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Kling: Experts Knew What Went On
It is tempting to blame the financial crisis on lack of regulation. However, the problem was not the absence of oversight. Instead, the crisis resulted from policies that were self-defeating. In order to prevent another crisis, we need to change our approach....

...The financial practices that we now understand to be dangerous were encouraged by regulators who believed that these practices served public policy goals. The regulators thought they were promoting homeownership and a more stable financial system.

To foster homeownership, policymakers promoted mortgage lending that was subsidized and lenient. Requirements for down payments were relaxed, as were requirements for borrowers to prove they had the ability to repay their loans....

...Washington also was responsible for creating and supporting the process of mortgage securitization. At the time, this was viewed as a way to lower the cost of mortgage credit and stabilize the mortgage lending industry.

Finally, it was bank capital requirements designed by regulators that induced bankers to weave the crazy quilt of collateralized debt obligations, credit default swaps on mortgage securities and off-balance-sheet financing. This was a gradual process, but two dates stand out. First, in 1989, the Basel Accords established capital requirements that made it more profitable for banks to hold Freddie Mac and Fannie Mae securities than to hold ordinary mortgage loans. Then, on Jan. 1, 2002, bank regulators amended these capital requirements to give the same break to securities issued by anyone, provided that those securities received AA or AAA ratings from credit rating agencies. ...