Question

It has become popular in the media to blame banks, consumers, Wall Street, and government for the 2007–2009 economic crisis. As an economist, do you think it is reasonable to blame each of these groups? Which group would you consider the primary culprit, if any? Why?

Answer 1

The crisis was not the result of just one party playing the role but it was the collaboration by all. With central bank pushing market with cheap liquidity, excess lending with low credit standards and investors behaviour, resulted in the economic crisis.   The investment banks, commercial banks, homebuyers, government, wall street, rating agencies all played a huge role in financial crisis.

1. Commercial banks - The loans originate from the banks which we can call on of the culprit, as it was them who lend recklessly to the people with poor credit rating and higher chance of default. The commercial banks were provided with ample liquidity by the central bank which resulted in more lending by commercial banks to generate higher revenue. And thus higher lending in housing market resulted in excess exposure of banks which when burst lead to negative credit growth

2. Homebuyers - Sumprime homebuyers were taking floating rate home loans from the banks, and continue to borrow money form the bank even knowing that they can not be able to make the payment in future. when the central bank raised the interest rates rise to the higheset level due to higher inflation, the homeowners were not able to make interest payment and thus defaulted in the principal payments of Home loans.

3. Government - Government did not played its role in diffusing the housing buble with strict credit standards as it was aiming to push higher growth rate and other reason was vote bank politics. The government must have given central bank advice to tighten the credit standards and diffuse the irrational exuberance.  

4. Rating agencies - The rating agencies provided these mortgage backed securities with Higher credit rating, when they should have given lower credit rating to these Mortgage Backed securities. As the fees was originating from the investment banks who were selling these instruments to investors, the rating agencies dosent want to miss the part in bubble.

5. Wall street - wWall street and investment banks were responsible for making these illiquid assets available in secondary market and selling these mortgage backed securities to the investors. This resulted in investors buying MBS in the secondary market for higher yield and thus exacerbating the situation.

I believe the Government and central bank here should have played a major role in diffusing the crisis, and if government had tighten the credit stadards then the crisis may not had been that severe as it was in 2007-08