrow from Keynes post-Depression warning.[viii] In keeping with Keynes, we should not expect the outcome of our financial crisis to be regressive—there no such thing as economic backtracking, only adaptation; instead, it is what he calls “magneto trouble,” in that the “machine”—capitalism, or the economy—is stalled or jammed, as he states, and must be unjammed and the ignition restarted, so that the machine may continue toward its destination.[ix] The problem then as now was how to establish the jam sites, which are neither causes nor sources of distress, but symptoms of the basest materials of the system’s construction.

According to Senior Research Economist at the Cleveland Federal Reserves Bank, Yuliya Demyanyk, pinpointing causes are nearly impossible.  Many of the explanations that are suggested as precise causes of the crisis are misjudged, and have created what she calls “myths” of the credit crisis—myths of subprime mortgages in particular.[x] The causes of the problem, Demyanyk insists, are instead symptoms of the larger problem of lender/borrower practices dating as far back as the 1980’s or earlier.  One of the top myths is that of who received subprime mortgages.[xi] It is a false assumption that only borrowers with poor or no credit histories received subprime loans.  Demyanyk asks us to look at high-cost loans given to borrowers with excellent credit histories, who, for example, wish to purchase luxury commodities, such as multi-million dollar homes or a private boat.  Taken into account, this occurrence does not appear to be a problem of at-risk borrowers, but of the attitudes of borrowers in general, who voraciously seek commodities.

Demyanyk’s further analysis deals with empirical evidence, and she finds that certain suggestions—that a) subprime mortgages promoted homeownership, b) declines in home values caused the crisis, c) underwriting standards declined, or d) extensive refinancing—have no empirical evidence of widespread contribution to the crisis.  In fact, she implies that the lack of such empirical evidence shows that these issues were actually situational and while contributing to an extent in certain cases, were in no way causes of the ultimate problem.  Ultimately, the lack of empirical evidence suggests that the circumstances of the borrowers and the individual acts of lending were so diverse that the most common guidelines for lending were interpreted on a borrower-to-borrower basis, which meant that often, the only commonality between borrowers in a particular grouping was the desire for the particular loan and its intended use (a house, education, etc.).  Considering the state of the mortgage industry, this is an odd thought, though perhaps it indeed tells us something about attitudes toward borrowing.  To think about this further, we need to know more about lending guidelines.

In the 2008 report submitted to the Federal Reserve by Demyanyk and Otto von Hemert,[xii] the pair explores information provided by banks, examining loan quality, borrower characteristics, loan characteristics, and macroeconomic conditions.  Loan quality, defined as the performance of the loans, depended on the expected and eventual outcome of loan repayment.  This is depicted in the increased visibility of risk taken by high loan-to-value loans with adjustable rates as the trend spread from low and mid income borrowers to high income borrowers seeking even higher risk loans for otherwise unaffordable properties.  Borrower characteristics include credit scores, previous and current debt, and personal documentation.  As previously remarked, the characteristics of the borrower are not necessarily high risk, and the individual may even have an excellent credit history that would permit a prime rate loan in other circumstances.  The risk is ultimately a high stakes gamble, regardless of traditional or no documentation of the borrowers credit and income history, and contingent on a projected future ability to meet payments.

Unfortunately, loan quality is often determinable only after delinquencies begin, though the characteristics of the loan should aid in the early determination of whether a particular borrower can feasibly afford the debt.  Beyond the actual mortgage amount, terms of interest and the ability to pay off portions of the principal balance also may determine the financial capacities of particular borrowers on a case-to-case basis.  The subprime loan itself may not be a disaster so long as its terms are adequately and responsibly established.  Here is where macroeconomic concerns are raised; in particular the widespread changes in unemployment rates and property values, along with personal and overall community incomes.  Mortgages were sold with all of the mentioned circumstances in mind; however, the variability of macroeconomic conditions posed a looming threat for the subprime market—not merely in terms of appreciation and depreciation, but of the overall sustainability of a lending system that knowingly depended on successful speculation.  The success of the subprime mortgage market was that it made borrowing accessible; its failure was that it depended too much on predicting the future state of the economy and financial state of the borrower.[xiii]

Thereby the problem of speculation is sustainability.  As Gary Gorton suggested in 2008,[xiv] the sustainability of the subprime mortgage balanced on the appreciation of house values, which differed to some degree from other subprime loans, such as auto loans, which comparatively depend less on variables of the economy, and more on individual financial ability to repay small amounts (small as compared to a mortgage payment).  As we have already discussed, the high risk loans left little wiggle room for affordable debt during an economic downturn, and the decline in house values meant the sale of the house might not yield enough to cover the balance of the mortgage repayment, leaving the borrower unable to sell.  That there was a decline in subprime mortgages between 2005 and 2006 is further evidence that financers had already begun hedging their bets.  As delinquency and default surged amongst all mortgage types, indicating that the depreciation of house values indicated that the market was already riding an ill wind.

The subprime loan was never intended to cause economic damage.  It was intended to extend loan eligibility to otherwise ineligible borrowers, who as recently as the 1970’s or 1980’s (even more recently) were redlined for reasons of credit history, current income and debt, and, unfortunately, due to ethnic or racial discrimination.  Anti-redlining legislation intended to block discrimination, by creating a means of getting a loan for those who wanted one enough to accept certain risks.  The subprime category of loan provided an avenue for borrowers who were willing to bet on their future job and income prospects, and who showed indications of need and a readiness to begin payments.  Thus, borrowers played an active role in determining the success of subprime lending.  Lenders, however, would try to make it profitable for themselves, engaging in a poorly (or insidiously) rigged opportunism.  According to Gorton, the new problem with the subprime category was the decreased informational transparency for investors, forging an informational gap.[xv] Therefore, as lines of securities paved a winding trail from the original loans, the balance of ultimate risk became uncertain, and like a Ponzi scheme, eventually the risk, though spread out, was shouldered by the security holders and the banks that supported them, and later by the taxpayers.

Here is where the concern over hedging bets occurs: securities, as described by Gorton, were “nested”,[xvi] thus providing ample opportunity to disguise risk.  In 2007, Goldman Sachs was found to have done as much, when it was shown that the firm was selling securities designed by its clients to investors.[xvii] The result was a web of obscured connections and misconduct.  Gorton best illustrates the chain reaction:

When housing prices began their growth and ultimate fall, the bubble bursting, the value of chain securities began to decrease.  But, exactly which securities were affected?  And where were these securities?  What was the expected loss?  Even today we do not know the answers to these questions.  In 2007, there was a run on off-balance sheet vehicles, such as structured investment vehicles and asset-backed commercial paper conduits, which were, to some extent, buyers of these bonds.  Creditors holding the short-term debt, i.e., commercial paper, of these vehicles did not roll their positions, which was tantamount to a withdrawal of funds.  A number of hedge funds collapsed.  As of this writing, the crisis is not over.[xviii]

Amidst this seeming frenzy, investors were buying securities in order to pass the bill onward to the next buyer.  All the while, as became clear in testimonies from investors such as Michael Burry[xix] (who by now has contributed to The Big Short by Michael Lewis), purchasing insurance on their securities and mortgage bonds became common practice—literally betting on the failure of subprime loans through the classic credit-default swap (CDS).[xx] By assuming that the loans would fail, but publically showing professional prudence by protecting a risky investment through insurance, investors such as Burry were sinking money into an annual premium with the expectation that they would more than recoup the expense upon loan default.  The default of risky borrowers became, in essence, a fast cash cow for those like Burry who knew enough to insure his losses, and avoid the final, crippling debt of those investors who bought the last security in the chain.

Much of the whole situation seems as if it could have been avoided, but was not.  Certainly, in hindsight, it is hard not to feel aggravated at what feels like society was duped—all the more since it was the well-intended legislation of the 1970’s that opened the door for subprime mortgages and potential for opportunism (read: predation).  However, we should not feel duped, I think, because the country and borrowers alike walked hastily into this situation like high-stakes gamblers, with bravado, high hopes and expectations.  Anti-redlining laws were created to end an era of financial prejudice and usher new demographics into the middle class.  Lax government and private supervision, predatory approaches toward those new demographics, and a lack of or disregard for forethought ruined the potential of the laws, turning borrowers into prey.

It seems wise to keep in mind the rather common sense advice offered by Paul Krugman in 2008[xxi]— that the country must determine which practices and mechanisms of the current system have caused the most noticeable damage, and place well defined, permanent regulations upon them, not merely for times of financial crisis, but for non-crisis times; that to regulate is not to restrict but to remind future investors and future generations of the potential for widespread debilitation certain practices entail.  Moreover, as Gorton advises, “innovation is a powerful force;”[xxii] and thus must be done with care.  For example, Gorton notes that the Financial Accounting Standards Board (FASB) began to scrutinize the “originate-to-distribute” practice of many lenders, in which banks did not merely sell high-risk loans without sufficient capital to back them up, but designed the loans this way in order to sell percentages to third parties.[xxiii] This is the primary issue at hand when subprime mortgages are discussed today, and Gorton emphasizes that dangerous as the practice may be, in its absence banks will be forced to maintain sufficient capital to cover the cost of lending, not only reducing the number of loans they are able to provide, but rendering them unable even when warranted to act on regulations passed from 1968 until 1998, which give banks cause to provide loans to underprivileged borrowers.  The choice he determines may ultimately be between reigniting the lending cycle when the current crises have settled and the “fittest” banks remain,[xxiv] or ceasing subprime style lending all together, and regressing the nation’s economic policy.[xxv] Ben Bernanke suggests a median ground exists, however, where monitoring lending can continue with the backing of the Federal Reserve in case of panic or crisis,[xxvi] though someone thinking along the lines of Gorton may argue that bank cooperation and responsible reactions will determine the viability of this option, especially in view of the controversial conduct of firms like AIG after the bailout.[xxvii] Where both agree is that it is necessary to approach monitoring through specific, manageable reforms aimed at protecting and stimulating consumer activity.

In their 2008 study, Carmen Reinhart and Andrew Felton contend that the current state of events are more or less manageable, due in great part to interventions to save the banks, and level of market discipline in the face of scrutiny.  This is not to say that problems are over, but stable so long as consumption remains steady though not exorbitant.  For the government and banks to deal with borrowers in dire need of assistance, there must be some semblance of stability in place for the larger economy, or the crisis will worsen.  To do this, the only prevention they can immediately offer is short-term injections of capital through real estate liquidation, and cessation of certain high-risk loans.[xxviii] However, cessation of loans does not necessarily end all risk, since not all subprime transactions involve traditional loans or mortgages.  Atif Mian and Amir Sufi’s 2008 calculation of the probabilities of high risk loans defaulting in 1996 – 2005, indicate that in communities where mortgages were most denied for new homes, borrowers who were already homeowners had access to high risk loans through refinancing and home equity loans.  Moreover, the number of houses for sale varied from far below to high above demand, though the rate of mortgage approval did not increase or decrease, indicating that risk was often omnipresent whether the market was favorable or not.  The research indicates, then, that the problem was a combination of tantalizing risk, house price, and housing supply shifts, combined with rate of approval, further indicating that there was a problem with how and which borrowers were chosen over others. [xxix]

The choices and loan designs made by lenders are therefore very important, and we must address these choices in order to understand the thin line between financial practice and financial predation.  Claudio Borio provides a fascinating approach to understanding the situation of choice and design, which are often very hard to understand from a lay perspective.  Borio asserts that “turmoil” is a more effective way to think of the economic crisis—not to downplay or shroud the actual effects on regular lives, but to understand that we are not experiencing true catastrophe or true failure; instead, we are experiencing the results of what we can here describe as an economic experiment in the making for as long as the economy has been reformed in response to changing needs and trends in society, especially after the turn of the century, moreover after legislation to reduce redlining.[xxx] The experiment resulted in a posed solution—subprime loans, which in turn were integrated into the banking system within a decade.  After a period of over thirty years, the results are in, the practices by which banks made subprime loans possible have proved faulty in the long term.  Thus the experiment must either be rejected or redone with a new solution.[xxxi] Borio does not excuse banks for their predation—quite to the contrary, he condemns the aggressive nature through which borrowers were courted; however, the point remains that what was intended as a limited socio-economic solution became widespread and desirable across incomes and qualifications, affecting macroeconomic conditions as foreign investors became further entangled, and culminating in the massive defaults and withdrawal of investments that brought about the credit crunch.

Most commentators we have discussed have suggested a need for increased transparency to combat the present circumstances of the economy, and to prevent future misinformation.  Moreover, securities must be limited and trade procedures distinctly outlined.  Certainly, too much regulation is not a good thing to maintain a healthy capitalist economy, if such a thing is possible.  If congress approaches regulations with too much zeal, however, then there may be borrowers denied loans that do have the capacity for repayment in their future, which, though unforeseeable, can be deduced from the growth and scope of respective careers and fields, and savings habits.  Large-scale loan denial would potentially prove detrimental if consumption is stunted by lack of loan availability.  The key is to prevent loopholes for opportunism.

The government may want to look at local or regional successes to determine a body of prudent approaches and solutions.  For example, the well-balanced local success of moderate loan approval increases in mid sized cities, as reported by the Wall Street Journal in 2009.  As the small locales were able to stabilize their economies, banks felt more confident giving loans, and the observed effect is that where small loans are approved, local economies are able to speed up economic activity, whereas in the big cities, where few loans are approves, regardless of qualifications, economic activity is slowing.[xxxii] This may indicate that the best reaction at this point is to avoid overreacting.

A 2007 study conducted for the National Bureau of Economics (NBE),[xxxiii] indicates that borrowers from the late 1970’s up to around 2000 were fairly successful with their risky loans, due in part to manageable housing costs and values.  This ensured that borrowers at the time were able to bet on their future earning prospects with confidence.  The NBE study suggests that borrowers acted responsibly within the limits of their current prospects, and banks were provided legal leeway to lend toward the future, so to speak, thereby expanding access to homeownership throughout the echelons of the middle class.  Thus, with responsibly assessed risk, this loan type can be beneficial.  Whether borrowers were misled in the long run is situational at best; however, the dangers of sustainability where risk was ignored were apparent from the start.  But how did this happen?  How did the financial practices of a country and system design its own distress, and why were there no protections in place to prevent such an outcome?  Was the outcome expected yet deemed manageable?

The Historical Implications of Modern Financial Practices

To begin answering the previous questions, we should look back to the period at the turn of the century when banks and trust companies had only minimal regulation before the foundation of the Federal Reserve.  This was a time of rampant speculation amidst the boom of technological advances and consumer frenzy following the Civil War and preceding the First World War.  The Federal Reserves Act of 1913 responded to the Banker’s Panic of 1907, caused in part by a run on trust companies after the stock market fell 50% from the previous year.  Jon Moen and Ellis W. Tallman have noted that the striking difference of 1907 from past panics is that the national banks were not affected to the extent that we have seen in the past.  The affected institutions were trust companies, at times owned by the major banks, but initially in service only to large institutional investors.[xxxiv] Though the national economy was affected at large, there were no runs on national banks.  Instead, investors at the trust companies rushed to removes their trusts, sometimes with penalties, to avoid losing their investments.[xxxv]

Until 1906, New York trusts, unlike banks, could make investments that exceeded their holdings, which permitted riskier investments and potential for greater yield, which made the trusts more desirable to certain depositors.[xxxvi] However, after 1906, banks convinced the state to place a minimum on trust reserves against deposits, which was set at 15%.[xxxvii] At the time, trusts were local institutions and there were fewer distinctions between them and the national banks.  The Glass-Steagall Act of 1933 eventually divided the banking industry into investment and commercial varieties, and trusts fell under the commercial heading, though they were not originally designed as commercial banks.[xxxviii] However, in 1907, whereas banks were required to invest based on reserves against deposits, trusts were investing with impunity and found themselves facing low returns compared to speculation.  The result was failure in the form of a banker’s credit crunch, leading to calls for more government regulation by many of the trusts’ critics.  However, the reforms put in place were often disregarded by the industry, or worse—so gradual as to go unnoticed by former supporters of the reforms, thus the true effects went unanalyzed and unappreciated.

As remarked by Charles Calomiris and Gary Gorton, regulation “prevents the evolution of the banking system in ways that may be very desirable” though not necessarily observable.[xxxix] The writers suggest that the inherent danger of regulation is doubt amongst critics and observers—doubt whether the regulation actually fostered change, or if the catalyst was no more than part of a cyclical shift of economic and social conditions.[xl] From this doubt can spring a trend toward under-regulation, which has proved time and again to lead to short-term booms, where only a very small percentage of investors ultimately profit.  The writers suggest that two options are necessary for successful regulation: 1) banks must be monitored by private and governmental coalitions; 2) banks should be able to sell loans to each other, not only to offset costs, but to diversify and reduce potential risk; however, banks selling loans must be responsible for maintaining transparency, and have the ability to prove coverage for securities.[xli] Ultimately, banking might need a public and federal check on its privileges, literally to be treated as a system of political entities subject to oversight, rather than mere business enterprise, of which it would seem many institutions perceive their interests.  After all, their business is the business of investing the deposits of private citizens and institutions, which is quite different from selling stocks and commodities.

The lesson we gain from the Panic of 1907 is that lack of restraint and aggressive practice are urgent social problems of the economy.  Ultimately, regulation is only necessary because basic human behavior proves too variable for so large a system where the assets of so many are at stake.  Instead, as Calomiris and Gorton contend, we should consider the effects of technological change on the economy.  Specifically, it is important to look beyond “seasonal money shocks,” and understand panics as indicators that the environment of the economy—commodities, demand, methods, markets, production—has changed beyond the limitations of its safeguards,[xlii] such as where regulation was lacking in 1907, the country accepted after the Panic that new safeguards were necessary—hence the formation of the Federal Reserve.

The idea of a central bank was not new in the U.S., though one had never before been established on a federal level.  The National Banks Acts of 1863 and 1864 had provided a set of guidelines for national banks across the country to follow (though not state banks, the point of the act was to coerce state currencies out of circulation); however, they were ultimately under direct supervision of Congress, without an expedient centralized source of supervision and lending, as found in European banking.[xliii] By 1907, the investment practices of trusts complemented foreign investment to create a safety net for depositors.  After the Panic of 1873, which prefaced the Long Depression of the 1870’s, depositors and industrialists alike had feared the effect of foreign investors on the availability of credit, and the trusts provided an alternative means of capitalizing on domestic investors, which reassured some investors that foreign defaults would prove less damaging to American interests.[xliv] The hope for economic balance at the turn of the century seemed to be political engagement against future crises.  The financial history of the country following the Civil War indicated that banks needed better control over investments,[xlv] but did not take into account vested national or public interests.   The eventual foundation of the Federal Reserve was a first step, and not until the crash of 1929 and the start of the Great Depression did it become clear that the role of the Reserve should also be as an analytical and regulative facility.

In 1913, the Federal Reserve was founded in the image of many of the centralized European banks that have existed since the eighteenth century, though, according to Allen Meltzer and Alan Greenspan’s history, its initial orientation took until 1920 to fully mirror the structure and efficiency of the Bank of England.[xlvi] Central banking evolved under the gold standard, which was officially adopted by the United States under the Gold Standard Act of 1900.  Bankers at the time were concerned that currency was too tied to the value of government bonds under the National Banking Act, thus early designs for the Federal Reserve were of a large commercial central bank of last defense, so to speak, responding to the bankers’ fears of government interference.[xlvii] However, critics of the design accused the bankers of designing a banking and big industry monopoly, as interests could be traced from the big banks and many the nation’s largest industrial corporations.  As a result, it was agreed that the bank should be under political control only to monitor practices and prevent centralization of commercial power.[xlviii] As Meltzer and Greenspan write of the early Fed:

First, there was the core principle of the gold standard: the central bank must raise or lower the discount rate as required to protect the gold stock and exchange rate.  Second, the central bank served as lender of last resort by offering to lend in a panic when the market did not function.  Third, the central bank was to accommodate the needs of trade and agriculture by discounting only (or mainly) commercial paper, a principle known as the productive credit or real bills doctrine.  This principle prevented purchases of government securities, mortgages, other long-term debt and the use of these instruments or equities as collateral for borrowing from the central bank.[xlix]

Despite the ability to control the value of currency and lend to troubled banks, in the early days many banks, state banks in particular, did not participate in the Federal Reserve System, leaving gaps in the American banking landscape.  Further, the Reserve did not automatically cover all pre-existing banks, but expected them to join the system by choice.  Credit became problematic at this time when foreign countries sought loans, since not all countries valued their currency against a gold standard, creating a credit imbalance when lending overseas.[l] Furthermore, as American banking expanded throughout the nation and internationally, the Reserve was at a disadvantage, namely because the system could only initiate reforms after the onset of a problem and could not stop the trend of those already in place.[li] It was thus the Roaring Twenties came to a screeching halt.   Massive speculation and borrowing occurred in the two or three years before the stock market crash, and as John Kenneth Galbraith wrote in 1954, “This was the way past speculative orgies had ended.  It was the way the end came in 1929.  It is the way speculation will end in the future.”[lii] The Federal Reserve needed no better proof that it needed the ability to preempt such crises in the future.

Today, as a result of the experience of the Depression, the Reserve regulates banking, and oversees economic policy and financial practice, all in addition to its role as a banking safeguard and lender to both the federal government and national financial institutions.  Ben Bernanke has argued that one of the biggest problems faced during an economic slump is the lack of information gathering on borrowers combined with misinformation given by lenders, which during a boom a time of speculation can lead to a collateral buffer of borrowers who will default, thus bringing the market to a grinding halt, as happened with the stock market crash.  Combined with poor domestic and foreign trade policy, the effect is speculation on the speculation, which layers the risk beyond control.[liii] During and preceding the Depression, numerous decisions were made to the detriment of the nation’s economic standing, including the controversial Smoot-Hawley Act under President Hoover, which raised tariffs on thousands of imports, resulting in decreased international trade and economic cooperation.[liv] More damaging, perhaps, was the refusal of the Federal Reserve to supply money to struggling banks, and all around deflation in commodities.  As investors jumped ship over fears of Smoot-Hartley, and banks began to call in loans on borrowers who could not meet payments, widespread default swept the country and the stock market collapsed.  With the added instability of the housing market now completely crippled by a lack of investors and credit, the country found itself stranded in a decade of hard times, characterized by unemployment and falling prices, which were accompanied by falling wages and the terrible natural disasters that hit rural areas of the Midwest of the country, leaving debtors of all kinds to repay debts that were now worth more than the current costs.[lv]

Bernanke, in line with Milton Friedman and Schwartz’s A Monetary History of the United States, has argued that the problem with the Fed at this time was that it was “highly doctrinal.”  Though the Reserve was founded with the purpose of safeguarding the banking system, the Depression Era governor believed in a kind of honor system among banks, along with a doctrine of ‘survival of the fittest’.  Bernanke suggests that Federal Reserve officials, along with United States Secretary of the Treasury Andrew Mellon, believed it would be to the benefit of the banking system if the weakest banks were allowed to fail, permitting the larger and more efficient banks to flourish.  Therefore the Reserve refused to give loans to the smaller banks, regardless of whether they belonged to the Federal Reserve System.[lvi] At the time, financial practices were still greatly influenced by 19^th century solutions for banking panics, and the solution for many early panics was to allow the large banks to bail out the little ones by suspending the payment of deposits for a period of time, regardless of public burden.  The 1929 decision of the Reserve reflected the perspective that banks were responsible for resolving crisis level issues before government intervention should occur.  This still is an ongoing debate on the issue of financial ethics and the political morality of the economy.  Since then, safeguards were put in place to prevent the Reserve from taking a moral-type stance in the future, though the extent to which such safeguards are effective are only now becoming apparent, and some may not be certain for many years to come.[lvii]

Some of the Reserve’s more responsive reforms from the past are today becoming snared in one of its most controversial actions, however.  In the case that banks are faced by widespread credit defaults, the Reserve has the ability to funnel money to lenders in need, more recently known as bailouts, in effect acting its part as the primary bank of the banking system in the country.  The eventual bailouts enacted in the U.S. and Europe after the 2007 crisis intended a rescue in this fashion.  However, additional non-depository and commercial industries were also bailed out, raising the question of whether the Reserve has the legal ability or political responsibility to lend to any institutions besides banks.  The consequence for bailouts and other government investments intended to unfreeze markets is raised taxes to cover interest repayment.  Unfortunately this plan, as in place since the regulations of the Depression Era, was met with much distrust and confusion, encouraged all the more by the face of indifference and extravagance put on by much of the industry, despite public and governmental outcry.  No one seemed sure of the ramifications of asking taxpayers to support industry and its failings.

For this reason, taxation plans to fund the bailouts were probably a serious catalyst for an outcry against the decision.  Another reason for the distrust and confusion over the bailouts is that the credit crunch that followed brought with it the unease of an increased unemployment rate and not-unfounded fears that investment firms would misuse funds—for instance by continuing to give out large bonuses and hold expensive business soirées.[lviii] Section 13(3) of the Federal Reserves Act in 2006 stipulates that under “unusual and exigent circumstances” an institution that is not a bank can receive government aid if the collapse of the institution is perceived as a threat to the national economy.[lix] However, while the bailout was legally enacted, some still argued that the federal government had overstepped its jurisdiction over business matters by asserting a moral-type stance of political responsibility without precedent.  Moreover, critics were concerned that the officials hired to oversee the specifics of the bailout transfers were themselves current or former employees of many of the firms in question, and pressure was exerted to ensure that conflicts of interest were avoided. [lx]

As William K. Sjostrom explains of the legality and reasoning behind the AIG bailout, the company was estimated to be days from collapse, and as the government was also dealing with imminent crises at both Lehmann Brothers and Merrill Lynch, there was little time to consider an approach to the AIG problem.  Therefore, a bailout was granted to avoid international repercussions should AIG collapse and the value of investors’ securities diminish.  Sjostrom notes, however, that the imminence of collapse was overblown in part by AIG itself, as the full-scale effects of bankruptcy were never fully calculated due to the assumed urgency of the situation.  To add insult to injury, in succeeding months it became clear that bankruptcy would not have majorly effected shareholders, as the value of CDS’s sold was not affected, and enough third party transactions could offset any negative effects.[lxi] In the end the federal government may have needed to facilitate a credit default swap replacement process at a lesser cost, though a complete bailout was probably unnecessary.  Moreover, Sjostrom suggests that the federal government was offered misleading information by AIG and Goldman Sachs, in which the extent of the CDS’s value was purposefully obscured to portray Goldman Sachs as in imminent danger should AIG go bankrupt because of $20 billion dollars in CDS’s purchased by firm.  Goldman Sachs did not, however, report that collateral and hedges sufficient to offset the effect of an AIG bankruptcy protected its CDS’s. [lxii] The truth of the situation is obscured however, since it is unclear what information was withheld or presented to AIG before negotiations with the federal government, as time was believed to be running out to take action.

What then can we deduce from the problem of AIG, and what does it illustrate for the purposes of this paper?  This question is vital, because the AIG problem is symptomatic of a trickle effect of deregulation upon the economy.  The truth of culpability may always be obscured, as truth always is; however, we can understand from this situation that a problem of the banking industry extends well beyond the banks.  Stocks and securities are so intricately interlaced within the market that a major investment bank such as Goldman Sachs can be perceived as threatened by the collapse of a major insurance company, throwing the whole economy into frenzy.   To fully comprehend this situation, we must examine the conditions that most immediately affected the practice of “layering”[lxiii] securities through diversification, and its effect upon lending practices, especially in the mortgage market, beginning, in particular during the 1970’s.

It must be noted that until the late 1970’s, savings deposits funded most home loans, which meant that subprime loan characteristics were virtually unheard of in the housing market, and subprime merely described a borrower who would probably never qualify for a loan (whereas today, it is often popularly conflated with the loan instead of the borrower).  However, during the 1960’s, as inflation rates rose along with interest, lenders were finding their business too costly.  As a result, in 1968, Congress permitted banks to sell loans to other investors to buffer the cost.  The investment agencies Fannie Mae and Freddie Mac, along will Ginnie Mae, and the Federal Home Loan Bank Board (FHLBB) were created to facilitate this change.[lxiv] While these institutions did not create a new regime of lender/investors, they facilitated one major occurrence in the economy: competition within the highly conservative lending/investment category of Mortgage-Backed Securities.  The result was an atmosphere in which lending practices were up for review to attract new borrowers while building security against risk through new and diverse investors.

Fannie Mae, around since 1938, continued its job as the Federal National Mortgage Association (FNMA, hence Fannie Mae).  The agency was originally formed in order to provide financing for banks issuing mortgages.  By 1954, the agency was no longer 100% government controlled, but partially funded by private investors under the Federal National Mortgage Association Charter Act.  In 1968, Fannie Mae was split into the modern privately funded corporation and Ginnie Mae, the Government National Mortgage Association, which covered government protected mortgages, such as those of the Veterans Administration.  Freddie Mac, the Federal Home Loan Mortgage Corporation, was created later, by 1970, in order to create competition for Fannie Mae and pump up the mortgage industry.[lxv] However, these innovations were slow to show results, and lenders and economists began to explore other ways to broaden the market, such as competitive mortgage design and higher risk securities.[lxvi] In 1975, Congress passed the Home Mortgage Disclosure Act, which intended to end the practice of redlining, and provide greater access for low income and discriminated against borrowers seeking to buy a home.[lxvii] Thus, we saw the birth of the subprime mortgage phenomenon as public and private lenders embraced the possibilities for investment and profit.

However, in view of the massive losses incurred by Fannie and Freddie Mac in 2007 and 2008, the problem of their bi-focused loyalties to shareholders and the government has shown itself.  Though subject to more stringent regulations and self-monitoring than completely private institutions, these two, due to their reputation, effectively validated risky mortgage lending in the industry by engaging so thoroughly in the subprime market.  According to Peter J. Wallison and Charles Calomiris, Fannie and Freddie Mac were caught between loyalty to Congress and private interests, which meant their losses were made all the more dramatic as the institutions purchased thousands of junk loans hoping to rake in higher yields.  However, their timing was both unwise and terrible, because, as we know, high-risk loans during this period defaulted at a rate not seen since the Depression.[lxviii] The junk trend grew in popularity during the mid 1990’s, and Fannie Mae and Freddie Mac had been quick to follow the private institutions.  Junk trading and subprime lending had long been a means of raising a higher yield for investors, ever since the start of anti-redlining legislation, and the continued trend of such legislation unfortunately left too much leeway for the temptation to continue gambling, even when the high stakes were so transparently approaching failure.[lxix]

Behind the risk trend of the 1990’s was the strong deregulation of banking, starting in 1980.  The Saving and Loans Crisis of the 1980’s further exacerbated the potential for problems and predation amongst mortgage lenders when increased inflation and interest rates put the industry in danger, which led to the passage of the Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn-St. Germain Depository Institutions Act of 1982.  These laws permitted lenders to determine their own regulations to a great extent in order to stabilize the mortgage market, and consequently provided lenders a means of protecting other investments through private transactions (transparency-free).[lxx] The Housing and Community Development Act of 1992 would further alter the course of the mortgage industry, with mandates for lenders to meet affordable housing goals, and later in 1999, to fulfill portfolio quotas in lower income and inner city areas.[lxxi] Unfortunately, as we have seen, the results were two-sided—higher risk borrowers were given access to home ownership, but were also potentially subject to predation by lenders through the terms of their mortgage.

Moreover, the lending industry became unbalanced as institutional purposes, popular incentives, and new investment practices were no longer in sync.  According to a study by Dwight M. Jaffee and John M. Quigley, part of the problem of the state of mortgage lending during the 1980’s and 1990’s was that housing policy expanded faster than the federally backed institutions that served as purveyors and guarantors of credit; therefore, the institutions were forced to compete in a market for which they were not equipped.  As the housing market changed, these institutions were subject to old regulations that changed too slowly, and thus private lenders took up the slack.[lxxii] As the federally backed corporations shifted toward the subprime market, the chasm began to close between them and privately owned mortgage lenders.  Private lenders often lacked the standards required of Fannie Mae and such, and marketed what Fannie Mae CEO, Daniel Mudd, described as “layered risk” mortgages,[lxxiii] which restricted repayment options while making it easy for borrowers with little or no documentation to obtain loans, so long as they were willing to take the risk.  As the layering process became a more and more prominent and acceptable practice, Fannie Mae and Freddie Mac began to follow suit, though, perhaps, not quite so aggressively.  With the growth of the housing bubble in the late 1990’s until the mid 2000’s, it became clear that the jig was up, and house prices would soon climax and drop, leaving homeowners with homes that could not sell.  As if the situation was not already urgent enough, the government was temporarily cornered by a need for expedient yet well-planned action that would cover domestic turmoil and perhaps prevent undue crisis overseas.

The extent of the subprime mortgage crisis is not restricted to the United States, and is in fact more prominent for some foreign investment institutions who purchased U.S. based securities, thus receiving the brunt of crisis.  According a study by Kenneth W. Dam, the international scope of the crisis is perhaps the greatest factor behind the haste with which the United States government acted in the weeks following the most urgent bankruptcy scares.[lxxiv] Dam notes that very often, foreign investors did not research the securities purchased, therefore there was little awareness of pending disaster, which effectively drew the crisis overseas and away from American investors.  This, odd as it may seem to the American observer, is not, Dam notes, strange to European investing, where mortgage securities have been sold for as long as 200 years in some countries and is considered quite commonplace, even safe, and risk on the American end of the transaction was apparently not expected or, at least, not viewed as an immediate threat.[lxxv] It is not very hard to observe how the effect of the American subprime crisis effectively mirrors the effect of the American Panic of 1873, which was caused by massive defaults in the European land market.[lxxvi] U.S. investors have effectively treated securities with the same lax attitude that European investors were forced to eschew, and now the country must confront its regulatory demons head on.

For the past four years a barrage of suggestions and observations has entered the national debate on how to deal with the current economic state, especially about the benefits and setbacks of permanent regulation of the banking and investment industries.  Research conducted in 2008 shows that banks—contrary to common assumption—often provided subprime loans of a lesser quality than private enterprises, oftentimes ignoring the principles set by their own institutional guidelines.  The authors of the study suggest that before federal regulation is permanently applied, banks and private institutions alike must be called upon to review and reform their lending practices, perhaps forming a kind of “ethical” guide among lenders, which then will be presented during the process of legislating firmer, more permanent, and more responsive regulation.[lxxvii] Moreover, the authors warn that state regulation has in the past led lenders to become less competitive, which reduces consumer options.  Therefore, the authors suggest that any legislation made must keep in mind fostering and, perhaps, mandating a code of competition that will not embroil borrowers in investment disasters.[lxxviii] While internal reviews conducted by companies is inarguably necessary, it seems unlikely, however, that the companies in question, whose ethicality is already under scrutiny, are best suited to interpret ethical behavior within their staff or the industry at large.

For this reason, Charles Calomiris has asserted that government regulation must be pliable in order to respond to “regulatory sidestepping,” in which investors find ways around regulations that restrict high-risk maneuvers, such as the method of securitization to offer a larger number of loans.[lxxix] Calomiris bluntly assigns blame to investors, bank managers, Congress-people, and bank regulators—all who he urges us to remember are subject to the basic human frailty of greed, temptation, and lack of consideration.[lxxx] Therefore, before any regulation is designed, the designers must take into account the psychology of economic and political behavior from a historical perspective, and regulate by accommodating for the potential for human fault.  Thus, regulation must not be rigid or reactive; it must be responsive—emerging from the historical dialogue.  However, it must also be authoritative, and once the regulation responds to new circumstances in the financial landscape, it must be clear in the legislation that any sidestepping, any use of loopholes or treating rules as options, will be considered a violation of the regulations and subject to public review before the regulatory commission.  Ultimately, the key to modern financial regulation is public transparency of both action and consequence; moreover, reforms must not punish retroactively or react solely to singular circumstance without connecting them to the larger pool of activities and future potential.  Essentially, Calomiris calls for a national doctrine of economic ethics and principles of practice, transforming the economic realm into a modern social and political agent.[lxxxi] Unlike the code previously mentioned, this one would be an official all-inclusive corporate and banking economic code, and not industry specific.

Observing the state of affairs today, it is fitting to wonder whether a new economic doctrine is on the horizon, or if it is even feasible in the present political climate.  However, Congress has passed the Dodd-Frank Act of July 2010, which intends to confront financial sector vs. national public relations issues. [lxxxii] Ultimately, the goal of the act is to eliminate the trend of “To-big-to-Fail” in American economics, and especially to eliminate the possibility that taxpayers will ever again be charged for the flaws of Wall Street.  Primarily, the act establishes supervision and dispute resolution capacities for the federal government.  The Federal Reserve will house an independent watchdog commission and a council devoted to determining problems and potential for risk or harm in advance.  In addition, the act intends to eliminate loophole strategies used in the past, requiring complete transparency and accountability in all large scale or potentially risky transactions.  Finally, the act establishes a right for shareholders to determine corporate compensation and governance, and provides investors with access to corporate investment information, all protected under a provision for a strict and aggressive regulatory monitoring council for all suspicions of fraud, conflicts of interest, and corporate manipulation.[lxxxiii] To an extent, we can observe aspects of the doctrine Calomiris suggests; however, as Arthur E. Wilmarth, Jr. contends, the act relies too much on supervision and does not protect consumers from information withholding on the part of investment institutions.  Without the adequate information to investigate and eventually prosecute when necessary, the regulatory procedures may turn out impotent.  It may not be farfetched to imagine that in the future there may be an automated monitoring system in which investment information is automatically entered into a public or governmental database however intrusive upon trade it may seem; however, at present institutions are in control of the diffusion of information to the government; thus even with a shrewd watchdog in place, institutions will still have the ability that they have now to simply withhold information until it is too obvious to miss.  There is no provision for enforced or automatic transparency—it is to be offered willingly and thus provides little safeguard.[lxxxiv] Wilmarth’s reservations aside, the act at least attempts to be reassuring to the American public and perhaps to foreign observers.  Additionally, it is prudent to wonder, when considering Wilmarth’s thought, how enforced transparency would work without limiting competition and perhaps pushing investors overseas.  Nonetheless, this paper does agree with Wilmarth that some degree of enforcement should be considered in the future, though it is hard to identify the best method of achieving a well-balanced result.

Ultimately, this paper must agree with Calomiris’ suggestion of a well-designed doctrine for the economy.  The public has a vested interest in the market as consumers, borrowers, and by-standers; moreover, the activities of Wall Street and the banking industry effect the national and international economy, and effect the overall ability of individuals of all qualifications to receive credit and make investments of their own.  Any time credit is frozen or the markets imbalanced, the balance of the whole society is rocked, and therefore accountability is necessary from all contenders—investors, lenders, borrowers, and regulators.  It is unfortunate that it has a taken over a century for a conversation of the current caliber between the financial sector and federal government to take place—bombastic and inadequate as is may be.  However, for this conversation to truly lead to a reform of our economy, society needs to ask itself some very important questions—namely, what is it about the structure of modern living and the structure of the economy itself that converged to create a crisis?  This is not merely a question about bad practices, legislation, or regulation, but of basic social behavior.

The Economic Implications of Social Trends

Arguably, we may understand the connection of social behavior and the economy as analogous to that of syntax and grammar.  Thus, consumption has social motivations, as much as it is driven by necessity, which greatly influences our perception of the functions and risks of financial practices.  To understand the social underpinnings of the mortgage crisis, we must try to understand the meaning of home ownership in American society, both as desire and necessity.  To achieve this understanding, it is important to understand (or at least try to understand) cultural ideals as the syntax that inform our economic behavior, and which underlies the blurry conception of the “American Dream.”  In this way, we can ask the ultimate question: what about us (Americans, consumers, society) made the subprime crisis possible?

To begin with, we should examine the ideals into which members of society are inculcated from birth, and which are absorbed (or at least embraced) by many of those who wish to become citizens.  Many of the ideals described by Tocqueville in 1840[lxxxv] are still valued, such as the implicit path of hard work to financial and social success, and democracy as the foundational character of a national culture of “Americanness.”  However, it would seem that the ideals behind the archetype of the American Dream no longer necessarily determine success.  An individual may work hard for many years at a particular job, never earning enough to be considered wealthy; moreover, she or he probably will not even earn enough to purchase a home without a mortgage.  Rising costs, employment qualifications, and standards of living wages affect the earning potential of everyday workers, affecting their access to credit.  Nonetheless, the essential message of the American Dream ideal is that anyone can achieve her or his dream of financial success.[lxxxvi] It is integral, perhaps, to the inspirational political character of the economy, and thoroughly embedded within the concept of American democracy.

Therefore, it is fitting to examine the symbol of the current economic crisis, the home, which was so significant to American consumers that they were willing to borrow money to obtain one of their own.  What is the significance of homeownership in American society?  As recent ontological security theory suggests, home ownership has come to symbolize an element of modernity—nearly a right.  The home is a site of personal control where the individual is unsupervised by external entities, such as employers, teachers, friends, or other individuals and authorities.  It is the symbol of self-identity and of political identity within the community—an environment of the self that exists as a respite amidst the potential stress and anxiety of everyday life.[lxxxvii] As suggested by Anthony Giddens, individuals seek a physical safety zone to feel secure enough to pursue goals in life.  The acquisition of such a place is vital to the individual, who may rationalize the risk taken to acquire this place based on preconceived notions of privilege, right, or nature.[lxxxviii] “The home” becomes a psychological need as much as a desire or necessity for shelter and community.  Others more recently have suggested that we may take this idea one step further, and understand risk as a social ideal—that the risk taken to acquire a house, the symbol of financial success, is a partial rite of passage toward the goal of success.[lxxxix] Risk becomes a social expression of determination as much as an action to fulfill a desire.

Peter Saunders’ study of the home as a locale of security and trust suggests that “home” represents something much deeper than a house—that the two have a certain degree of conflation is thus highly significant.  Owning a home effectively determines who owns the self, as the home becomes the location of identity.[xc] Even a cursory examination of American history shows a cultural preoccupation with the rights and identity of the individual, and the individual’s right to achieve independence of home and finances.  Home ownership is thus a fitting symbol of American individualism that lends itself to an ideal of the pursuit of independent means and socially visible success.[xci] In many ways, it is a symbol of the transition from worker to manager, from class to class, even from child to adult.  It is a symbol of the self-reward for individual deeds.[xcii]

There is a religious quality to the symbolism of the home when thus examined, and the foundations of the earliest ideals of the nation are not far from a set of ethics and values of religious origins.[xciii] As Tocqueville suggests, democracy in America was not merely unique for its political processes, but for its integration of religious and social values into the makeup of the political process.  To Tocqueville, this lent a distinct character to what we today call the American Dream.  This character was expressed in the belief that the society at large was destined to reap rewards based on individual effort; thus the individual has a natural right to independence of person and of means of living.  It is hard to think of any other physical object or structure that could denote achievement and success to the extent and with the deepest and most personal psychological meaning as the home and to whom it belongs.

A recent study by Ann Duipis and David C. Thorns raises a number of important issues concerning the rationale of meaning behind homeownership, in particular the social context.[xciv] How homebuyers perceive class and social group imparts the meaning of the house to the buyer, as well as the meaning of the community in which the buyer will live.  Different buyers may have separate motivations for home ownership ranging from utility and security, to sense of normalcy or status—that somehow home ownership is a “next step” in an adult life, or a middle class life, or a public life.[xcv] The degree of a buyer’s determination ultimately sheds light on the point where home buying ceases to be merely of sociological or economic interest, and indicates a deeper psychological value, on a societal level.

The determination of homebuyers, especially when widespread demand is obvious, influences the level of risk at which homes will be sold and that desirable loans will be given.  Risk is therefore learned as much as accepted where the reasons bear the strongest significance.  As noted by Alan Aldridge, when commodities become increasingly accessible, consumers begin to expect the expansion of accessibility to more commodities as a natural part of the market and of economic society in general.[xcvi] To a degree, the notion of affordability adheres to expectations of access, creating a sense of security around the transaction.  Even when risky, the opportunity of “access” suggests that the structure of the transaction will eventually permit a kind of natural financial balance—even if the transaction will lead to initial debt.  Access therefore is conflated with capacity (to afford, to repay) in a way that obscures the process of granting access; that obscures the process of receiving access.  Access becomes capacity, muddled as that may seem.

This is a matter of authority—to be clear, of who has authority over the transaction.[xcvii] Does the “granter” have the authority to decide who receives access, or does the “receiver” have the authority to demand or expect access?  When access becomes conflated with the capacity to handle the consequences of an opportunity, then the design of the transaction acquires a new meaning.  It is no longer a matter of an ideal of access but of expectation.  When this new ideal of expectation converges with the inculcated ideals and expectations of the individual, then the design of the transaction becomes seemingly unstoppable.  It becomes systematic—and that is what we have witnessed during the current economic crisis.  The transactions between many borrowers and lenders are a part of a systematic design of lending that was intended to create access, but instead has fostered an idealized form of speculation.  The symbolism of homeownership overrode any reservations about the actual affordability of access for borrowers.

When we consider the historical experience of the American economy, risk—often unaffordable—is inherent to its success and its failings.  Its ability to adapt systematically is part of its strength, even in the face of crisis, which means risk plays a strategic role in the formation of the economy.  There is a certain degree of logic involved in the transactions of the economy; however, where investing and lending occur, like with all games of strategy, player psychology can always alter the course of the game.  We can see how individuals can alter the financial course just by looking at the millions of loans since the 1970’s.  The manageability of the situation was not merely out of control because of the presence of these loans, but because so many people wanted to take part.  Furthermore, so many wanted to take part because the loans were so accessible, and the loans were only accessible because so many people wanted to buy homes.  Legislations that permitted subprime lending and deregulated banking practices were in part a response to demand; however, more importantly, they were recognition of a basic, perhaps, natural desirability of homeownership.  Underlying everything were two factors: 1) the desire to purchase, and 2) the ideal of the naturalness of this desire—the very inherency of it to our culture, whether as a symbol of individual success or security, or of achieving “the dream,” however one wishes to think of it.[xcviii]

“Wanting” and the ideal of its naturalness are integral to the mortgage borrowers impulse.  Wanting in general may lead to borrowing; however, when paired with the ideal of homeownership and all that suggests, the circumstances of this particular wanting are linked to identity as social evidence of an individual’s success in life.  Access and wanting have always had a connection, but with an ideal of nature in the mix, that which we want develops a nearly natural character about it—a natural desire to be expected; what anyone would want or expect from a member of society.  The ideal provides the justification, the access provides the solution, and the desire provides the impulse.  What we are left with is a psychology of American homeownership.

It is the psychology of homeownership that must be addressed to fully understand and deal with the mortgage problem and any future crises of the kind.  The choices made by borrowers intending to purchase a home reflect the values and ideals held about homeownership more than the desire itself.  Subprime mortgages are a recent a phenomenon of the past thirty years.  Before then, prospective buyers could only get a loan based on a combination of collateral and credit history.  In absence of these qualifications, borrowers have little evidence of an ability to repay a loan.  Therefore the practice of risk is made to satisfy the desire, but the ideals and values behind the house-as-home determine how much the risk is worth to the borrower.  The logic of practice, as Pierre Bourdieu has written, is that our actions are informed by experience and intuition; the logic of risk as practice, however, is no logic at all—there can be no syllogism, only a game of chance, in which a person is willing to stake everything on the probability of achieving a higher goal.[xcix] Perhaps that is in itself a cultural ideal so adhered to American society that it, in fact, makes any ideal of success possible through the seduction of risk as a kind of Herculean trial.

However, embracing risk does not explain why amidst the current crisis, reservations abound regarding the role of the government in dealing with banks and corporations.  In spite of the actual misconduct that contributed to the current crisis, the public appears hesitant to regulate the contributing industries and institutions.  Steven Barley has suggested that major corporations have grown beyond the sphere of private financial interests, and now involve their environments (social and ecological) to the extent that their locale may rely on the presence of the corporation as much as investors across the country or overseas.[c] The web of investment, securities, employment, and other diverse interests makes the presence of many corporations vital to the survival of certain industries and regions.  Areas of the U.S., such as Gary, Indiana[ci] have been devastated by the removal of factories overseas, leaving ghost towns in their wake, providing ample evidence of this reality.[cii] At the white-collar level, the AIG/Goldman Sachs debacle illustrates the extent to which the federal government was willing to step in to avoid a bank crisis involving multiple corporations and foreign nations.  A problem behind the current economic crisis is that the growth of the economy has outpaced the growth of our understanding and, more importantly, the growth of our capacity for fruitful dialog.  We are stubbornly stuck on our economic ideals.

Therefore, while sectors of the economy flourish, others flounder.  This is a problem of society needing to learn how to recognize its integration with the economy, and how to make sure that it is an economy of the country and not of corporations.  Though a corporation has no legal vote in a democratic society, it does have the power to lobby and to control employment and the types of jobs offered in particular regions.  After all, there are regions of the United States that depend entirely on specific industries, and often, on specific corporations.  The investments and business decisions eventually affect these regions to positive or negative effect.[ciii] When the corporation is vitally connected to the banking and investment industry the entire financial future of the public can be affected.  We have already seen evidence of this in the recent credit crunch, and the damages suffered by the American automotive industry.[civ] As the country works its way out from the recession, it may become necessary to take under consideration the ways to permit financial growth of corporations, while protecting the public and economically invested regions of the country from the negative effects of corporate decision-making.  However, corporations must not be allowed to profit from government exploitation.

A first step may be semantic, following the advice of researchers Palazzo and Scherer, who suggest that by labeling large corporations, especially the multinationals, “political actors,” a special political and intellectual category may be created to determine the kind of political entity that is a corporation.[cv] The writers reject the term “corporate citizens,” asserting that the phrase does not recognize the true character of the political relationship with the public.  “Corporate citizens” suggests that corporations exist as entities with the rights and regulations of an individual, but also with the sphere of influence of the individual.  Palazzo and Scherer contend that this must not be the assumption.  Corporations are not individuals, and we must label them for what they are: businesses.  The federal government has an invested interest in regulating interstate and overseas trade, but the regulation of business decisions has always been a blurry area.  By determining the character of corporations not as individuals per say but as actors creates a performative distinction between the businessman and the business interest, establishing that business activity can have active political effects.[cvi]

Semantic differences are not to be overlooked in any political dialogue, and nowhere less than in the dialogue between corporations, the public, and the government.  There needs to be a clear recognition of the roles and abilities of institutions and individuals, and a clear recognition of where institutions and individuals converge—as in where the individual represents the interests of the institution (a CEO or institutional figurehead).  Moreover, there needs to be a distinction between roles and purpose.  An institution, like an individual, has a role in society, but their purposes are different.  The purpose of a business is business, just as a bank’s is banking, and the rights of the institution, which function as a system (and not an organism), should not be confused or conflated with the rights of the human individual.  Instead, institutions should be recognized as an extension of the public, whether private or publically owned, which means their actions have political ramifications with effects outside private concerns.

It would be too easy to pardon the failings of the financial sector wielding the Shakespearean adage, “neither a borrower nor lender be,” laying blame on individual choice and practice by both financial professionals and the public, and not on systematic conduct.[cvii] Individuals are not the problem.  The problem is the system—more specifically, the discipline of the system.  American capitalism wedded to American consumption produces the out of control situation, in which we find ourselves.  Moreover, as a society we overvalue the ideals that promote economic growth, squelching some crucial social inhibitions such as predatory lending or spending beyond means.  We have truly formed a credit society, in which the value of expectations outweighs risk.  Our confidence in “too-big-to-fail” encouraged us to invest too much of our wealth, and too much of our expected wealth.  What resulted was a void, and the question now is whether we can fill the void before the crisis worsens.  To prevent a worsening scenario, actions must be drastic yet strategic; moreover, we must be willing to reevaluate our economic system, and reject those practices and structures that have contributed to detrimental effects, regardless of what those structures symbolize.  Our economy must adapt to the modern character of contemporary American democracy, responding to the needs and desires of consumers and wage earners; moreover, responding to their ideals.  Only then can a new transformation begin.

CONCLUSION:

Implications of Crises Toward a Future Economy

The success of economic reformation in the U.S. is contingent on the ability of reformers to align fresh ideas and manageable plans with the democratic and cultural ideals that form the base of the psychology of our political economy.  A strategy for success that feeds into the American psyche should promote democratic ideals while embracing a new relationship of oversight between the federal government and the business and financial sectors.  Ultimately, the strategy must encompass a reevaluation of the political economy of the country, promoting a systematic strengthening of weaker sectors and determining the extent to which credit is made accessible.  To achieve this goal, there must be a coherent regulation of the practices of borrowing and lending, in addition to firm consequences for corporations that opt to outsource labor.  Moreover, there must be a zero tolerance policy for corporate and institutional misconduct, and repercussions for opportunism.

The principles of stakeholder theory complement the ideals and economic structures currently relevant in American society, including the promotion of democratic process and continued expansion of investment opportunities, and thus are of great utility to current considerations for the future.  According to Thomas Donaldson and Lee E. Preston, “Stakeholders are identified by their interests in the corporation, whether the corporation has any corresponding functional interest in them.”[cviii] This could be defined as shareholders or other corporations or individuals connected through business association, borrower/lender relationship—the definition is blurry, and often depends on any particular writer’s intended meaning.  However, as Donaldson and Preston suggest, a new definitive meaning of “stakeholder,” could alter the way corporations are conceived and run.  “Functional interest” could mean any party that is affected by the presence of a corporation, or any economic institution, whether positively or not, including local communities and the public at large as connected through the market.[cix] Currently, this is one of the most significant concepts to debate as the recession wears on, as we desperately need to recognize the breadth of true economic interests.

Already, the Dodd-Frank Act attempts to open the doors for increased government and public oversight of the financial sector.  Its expected effect is a wider understanding of whose stakes must be recognized by an institution; however, the breadth is not wide enough.  While direct investors are protected, borrowers must rely on the competence of the watchdogs to ensure that lenders are engaging in responsible business.  Additionally, bank depositors are not assured that their savings are safe from bank failure, since they still must rely on the conduct of bankers and investors, who need not disclose the details of institutional investments.  Dodd-Frank effectively protects against only the “layered risk” element of the securities failure that contributed to the subprime mortgage crisis.  If given the chance, it could open up a debate on how best to involve community interests in the reformation of failed economic structures and financial practices.  However, at present such an inclusion in the national debate seems noticeably lacking.  Nonetheless, the act set a precedent for the extension of direct interest from major shareholders to all shareholders and connected institutions.  Is it so unlikely that we might see a further extension to include depositor access to information on bank investments, and borrower access to information on the investment and securitization methods of their lender?   This idea does not seem so farfetched, and may even prove beneficial in the long run, promoting ethical conduct in the investment industry, and providing the public with the option to choose banks and investment institutions based on a sense of security derived from the open operations of the institution.  However, even amidst the already existing extension of protections, the systemic problems of the economic crisis are not attended to—namely, long-term public interests.

Nachoem M. Wijnberg argues that the systemic problem that obscures the idea of “interest” is a consequence of a missing code of ethics to psychologically join economics and politics.[cx] Wijnberg asserts that the reason the idea of “stakeholders” is so blurry and sometimes controversial is because the code of ethics that are expected in the political realm are not expected in the economic.[cxi] It is necessary to establish the potential and actual agency of corporations at a national level, which, for Wijnberg, entails the emergence of a new discourse on the convergence of the public and the economy within a democracy.[cxii] However, such a discourse is only possible if reformers can arrive at the heart of the American dilemma—how to involve the federal and state governments in economic regulation and reformation, without encountering semantic, ideological, and philosophical conflicts with deep-seated social and political ideals of economic freedom.

There is certainly no easy solution, since the political morality of the economy elicits heated and emotional debate.  What is easy, however, is accepting the very present circumstances of the economy, which inform the public that it is vulnerable, and at risk—by its own fault and by the fault of those with power over the financial sector and regulation.  Whether the public accepts the ease of this observation relies on how firmly we can deny the self-perpetuation of unequal and harmful practices.  In a democratic society, this vulnerability is not acceptable, though neither is it irreparable.  We should not embrace a new (or continued?) doctrine of social Darwinism; instead, we should look to the political structures we so value of democracy for a change.  The very structure of democracy, regardless of its variations of administration, lends itself to adaptability.  Adaptation, ultimately, is what we must aspire to.  Robin Hahnel has long argued that unregulated and unrestricted markets fly contrary to basic democratic ideals, and this notion is increasingly validated as the recession persists.[cxiii] Uninhibited economic freedom results in what we are currently experiencing, and perpetuates a system of conflicting interests, where the benefit of one party leads to the detriment of another.

Thus, leaving ethics to the expectation of self-control and “common decency” only leaves room for predation and victimization.  However, in a system where the public has supervisory power over the market at large, the market ceases to be “the market” in the common uncontrolled sense of the term—a giant, ominous force that most people are uninformed about, of Wall Street, private and exclusive; it is, instead, a market place—a place of commerce, where rules dictate conduct, and transactions are out in the open.  Part of the problem of the market is its lack of transparency—more importantly, its reliance on probability.  As much as strategy is involved, the ultimate result of market action is conceived by chance, just like a chess game if player victory was determined by a roulette wheel or role of dice.  All strategy is in the end for nothing—except for those who profited before the spin of the wheel.  This is the essence of Hahnel’s argument—business must be political in a democracy, otherwise the democracy, constructed of public interest, fails.  It fails because the economy excludes the public.

An important step toward reform will be to study areas of successful alternative economic practices, such as worker cooperatives or public shareholding practices—in a way that is not attempted or possible in this paper.  It is not necessary for workers or the public to absorb a corporation or its shares in order to vest interest in the company.  We need only look at the effect companies have on the environment and employment of the surrounding community to see the obvious relationship.  Carrying that observation into the larger macroeconomic view, we can perceive a similar relationship between the market and general public.  Therefore, there is a general ethical precedent already guiding the practice of regulating corporate action to protect communities from negative consequences such as pollution.  However, this requires a combination of self-regulation and government oversight, which unfortunately, also permits the persistence of opportunism.[cxiv] At the national level, we must reject the notion that government interference or regulation represents a takeover of economic freedoms, because this fearful and irrational notion only prevents the country from confronting economic instability head on.  Instead, we must embrace ideas and solutions that promise to protect our economic interests in the long run, regardless of ideological conflicts.

For example, research conducted by Henry Hansmann in 1990 indicates that where homogenous[cxv] groups of workers had significant vested interests in their corporation, the corporation ran more smoothly and efficiently.  This occurrence was evident in worker owned firms in such areas as law, accounting, medicine, investment banking, and certain agricultural or commercial ventures.[cxvi] Hansmann concluded that the workers were more likely to protect their interests by preventing corporate misconduct through diligent participation in the operation of the firm.[cxvii] We may infer that the community of the workers, their homogeneity, permitted a social link to one another that encouraged diligence of surveillance and conduct.  We may not infer that community fostered any greater solidarity than already existed; we may only infer that the network of the community fostered greater efficiency.  The network of the community is the key to its success—it establishes the pathways of responsibilities and accountability, and it is the site where the associations of individuals are visible.[cxviii] As a homogenous community, the members of the network are known and trusted.  Ultimately, the corporation complemented the needs of the community; however, this was a consequence of worker-ownership of the corporation.  In the traditional corporate model, the workers do not own the corporation despite their vested interest in its survival.

However, even while many corporations will offer corporate interests and shares to employees, it is not without caveat.  As Robin Blackburn notes, the current structure of the investment and banking industry indeed provides a vital service to public interests, investing from deposits and 401(k) accounts; nevertheless, institutions are not required to disclose any information about how these monies are invested.[cxix] Instead, accountholders receive a percentage of the return from the larger investment made by the investing institution.  Even where public interests are at stake, there is no protection for industry outsiders; instead, they are expected to trust investors and accept that they are lucky to have access at all.[cxx] In the event that an employee’s company or the investment institution goes bankrupt, however, the 401(k) is lost.  As Blackburn notes, the beneficiaries are involved only so far as their money provides access; beyond that, their investment is out of their control and effectively no longer their own until the investors have taken their share.[cxxi] This is exactly the type of problematic conduct on the part of the investment industry that leaves a blemish of indifference on its relationship to the American public, and it is a vulgar manipulation of the ideals of economic freedom that promote industry in the first place.

Unfortunately, as Benjamin Friedman contends in a recent essay, so long as members of the public feel that the prospect of economic success outweighs the protection of their economic security, there will always be room for negative opportunism.[cxxii] The concept of the risk society as described Anthony Giddens[cxxiii] or Ulrich Beck[cxxiv] seems turned on its head when we think of the way that risk was assessed and seized, even in the face of obvious flaws.  As this paper has stated before, it cannot be ignored that the current character of risk found its roots in the advantages taken after the deregulatory acts, and after anti-redlining policies opened doors for unscrupulous investors and lenders.  The investment and lending industries used government deregulation as an excuse to ignore prudent risk assessment, and the public was seduced by the eased access of new financial and social opportunities.  It is imperative that this conduct is prevented in the future, and to do so, federal and state governments must officially recognize the vested interest of the public in all economic matters.  The market must be a place of transparent transactions without exception, and corporations must be held responsible as political actors for their role and effect in a region and community.  For this to occur, communities and regions of the country must have a clearly determined relationship with corporate and investment industries, promoting mutually beneficial economic policies to their area.

Whereas the country as a whole may not be ready for a shift toward total economic democracy, which would require a shift in mindset (pertaining to who has the right determine economic matters) as much as profit distribution, there is much to absorb from the body of theory and its practice instituted in various parts of the world, and I think this paper would benefit from some consideration of this perspective.  It would be premature to claim that a major and sudden socio-economic shift is in the works; there is no evidence that capitalism is in the throes of death or that globalization will cease and shrivel, just as there is not indication that the American people as a whole are willing to detach from long-held beliefs against interference in the economic realm, so for now at least, it seems unlikely that the public as a voting body will have a direct voice in the financial and corporate sectors.  Instead, it seems that capitalism is at the brink of a gradual adaptation to social problems that it has long enflamed, and globalization is headed for a boom time as so much of the world economy has proven inextricably intertwined.  Isolationist policy would only be detrimental, and a sudden shift toward socialism while the markets are so unsteady and regionally imbalanced would not be wise.  It seems that the best immediate course of action is to embrace Karl Polanyi’s observation that the state and the market economy have evolved as a unit, and thus their ultimate transformation will occur as such.[cxxv] The democratization of the economy will thus be a major, yet gradual cultural event, which may be inescapable as credit relationships draw the public further into the realm of macroeconomic interests.

We need only look to attempts around the world to democratize economic practices to envision the possibilities that lie in store (should the psychological hold behind our own economy permit).  Beyond the small white-collar or commercial worker cooperatives that we have mentioned, we should look at the Fair Trade movement, the existence of which is necessary for no other reason except gross exploitation of rural workers in developing (toward capitalism) or war torn nations.  Ideally, something similar to Takis Fotopoulos’ conception of inclusive democracy[cxxvi] would appeal to areas of the world that struggle to compete within the system of globalized capitalism; ideally, our own part of the world could embrace such a transformation.

However, the American national political system is deeply and socially bonded to its economy, therefore the social psychology of economic reforms, as previously stated, must speak directly to this bond—which we could think of as the majority voice.  As Hansmann notes, American culture has developed a strong hostility to ideological differentiation within its economy, and public involvement or ownership of institutions smacks of socialism, the long archenemy of 20^th century American capitalist democracy.  The fears of the Cold War are so ingrained within public ideology that anything that remotely resembles a government/public intervention in the economy is feared and the target of protest and political outrage.[cxxvii] When exploring the necessities of radical public policy change, we should heed the advice of recent group psychology research that suggests that we must determine the emergence of the properties of the group in order to devise links between individuals, and vice versa.[cxxviii] The goal is to determine how individuals cohere as a group, and inspires the group to act as one.  This is ultimately the spark to the fire—where the group may profit, so too will the individual.[cxxix]

As Polanyi suggests, we are a “market society,” so embedded is our market economy in our political society,[cxxx] and we must reform ourselves with that thought in mind, as well.  There is a sociological precedent for the emergence of new economic group properties—namely, the necessity for multiple shareholders to mitigate individual risk vs. security in modern trading and investing.  The market of the 20^th century was the true “risk society” along the descriptive lines of which Ulrich spoke, after all—not because it assessed risk at a societal level, but because industry assessed its private risk and created security web where only the “weak” or most at-risk traders suffered major damages.  It was the American public that ignored the warning signs, rejecting the most basic standards for affordable debt.  Therefore, as a political body—and the country as a whole is a political body—the mindset of the country was restructured by the desire to participate in the market, which they are invested regardless of personal investment of funds or bank loans, or whatever other means of directly dealing with the market there may be.  The economy, via the conduct of its financial and corporate elites, subverted the authority and power of the public, rendering the public at odds with its own social needs and political ideals.

For the “market society” to continue, it must embrace its political and economic origins, to which the public is inherent.  The new market society could be an increasingly open democratic capitalism, in which the federal government has the power to extend safety regulations for the public, restricting corporate actions that have the potential for negative market effects, and preventing major under-the-table investment deals to which the public is unadvised.  While public oversight does not necessarily mean public profit, oversight will provide a space for dialogue between communities and corporations, both who require the cooperation of the other to maintain consumption and employment.  At a national level, oversight may be overstretched, thus the federal government may eventually assign regional watchdogs that work out of Federal Reserve locations across the country, representing public interest.  Ultimately, it may serve the public if watchdogs are empowered to supervise corporate as well as investment practice, forging an undeniable direct connection of industry to public and community welfare and accountability.  The ultimate goal must be a balance of interests, and a rejection of the ideal of the “righteousness” of private economic freedom, to be replaced by an ideal of responsible economic freedom.  The future of a healthy economy is contingent on this action, otherwise no real changes will have been made, and the underlying problems of the current crisis will merely remain and fester.

The “spirit” of our capitalism, to borrow the term from Max Weber,[cxxxi] is under scrutiny only because of the unwavering trust (or unflinching bravado?) of the American public toward the promises of its economic ideology.  Evidenced in public forums across the country, from news programs to town hall meetings, there appears to be a great discomfort with the idea of permitting the federal government or the public to interfere.[cxxxii] This fear seems to be connected to a general fear that any extension of government oversight could lead to a domino effect, resulting in the loss of privacy.  However, this idea is mostly unfounded, since the structure of our society already limits privacy of its own accord, voyeuristic and preoccupied with security as it is.  Moreover, rationally, federal oversight does not negate the ideal of economic freedom unless that freedom includes the right to conduct business without following the ethics supported by society in the first place (ethics, which perhaps can only be inferred at a national level from legislation and judicial precedent).  The society that would trust its investment institutions and the market, does not trust its government, even when that government provides an opportunity to secure the public from financial ruin.  This is a quandary that requires delving deeper than this paper can and has achieved, unfortunately.

To conclude, this paper suggests again that before any drastic or radical reforms are even contemplated, the country needs to accept a new doctrine of American economics.  To do this requires a major shift in the contemporary political mindset that perceives American democracy as contingent upon the fixed ethics and structure of its capitalist economy.  Somehow, a new vision of the meaning of “American democracy” must evolve, as only then can the economy truly reform—the ideas are too ideologically and philosophically enmeshed.  Regulators of the current crisis need to keep this in mind while trying to remedy the ills of the recession.  A new economic doctrine must resonate with modern American ideals, taking into account the desire for homeownership, higher education, and access to luxury and commodities.  The process will be semantic, practical, and, moreover, psychological.  Commodity desire will not disappear just because the country at current needs to tighten its belt.  Old habits die hard, and the American economy relies as much on its own self-reverence as on the continuation of consumption, production, and investment.  Eventually, a new commodity trend will replace the homeownership push that enabled the subprime mortgage crisis, and the economy will face new burdens.  How we deal with the crisis now, however, could determine the form and extent of a future crisis.  The problem, perhaps, is whether political society can change enough to accommodate economic needs, or if it will need future crisis to be inspired.  One is left to wonder if a modern American economy can truly flourish with the absolute inclusion of the public into the financial sector—can it flourish without?  Moreover, what will be the catalytic transformation that will facilitate our ultimate goals?

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NOTES

[i] Frame, Scott and Lehnert, Andreas and Prescott, Ned, 2008, “A Snapshot of Mortgage Conditions with an Emphasis on Subprime Mortgage Performance,” submitted to Federal Reserve’s Home Mortgage Initiatives coordinating committee, Federal Reserves Online, accessed at http://federalreserveonline.org/pdf/MF_Knowledge_Snapshot-082708.pdf, 2.

[ii] Ibid., 6.

[iii] Christie, Les, 2010,  “Mortgage delinquencies hit 10%,” CNNMoney.com, accessed at http://money.cnn.com/2010/05/19/real_estate/quarterly_delinquency_report/ index.htm.

[iv] Jager-Hyman, Joie, 2008, “Subprime Mortgage and Student Loan Parallels,” Huffington Post (January 25, 2008), accessed at http://www.huffingtonpost.com/joie-jagerhyman/subprime-mortgage-and-stu_b_83281.html; also, U.S. Dept. of Education, 2010, “Student Loan Default Rate Increase,” ED.gov, accessed at http://www.ed.gov/news/press-releases/student-loan-default-rates-increase-0.

[v] The Project on Student Debt, 2007, Student Debt and the Class of 2006,” The Project on Student Debt, 2, accessed at http://projectonstudentdebt.org/pub_view.php?idx=279.

[vi] Lewin, Tamar, 2010, “Student Loan Default Rate is Continuing to Increase,” The New York Times (September 13, 2010).

[vii] See: Ashburn, Emma and Lentz, Jon, 2010, “U.S. Senator Lashes Out at For-Profit Education (Reuters August 10, 2010), accessed at http://www.reuters.com/article/ idUSN0421762120100804; also, Lewin, Tamar, 2010, “U.S. Revises Report on Commercial Colleges,” New York Times (December 9, 2010).

[viii] Keynes, John Maynard, 1930, “The Great Slump of 1930,” The Nation and Athenaeum (December 20 & 27), paragraph 2, accessed via Project Gutenberg at http://www.gutenberg.ca/ebooks/keynes-slump/keynes-slump-00-h.html.

[ix] Ibid., 3.

[x] Demyanyk, Yuliya, 2009, “Ten Myths about Subprime Mortgages,” Economic Commentary for Federal Reserve Bank of Cleveland, accessed at http://www.clevelandfed.org/research/commentary/2009/0509.cfm.

[xi] Ibid.

[xii] Demyanyk, Yuliya and von Hemert, Otto, 2008, “Understanding the Subprime Mortgage Crisis, Working Papers Series, Social Science Research Network (December 5, 2008), accessed at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1020396.

[xiii] Ibid., 33.

[xiv] Gorton, Gary, 2008, “The Panic of 2007,” work in progress as of August 4, 2008, prepared for the Federal Reserves Bank of Kansas City, Jackson Hole Conference, August 2008, accessed at the Kansas City Federal Reserve Bank website, http://www.kc.frb.org/ publicat/sympos/2008/gorton.08.04.08.pdf.

[xv] Ibid., 4.

[xvi] The matter has been criticized by Daniel Mudd as systematic “layered risk,” which is inherent to both the success an failure of the system.

[xvii] See: Johnson, Simon, 2011, “What Goldman Sachs Failed to Acknowledge,” New York Times (January 13, 2011), accessed at http://economix.blogs.nytimes.com/2011/01/13/what-goldman-sachs-failed-to-acknowledge/?scp=3&sq=goldman%20sachs&st=cse; also, Protess, Ben and Craig, Susan, 2011, “Goldman Vows to Open Up About Its Business,” New York Times (January 11, 2011), accessed at http://dealbook.nytimes.com/2011/01/11/goldman-vows-to-be-more-open-about-its-business/?scp=7&sq=goldman%20sachs&st=cse; also Story, Louise and Landon, Thomas, Jr., and Schwartz, Nelson D., 2010, “Wall Street Helped to Mask Debt Fueling Europe’s Crisis,” New York Times (February 13, 2010) accessed at http://www.nytimes.com/2010/02/14/business/global/14debt.html?_r=1&scp=15&sq=goldman%20sachs&st=cse.

[xviii] Gorton, 4.

[xix] In Lewis, Michael, 2010, “In the Land of the Blind,” The Big Short: Inside the Doomsday Machine (New York: W.W. Norton).

[xx] Ibid., 29-30.

[xxi] Krugman, Paul, 2008, The Return of Depression Economics and the Crisis of 2008 (New York: W.W. Norton), 189-190.

[xxii] Gorton, 77.

[xxiii] Ibid.

[xxiv] See: Bernanke, Ben S., 2002, Remarks by Governor Ben S. Bernanke ate the Conference to Honor Milton Friedman, University of Chicago, Illinois, November 8, 2002, accessed at http://www.federalreserve.gov/BOARDDOCS/SPEECHES/ 2002/20021108/default.htm.

[xxv] Gorton, 77.

[xxvi] Bernanke (2002).

[xxvii] See for example: Karnitschnig, Matthew and Solomon, Deborah and Pleven, Liam and Hilsenrath, Jon E., 2008, “U.S. to Take Over AIG in $85 Billion Bailout;
Central Banks Inject Cash as Credit Dries Up,” The Wall Street Journal (September 16, 2008).

[xxviii] Reinhart, Carmen and Felton, Andrew, 2008, The First Global Financial Crisis of the 21^st Century (London: Centre for Economic Policy Research, 2008-2009),  70, accessed at http://onlinebooks.library.upenn.edu/webbin/book//lookupid?key=olbp46215.

[xxix] Mian, Atif and Sufi, Amir, 2008, “The Consequences of Mortgage Credit Expansion,: Evidence from the 2007 Mortgage Default Crisis,”  The Quarterly Journal of Economics (November 2009), 31.

[xxx] See: The Fair Housing Act of 1968 and The Home Mortgage Disclosure Act, which both attempted to prevent redlining practices.

[xxxi] Borio, Claudio, 2008, “The financial turmoil of 2007-?: a preliminary assessment and some policy considerations,” Working Paper for The Bank for International Settlements, accessed at http://www.bis.org/publ/work251.pdf, 21.

[xxxii] Fitzpatrick, Dan, 2009, “Many Smaller Cities Dodge Crunch in Consumer Lending,” Wall Street Journal (March 30, 2009).

[xxxiii] Gerardi, Kristopher, Rosen, Harvey S., and Willen, Paul, 2007, “Do Households Benefit from Financial Deregulation and Innovation?: The Case of the Mortgage Market,” Public Policy Discussion Papers, Federal Reserve Bank of Boston, 6-12, accessed at http://www.bos.frb.org/economic/ppdp/2006/ppdp066.pdf

[xxxiv] Moen, John and Tallman, Ellis W., 1992, “The Bank Panic of 1907: The Role of Trust Companies,” The Journal of Economic History 52:3 (September 1992, 611-630).

[xxxv]Ibid., 611-613.

[xxxvi]Ibid., 614.

[xxxvii] Ibid., 615.

[xxxviii] Calomiris, Charles W. and Gorton, Gary, 1991, “The Origins of Banking Panics: Models, Facts, and Bank Regulation,” Financial Markets and Financial Crises, ed. R. Glenn Hubbard (Chicago: University of Chicago Press, 109-174), 109-110.

[xxxix] Ibid., 158.

[xl] Ibid., 158.

[xli]Ibid., 158-159.

[xlii] Ibid., 155.

[xliii]Million, John Wilson, 1894, “The Debate on the National Bank Act of 1863,” The Journal of Political Economy 2:2 (March), 231, 255-256.

[xliv] Logojan, Aurelia Ioana, 2009, “The Greatest Financial Crises and the Economic Theories,” Romanian Economic and Business Review 4:3, 9-10.

[xlv] Ibid.

[xlvi] Meltzer, Allan H. and Greenspan, Alan, 2003, A History of the Federal Reserve, Vol. 1: 1913-1951 (Chicago: University of Chicago Press), 19.

[xlvii] Ibid, 66-67

[xlviii] Ibid.

[xlix] Ibid., 22.

[l] Ibid., 137-139; in particular, see: Lopez-Cordova, J. Ernesto and Meissner, Christopher M, 2003, “Exchange-Rate Regimes and International Trade: Evidence from the Classical Gold Standard Era,” The American Economic Review 93:1 (March 2003, 344-354), 344.

[li] Meltzer and Greenspan, 178-180.

[lii] Galbraith, John Kenneth, 2009, The Great Crash, 192 (1954) (New York: Harcourt), 169.

[liii] Bernanke, Ben S., 1983, “Nonmonetary Effects of the Financial Crisis of the Great Depression,” The American Economic Review 73:3 (June 1983, 257-276), 257-256.

[liv] Irwin, Douglas A., 2009, “Avoiding 1930’s-Style Protectionism: Lessons for Today,”  page 2, accessed at the World Bank website at http://siteresources.worldbank.org /INTRANETTRADE/Resources/239054-1239120299171/5998577-1244842549684/6205205-1247069686974/Irwin.pdf.

[lv] Ibid., 3-4; Bernanke (2002).  Certainly, in its brevity this is a vulgar retelling of the circumstances of the Depression Era.  However, its purpose is to emphasize the growing presence of the Federal Reserve as a necessity of the modern economy.

[lvi] Bernanke (2002).

[lvii] Ibid.

[lviii] See AIG scandal mentioned earlier, specifically the article detailing bonuses, company parties, and travel expenses for which bailout money was used.

[lix] Sjostrom, William K., Jr., 2009, “The AIG Bailout,” Washington and Lee Law Review 66 (2009), 976.

[lx] See: Henning, Peter J., 2010, “Should the U.S. Fund a Ponzi Scheme Bailout,” New York Times (March 11, 2010), accessed at, http://dealbook.nytimes.com/2010/03/11/should-the-u-s-provide-a-ponzi-scheme-bailout/?scp=19&sq=bailout%20legal%20issues&st=cse; also see, Landler, Mark and Andrews, Edmund L., 2008, “For Treasury Department, Now Here Comes the Hard Part of the Bailout,” New York Times (October 3, 2008) accessed at, http://www.nytimes.com/2008/10/04/business/economy/04plan.html.

[lxi] Sjostrom, 976.

[lxii] Ibid., 979-981.

[lxiii] See: Mudd, Daniel H., 2007, Testimony by Daniel H. Mudd Before the U.S. House Committee on Financial Services (Opening Statement as Submitted), Washington, D.C., April 17, 2007, accessed at http://www.fanniemae.com/media/speeches/ speech.jhtml?repID=/media/speeches/2007/speech_267.xml&p=Media&s=Executive+Speeches&counter=1.

[lxiv] White, Lawrence J., 2009, “Fannie Mae, Freddie Mac, and Housing: Good Intentions Gone Awry,” in Holcombe, Randall G. and Powell, Benjamin, Housing America: Building Out of a Crisis (Oakland: The Independent Institute, 2009), 264.

[lxv] Ibid., 264-265.

[lxvi] Ibid., 263-269.

[lxvii] See: Schill, Michael H. and Wachter, Susan M., 1993, “A Tale of Two Cities: Racial and Ethnic Geographic Disparities in Home Mortgage Lending in Boston and Philadelphia,” Journal of Housing Research 4:2 (1993).

[lxviii] Wallison, Peter J. and Calomiris, Charles W., 2008, The Last Trillion-Dollar Commitment: The Destruction of Fannie Mae and Freddie Mac,”  American Enterprise Institute for Public Policy Research (September 2008), 2-3, 8.

[lxix] See: Zuckerman, Laurence, 1994, “Junk Loans, Not Bonds, are Hot on Wall Street,” The New York Times (August 31, 1994).

[lxx] See: Birger, Jon, 2008, “How Congress helped create the subprime mess,” CNNMoney.com (January 31, 2008), accessed at http://money.cnn.com/2008/01/30/ real_estate/congress_subprime.fortune/; also, Emmons, William R. and Pennington-Cross, Anthony N.M., 2006, “The Savings and Loan Crisis,” Federal Reserve bank of St. Louis Review (July/August, 2006); also, Curry, Timothy and Shibut, Lynn, 2000, “The Cost of the Savings and Loan Crisis: Truth and Consequences,” FDIC Banking Review (2000).

[lxxi] Immergluck, Dan, 2008, “Out of the Goodness of Their Hearts?  Regulatory and Regional Impacts on Bank investment in Housing and Community Development in the United States,” Journal of Urban Affairs 30:1 (2008, 1-20).

[lxxii] Jaffee, Dwight M. and Quigley, John M., 2009, “Housing Policy, Subprime Mortgage Policy, and the Federal Housing Administration,” Working Paper originally presented at the NBER Conference on Measuring and Managing Financial Risk, Evanston, IL, February 2007, 2, 38-40, accessed at http://faculty.haas.berkeley.edu/jaffee/Papers/ MS_ch5_DwightJaffeeJohn Quigley_p163-213.pdf.

[lxxiii] Mudd (2007).

[lxxiv] Dam, Kenneth, 2010, “The Subprime Crisis and Financial Regulation: International and Comparative Perspectives,” The Chicago Working Papers Series, The Law School of the University of Chicago, 1-2, accessed at http://papers.ssrn.com/sol3/papers.cfm ?abstract_id=1579048.

[lxxv] Ibid., 2.

[lxxvi] Logojan, 10.

[lxxvii] Keys, Benjamin j. and Mukherjee, Tanmoy and Seru, Amit and Vig, Vikrant, 2008, “Financial Regulation and Securitization: Evidence from Subprime Loans,” 2, 28-30.

[lxxviii] Ibid, 29.

[lxxix] Calomiris, Charles W.,  2010, “Financial Innovation, Regulation, and Reform,” in Spence, Michael and Leipziger, Danny, eds., Globalization and Growth: Implications for a Post-Crisis World (Washington: The Commission on Growth and Development), 47-48

[lxxx] Ibid., 55-56.

[lxxxi] Ibid.  Moreover, the international scope of this paper is limited at best, which is a serious fault.  However, time and space (oddly enough, considering the girth of this paper) precluding, it is a fault that hopefully will have minimal effect on the overall analysis..

[lxxxii] See: Wilmarth, Arthur E., Jr., 2011, “The Dodd-Frank Act: A Flawed and Inadequate Response to the Too-Big—To-Fail Problem,” Oregon Law Review 89:3 (2011), accessed at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1719126.

[lxxxiii] “Brief Summary of the Dodd-Frank Wall Street Reform and Consumer Protection Act” accessed at http://banking.senate.gov/public/_files/070110_Dodd_Frank_ Wall_Street_Reform_comprehensive_summary_Final.pdf.

[lxxxiv] Wilmarth, 100-105.

[lxxxv] Tocqueville, Alexis de, 1840, Democracy in America and Two Essays on America (New York: Penguin, 2003).

[lxxxvi] See for example: Bellah, Richard and Madsen, Richard and Sullivan, William M., Swidler, Ann and Tipton, Steven M., 1985, Habits of the Heart (Berkeley: University of California Press).  The authors conduct an interesting series of studies on American culture during the 1980’s, focusing on how individuals and communities determine values and ideals that they consider particularly “American.”

[lxxxvii] See: Duipis, Ann and Thorns, David, 1998, “Homes, home ownership and the search for ontological security,” The Sociological Review 46:1, 24-47; also, Kinnvall, Catarina, 2004, “Globalisation and Religious Nationalism: Self, Identity, and the Search for Ontological Security,” Political Psychology 25:5, 741-767.

[lxxxviii] Giddens, Anthony, 1991, Modernity and Self Identity: Self and Society in the Late Modern Age (Stanford: Stanford University Press), 35-38.

[lxxxix] See: Mitzens, Jennifer, 2006, “OntologicalSecurity in World Politics: State and Identity and the Security Dilemma,” European Journal of International Relations 12:3 (September 2006), 340-370.

[xc] See: Saunders, Peter, 1984, “Beyond housing classes: the sociological significance of private property rights in means of consumption,” International Journal of Urban and Regional Research 8:2,202-227.

[xci] This idea is undeniably derived from Thorsten Veblen’s work, in particular his writing on “conspicuous consumption.”  For reference, see: Veblen, Thorsten, 1912, “Chapter 4: Conspicuous Consumption,” The Theory of the Leisure Class: An Economic Study of Institutions (New York: MacMillan), 68-101.

[xcii] See for recent research and reconsideration of the early foundations of individualism as a social philosophy and ideal, and of modern considerations: Grabb, Edward and Baer, Douglas and Curtis, James, 1999, “The Origins of American Individualism: Reconsidering the Historical Evidence,” The Canadian Journal of Sociology / Cahiers canadiens de sociologie 24:4 (Autumn 1999, 511-533).

[xciii] An underlying religiosity of the American political character has long been a topic of interest in American studies of history and social philosophy.  For example, see: Bellah, Richard, 2005, “Civil Religion in America,” Daedalus 134:4 (Fall 2005, 40-55).  Max Weber’s The Protestant Ethic and the Spirit of Capitalism from 1930 is the foundational literature of this area of American studies, influencing scholars from Talcott Parsons to Clifford Geertz, Anthony Giddens and, of course, Richard Bellah, who is already indicated.  I would recognize Parson’s translation of Weber’s book (New York: Routledge, 2001) as the definitive edition, far—far— superior to the popular Roxbury Press edition.

[xciv] Duipis and Thorns, 24-29, 43-45.

[xcv] Ibid., 43.

[xcvi] Aldridge, Alan, 1998, “Habitus and Cultural Capital in the Field of Personal Finance,” The Sociological Review 46:1, 1-23.

[xcvii] West, Robin, 1985, “Authority, Autonomy, and Choice: The Role of Consent in the Moral and Political Visions of Franz Kafka and Richard Posner,” The Harvard Law Review 99:2 (December 1985, 384-428).  This article suggests that parties agree to transactions based on respect for or pressure from authority; however, while I understand where this occurs, I would suggest that there are circumstances where authority is obscured by external forces.  For example, while a bank has the authority to determine the qualifications and terms of a subprime mortgage, the bank only has that authority because demand existed for the loan type.  Borrower demand determined the option of subprime mortgages, and the government determined a degree of right to access.  This is why I assert that authority lies in the value structure of the society at large, which determined a naturalistic value to the desire for home ownership.

[xcviii] See: Stampe, Dennis W., 1987, “The Authority of Desire,” The Philosophical Review 96:3 (July 1987, 335-381), 335-339, 344-348.  While I agree with the premise that desire has authority of certain action, in this paper I assert that in certain situations values have authority over desire, rendering desire a kind of symptom and impulse of the ideal formed by values.

[xcix] See: Bourdieu, Pierre, 1980, The Logic of Practice (Stanford: Stanford University Press), 82-86.

[c] Barley, Stephen, 2007, “Corporations, Democracy, and the Public Good,” Journal of Management Inquiry 16:1, 201–215.

[ci] See for example: Barnes, Sandra L., 2005, The Cost of Being Poor: A Comparative Study of Life in Poor Urban Neighborhoods in Gary, Indiana (New York: State university of New York Press).

[cii] Also, for an extended discussion of race, industrial decline, property value, and the ability to leave poverty entrenched by these issues, see: Sugrue, Thomas J., 1996, “‘Forget About Your Inalienable Right to Work’: Responses to Industrial Decline and Discrimination” From The Origins of the Urban Crisis: Race and Inequality in Postwar Detroit (Princeton: Princeton University Press); also: Collins, William J. and Margo, Robert A., 2007, “The Economic Aftermath of the 1960s Riots in American Cities: Evidence from Property Values,” The Journal of Economic History 67:4 (December 2007, 849-883).

[ciii] See: Armstrong, Harvey and Taylor, Jim, 2000, Regional Economics and Policy (Malden: Blackwell); also: Ellison, Glenn and Glaeser, Edward L. and Kerr, William R., 2010, “What Causes Industry Agglomeration? Evidence from Coagglomeration Patterns,” American Economic Review 100:3 (July 2010, 1135-1213); also: Montana, Jennifer Paige, 2008, “The Evolution of Regional Industry Clusters and Their Implications for Sustainable Economic Development Two Case Illustrations,” Economic Development Quarterly 22:4 (November 2008, 290-302).  Also, for a European comparison, see: Brulhart, Marius and Torstansson, Johan, 1996, “Regional Integration, Scale Economies and Industry Location in the European Union” CEPR Discussion Papers Series 1435 (July 1996).

[civ] See federal paper: Platzer, Michaela D. and Harrison, Glennon J., 2009, “The U.S. Automotive Industry: National and State Trends in Manufacturing Employment,” Federal Publications (Paper 666).

[cv] Palazzo, Guido and Scherer, Andreas Georg, “Corporate Social Responsibility, Democracy, and the Politicization of Corporations,” Academy of Management Review 33 (2008, 773-775), 777.

[cvi] Ibid., 773-774.

[cvii] Line 80, see NOTE #1.

[cviii] Donaldson, Thomas and Preston, Lee E., 1995, “The Stakeholder Theory of the Corporation: Concepts, Evidence, and Implications,” Academy of Management Review 20:1 (January 1995, 65-91), 67.

[cix] Ibid., 67-68.

[cx] Wijnberg, Nachoem M., 2000, “Normative Stakeholder Theory and Aristotle: The Link between Ethics and Politics,” Journal of Business Ethics 25:4 (June 2000, 329-342), 329-330.

[cxi] Ibid.

[cxii] Wijnberg, 340-342.

[cxiii] See, especially: Hahnel, Robin, 2009, “Why the Market Subverts Democracy,” American Behavioral Scientist 52:7 (March 2009, 1006-1023); also: 2007, “The case against markets,” Journal of Economic Issues, 41:4 (December 2007, 1139-1159); also: 2000, “In defense of democratic planning,” in Pollin, R., ed., Capitalism, socialism, and radical political economy: Essays in honor of Howard Sherman (Cheltenham: Edward Elgar, 318-339); also: 2005, Economic justice and democracy: From competition to cooperation (New York: Routledge).

[cxiv] For an in depth examination of effects in the chemical industry and the question of private vs. government oversight, see: King, Andrew A. and Lenox, Michael J., 2000, “Industry Self-Regulation without Sanctions: The Chemical Industry’s Responsible Care Program,” The Academy of Management Journal 43:3 (August 2000, 698-716).

[cxv] By “homogenous,” Hansmann means workers with similar community interests, such as class, education, profession, political beliefs or activity, etc.

[cxvi] Hansmann, Henry, 1990, “When Does Worker Ownership Work?  ESOP’s, Law Firms, Codetermination, and Economic Democracy,” The Yale Law Journal 99:8 (June 1990, 1749-1816), 1750.

[cxvii] Ibid., 1816

[cxviii] Though not outwardly influenced by the work of Actor-Network Theory, this paper owes much to its literature, in particular Bruno Latour’s student-ready Reassembling the Social: An Introduction to Actor-Network Theory (Oxford: Oxford University Press, 2005).

[cxix] Blackburn, Robin, 2007, “Economic Democracy: Meaningful, Desirable, Feasible?,” Daedalus 136:3 (Summer 2007, 36-46), 37-38.

[cxx] For an excellent, in depth discussion, see: Hamilton, Robert W., 2002, “The Crisis in Corporate Governance, 2002 Style,” The Houston Law Review 4-:1 (Spring 2003, 1-75).

[cxxi] Blackburn (2007), 38.

[cxxii] Friedman, Benjamin, 2007, “Capitalism, Economic Growth, and Democracy,” Daedalus 136:3 (Summer 2007, 46-56), 55-56.

[cxxiii] See: Giddens, Anthony, 1999, “Risk and Responsibility,” Modern Law Review 62:1 (January 1999 ,1-10).

[cxxiv] Beck, Ulrich, 1992, Risk Society: Towards a New Modernity (New Delhi: Sage).

[cxxv] Polanyi, Karl, 1944, The Great Transformation (Boston: Beacon Press, 2001).

[cxxvi] Fotopoulos, Takis, 1997, Toward an Inclusive Democracy (New York: Cassell Continuum).

[cxxvii] Hansmann, 1810-1811.

[cxxviii] Haidt, Jonathan and Seder, J. Patrick and Kesebir, Selin, 2008, “Hive Psychology, Happiness, and Public Policy,” Journal of Legal Studies 37 (June 2008, 133-156).

[cxxix] The writers (see previous note) borrow much from Actor/Network Theory, which may further illuminate their points.

[cxxx] Polanyi, 71.

[cxxxi] Weber, The Spirit of Capitalism.

[cxxxii] Look for instance at the rise of the Tea Party movement, and furthermore at the interests (immigration, economy, taxation, education, terrorism, healthcare, anti-socialism, definition of patriotism) of modern American populism.