Well, now that Obama has won, perhaps the press will finally allow the truth to come out about the subprime lending problems that have been plaguing us. However, as that would involve letting Republicans off the hook (somewhat), I doubt that will happen. instead we will continue to hear absurd lies about Wall Street greed and predatory lenders. Well, just ask yourself one thing: Who bankrupts themselves to get rich? Better yet, ask why the lenders suddenly decided to start making bad loans to get rich? If bad loans were the path to prosperity, why not do it all along? I can give you a hint, it has nothing to do with "deregulation" and everything to do with government.

Well, to start, let us go back to the creation of the Federal Reserve. It seems a long way to go back to describe a contemporary problem, but you need to understand the change in banking to understand what happened. Prior to the creation of the Federal Reserve, banking was a private business. Admittedly, it was still heavily regulated, but there was a basic requirement that banks had to pay out in gold when presented with bank notes. Thus they had to keep reserves in order to be able to pay out any foreseeable requests. From time to time, they printed too many notes, or extended to much credit, and there would be a bank run, depositor would withdraw all their holdings and the bank would collapse. Except that usually, rather than allow the bank to fail, the government would often step in and place a moratorium on withdrawals to stop the run. Because of this, banks were often rather irresponsible in creating credit, knowing the state would bail them out. So there began the cycles of inflation and recession, as banks overinflated because of government promises, then suffered forced deflation when their outstanding notes grew too great for the reserves that supported them.

In response to this government created problem, the government proposed more government, and created the Federal Reserve, centralizing note issue in one place. It still redeemed notes in gold, but it also allowed the government to more easily inflate and to more easily declare bank holidays and suspend redemption in gold. That is until FDR made holding monetary gold illegal in 1934, essential ending redemption for any but foreign holders of currency. (They lost the right to redeem in a series of acts in 1971 and 1973, thanks to Nixon.)  After the closing of the gold window, our money was based on nothing at all, leaving questions of inflation entirely at the discretion of the government.

The massive inflation of the 1970's is the legacy of this policy, ended only by Reagan's forced restraints on increases tot he money supply. We still faced inflation, and our money was still backed by nothing, but so long as the money supply increased only modestly, the worst effects of the change to fiat currency were abated somewhat.

Which brings us to Carter and the real origins of our troubles, the Community Reinvestment Act.

Actually, let me step back a little bit, as there is one other matter we need to understand to make sense of what happened. In the past, banks were banks. Some states may have had regulations about the sort of business they could do, but until the New Deal, there was no such thing as a "savings and loan" or "investment banks". Banks could engage in consumer lending, commercial lending, investment, insurance, even sell fish and chips if hey wanted. There was no division of tasks, at least none forced by law.

But FDR could not leave well enough alone. For example, his advisors thought that competition to offer higher interest rates would bankrupt banks, so he prohibited the paying of interest on checking accounts. It is an absurd position, but one that lingered for decades. Likewise, FDR split apart the functions of investment, lending, and so on. That is the origin of the the Savings and Loans that collapsed in the 1980s. And it is part of the reason why the left blames "deregulation" for this crisis. Because prior to the collapse, banks were allowed to enter the investment field again, and, according to left wing theories, that created the crisis.

Of course, the truth is a bit different. Diversification tends to strengthen, not weaken companies. Were banks limited to a single field, the way S&Ls were invested heavily in mortgages, it tends to weaken them. Just look at the way holding almost nothing but low interest, low liquidity pre-70's mortgages caused the S&L's to collapse. Unable to unload those low interest mortgages fast enough to meet obligations, the S&Ls suffered massive liquidity crises. Yet that crisis too is blamed on deregulation. In reality, as with the old bank holidays, it was FSLIC which hurt, not deregulation. Deregulation simply opened up the types of investments in which banks could be involved, and thanks to the FSLIC they had no worries about risk. So, they effectively were gambling with other people's money, with no risk. Of course that led to crisis, but the problem was not deregulation, but the remaining government guarantees. (And other regulation, which had created the mortgage-heavy portfolios with which they had been saddled.)

And now, THAT brings us to the Community Reinvestment Act.

The Act was a standard liberal brainchild. The idea behind it was that the only thing keeping poor people from getting loans was greed, and if bankers were just encouraged to give loans to poor people, it would work out fine. Only their insistence on unfair criteria such as income and credit that kept the poor form owning homes. And so Freddie and Fannie were created to encourage loans bankers would not normally make, by providing a buyer for undesirable loans.

Thanks tot he massive inflation of the Carter years, property prices skyrocketed, making even bad loans a winning proposition, as the value of houses come foreclosure were much greater than the purchase price. Similarly, the prosperity of the Reagan Bush years, kept the loans from being a problem. (Though the bad mortgages probably created some additional problems for the failing S&L's in the early 80's.)

Which brings us tot he Clinton years and two of the greatest influences on the problem. The government pressed for greater lending to the poor, effectively reducing the requirements even more. On top of that, Clinton was prone to inflate the money supply, in an effort to prevent the crashes which eventually claimed the dot coms. (Following Clinton, Bush too was guilty of inflating to keep rates low.) The inflation kept interest rates absurdly low, not only making these bad loans popular, but inflating housing prices dramatically. And to buoy the market, the Clinton administration kept up pressure on Fannie and Freddie to by up these loans, which they subsequently packaged and sold, marketing them as more stable than they were, spreading the trouble throughout the market.

Of course, eventually such situations must come to an end. Eventually the inflationary housing bubble burst, and the constant escalation of prices ended. And with the end of the housing bubble many of these bad loans proved as worthless as everyone expected.

After that the rest is well known. The media may have exaggerated the risk, but otherwise we know the story. The markets began to tank, both parties want to throw money at it, and I doubt it is over yet.

And that, in a nutshell, is the story of the current problems. As you can see, the Republicans are not without fault, they are guilty of inflating to stave off economic problems as much as the  Democrats, but the root of the problems, the Community Reinvestment Act and the subsequent pressures to make bad loans was all the Democrats. in fact, when the Republicans attempted to reform Fannie and Freddie during the Bush administration, the Democrats resisted all pressures. So, while both parties are guilty of manipulation of the Federal Reserve , the bulk of the current problems are the fault of the Democrats.

POSTSCRIPT

I am sure I have omitted some important points, there are too many related matters to go into. All of the banking regulations, the manipulation of the money supply, it is enough for a thick volume. So, please, feel free to add to my description in the comments.  I realized about halfway through that I could expand this to several pages. Still, I thought a more comprehensive description would be beneficial.

Also, I have to add that this was inspired by reading Reisman's blog. I knew of Professor Reisman form his writing in the 80's, but didn't know he had a blog until I saw it mentioned in Walter Williams' article today.