I have no interest in defending bankers; however, in the interest of considering as many facts as possible, here is an opinion contrary to the dominant one that the banks and bankers gamed the system.

The case against The Crash conspiracy theory
Neil Reynolds

Last updated on Wednesday, Jul. 08, 2009 10:15AM EDT

In a column earlier this week, New York Times op-ed writer Frank Rich perfectly articulates the dominant mythology of the 2008 market meltdown. Wall Street caused The Crash, he says, by manipulating the U.S. mortgage market in so vast and so venal a fashion that Bernard Madoff's criminal Ponzi scheme was insignificant in comparison - "merely a one-off next to the esoteric (and often legal) heists by banks and bankers." These bankers, Mr. Rich says, "gamed the entire system, then took the money and ran before the bubble burst, sticking the rest of us with fear, panic and loss."

As prevalent as this conspiracy theory is, it remains highly improbable. For one thing, it rests rhetorically on a loose use of the English language. Note Mr. Rich's caution in identifying Wall Street's actions as criminal - though simultaneously describing them as "heists." Webster defines "heist" as theft, robbery or any other "unlawful appropriation."

But the case against the conspiracy theory rests much more substantively on historical fact. Mr. Rich asserts, for example, that evil bankers "took the money and ran before the bubble burst." This is mythology. Writing in the current issue of Policy Review magazine, published by the Hoover Institution at California's Stanford University, Wall Street Journal columnist Holman W. Jenkins sets the record straight.

"[I]t isn't true that Wall Street made [subprime] mortgage securities just to dump them on the proverbial greater fool, or that the disaster was wrought by Wall Street firms irresponsibly selling investment products they knew or should have known were destined to blow up," Mr. Jenkins writes. "On the contrary, Merrill Lynch retained a great portion of subprime mortgage securities for its own portfolio (it ended up selling some to a hedge fund for 22 cents on the dollar). Citigroup retained vast holdings in [these securities]. Holdings of these securities brought down Bear Stearns and Lehman Brothers. AIG, one of the world's most admired corporations, made perhaps the biggest bet of all ... Wall Street can hardly be accused of failing to eat its own dog food."

Further, it is not true that Wall Street executives and CEOs had no "skin in the game," Mr. Jenkins says. Most of these big players held considerable personal wealth in the stock and the stock options of the companies they managed - which bet their own money on the mortgage securities. "Personal losses to top executives in banks that failed or whose share prices collapsed were in the millions, hundreds of millions, and in some cases, the billions," he writes. Richard Fuld (Lehman Brothers) lost $100-million (U.S.). James Cayne (Bear Stearns) lost nearly a billion dollars. Hank Greenberg (AIG) lost as much as $2-billion. "They had skin in the game," Mr. Jenkins says.

Further, it is not true that Wall Street manufactured mortgage securities "as a purblind bet that home prices only go up." The securities were explicitly designed to handle a large number of defaults - with a carefully calculated rise in the anticipated foreclosure rate. Wall Street, in other words, knew exactly what was in the dog food and willingly bet its own money on it.

Mr. Jenkins acknowledges that some hedge fund managers made fortunes by selling these securities short before The Crash. But there is a short seller in every market transaction - a seller as well as a buyer. Yet the hedge funds that profited from subprime skepticism were remarkably cautious, making their bets "only through elaborate, expensive, negotiated deals," he writes.

"Had [these investors] really seen what was coming, they could have saved themselves a great deal of expense and bother simply by shorting Citigroup, Bank of America, Lehman, Bear Stearns, etc.," Mr. Jenkins notes. "Their profits would have been huger, their ... hassle factor much less." Wall Street made its risk-assessment judgments as best it could - and paid the consequences. "Market efficiency is not market clairvoyance."

The more probable cause of The Crash, Mr. Jenkins finds, was government - especially the early and inept response to the subprime "snafu" by the U.S. Federal Reserve (which inflated the housing bubble in the first place) and the U.S. Treasury. Although the government did act with the best of intentions, it inadvertently set off a global panic. In the end, the Fed averted a cataclysmic collapse of its own making by swapping one disaster threat (market meltdown) for another (future inflation).

One result of the Federal Reserve role in mismanaging the crisis, Mr. Jenkins says, is Obamanomics, a platform "born in the inexperienced mind of a Chicago academic and state legislator." The greatest risk now, he says, is an economy with too little risk-taking, not too much - with the government making the important industrial decisions. President Barack Obama, for his part, "has all the hubris of a [Japanese] bureaucrat in the mid-1980s."

"It is likely to end badly," Mr. Jenkins concludes, "as such dirigiste overreaching always does." Dirigiste: Now there's a persuasive resort to rhetoric. From the French diriger (to direct), dirigiste means state control of an economy. In the United States these days, it's government policy.