Bankers' Actions: Criminal Or Careless Before The Crash?

The 2008 financial crash, the worst since 1929, was caused by a multitude of factors, including the irresponsible and unethical behaviour of Wall Street. While some of the actions taken by bankers were legal, others were not. The Massachusetts senator, Elizabeth Warren, argued that the only way to avoid another crisis is to break up the Wall Street banks and hold wealthy executives accountable for their crimes. She introduced the Ending Too Big to Jail Act to punish bankers who break the law. The primary culprits of the crash were Wall Street's too-big-to-fail financial institutions that engaged in a binge of risk-taking, irresponsible lending, and, at times, massive illegal conduct.

Did bankers' illegal conduct cause the crash?

The financial crash of 2008 was the worst since the Great Crash of 1929, and the economic crisis it caused was the worst since the Great Depression. The primary culprits were Wall Street's too-big-to-fail financial institutions that engaged in a binge of risk-taking, irresponsible lending, and, at times, massive illegal conduct.

The illegal conduct of bankers was certainly a factor in the crash. There was pervasive fraud in the sale of residential mortgage-backed securities and the related derivatives and structured products that the biggest banks created, packaged, and sold.

However, it is important to note that not all of the behavior that led to the crash was illegal. Some of it was legal, some of it was unethical, and some of it was just irresponsible or stupid. The causes of the crash were multifaceted and complex, and it will be debated for decades, if not longer, what exactly caused it.

One important factor was the repeal of the Glass-Steagall Act, which prohibited the same bank from engaging in both relatively low-risk traditional commercial banking and higher-risk trading, insurance, and investment banking operations. The repeal of this act allowed for the combination of traditional bank lending with trading, securities, and insurance activities, resulting in gigantic, sprawling, interconnected, global financial institutions. These so-called too big to fail institutions threatened the entire financial system and economy if they ever failed.

In addition, the massive bipartisan deregulation during the 1990s and 2000s also played a role in the crash. The years before the crash saw a dramatic increase in irresponsible and unethical behavior by Wall Street, enabled by the loosening of restrictions.

To avoid another financial crisis, there have been calls to break up the big banks and hold wealthy executives accountable for their crimes. The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in an attempt to regulate the financial sector's activities and protect consumers.

Did bankers' unethical conduct cause the crash?

The 2008 financial crash was the worst since the 1929 crash, causing the worst economy since the Great Depression. It cost the US more than $20 trillion in lost GDP, and millions of Americans are still recovering from lost homes, jobs, savings, stagnant wages, and student loan debts. The primary culprits were Wall Street's too-big-to-fail financial institutions that engaged in a binge of risk-taking, irresponsible lending, and, at times, massive illegal conduct.

Some of this behaviour was legal, some of it illegal, and some of it was criminal. Some of it was just unethical, irresponsible, or stupid. Much of it was a mix of all of that. Some of it directly contributed to the financial crisis, and some of it indirectly. But Wall Street's reckless, high-risk behaviour was representative of the unregulated, freewheeling, money-soaked, bonus-driven culture that existed throughout too much of the financial industry before 2008.

Wall Street firms grew enormously in size while ramping up their leverage to dangerously high levels. They also originated or supplied the funding for others to originate as many subprime mortgages as they could, while their derivatives and structured products divisions simultaneously created an insatiable demand for those mortgages. This was enabled by massive bipartisan deregulation during the 1990s and 2000s.

One of the more important laws passed after the 1929 crash, and whose repeal was a key factor leading to the 2008 crisis, was the Glass-Steagall Act. It prohibited the same bank from engaging in both relatively low-risk traditional commercial banking and higher-risk trading, insurance, and investment banking operations. Because Glass-Steagall required that these activities be conducted in entirely different financial firms, it prevented Wall Street's highest-risk activities from endangering the bank that engaged in socially beneficial lending to the real economy.

Glass-Steagall was effectively repealed with the passage of the Gramm-Leach-Bliley Act in 1999, which unleashed an acquisition spree that supersized banks by allowing the combination of traditional bank lending with trading, securities, and insurance activities. When the merger frenzy peaked, what had been almost 40 financial institutions resulted in just four sprawling financial conglomerates.

The result was gigantic, sprawling, interconnected, global financial institutions that threatened the financial system and the entire economy if they ever failed. These so-called "collateral" consequences are what makes these giants "too big to fail" and, in violation of the most basic rules of capitalism, virtually guarantees they would be bailed out rather than failing in bankruptcy like every other firm in the US.

Another deregulatory change that made these firms more fragile and unstable was the Commodity Futures Modernization Act, passed in 2000, which effectively prohibited the regulation of the swaps derivatives markets. As a result, legal hurdles to unbridled derivatives speculation that dated back decades allowed the derivatives markets to balloon to more than $700 trillion, only a small fraction of which was related to the real economy. Not only were these derivatives bets dangerous to the individual firms, but they acted as a conveyor belt distributing unseen risks throughout the global financial system.

The financial crisis of 2008 resulted from numerous market inefficiencies, bad practices, and a lack of transparency in the financial sector. Market participants were engaging in behaviour that put the financial system on the brink of collapse. Historians will cite products such as CDOs or subprime mortgages as the root of the problem; however, it's one thing to create such a product, but knowingly selling and trading these products requires moral hazard.

One moral hazard that led to the financial crisis was banks believing they were too important to fail and that if they were in trouble, they would be rescued, leading them to take on more risks. A second moral hazard that led to the crisis was banks selling off their mortgages to third parties for collateralization, which incentivized them to make as many mortgages as possible without thorough risk analysis or standards.

The causes of the crash and the economic crisis it created will be debated for decades, but the unethical conduct of bankers was certainly a contributing factor.

Did bankers' risky behaviour cause the crash?

The 2008 financial crash was the worst since the 1929 Wall Street crash, causing the worst economic crisis since the Great Depression. It cost the US more than $20 trillion in lost GDP, and tens of millions of Americans are still recovering from lost homes, jobs, savings, and stagnant wages.

The primary culprits were Wall Street's too-big-to-fail financial institutions, which engaged in a binge of risk-taking, irresponsible lending, and illegal conduct. The behaviour was driven by a desire to maximise short-term profits and pocket huge annual bonuses, at the expense of clients, customers, and the long-term viability of the firms.

In the years leading up to the crash, Wall Street firms grew in size and ramped up their leverage to dangerously high levels. They also originated or funded subprime mortgages, creating an insatiable demand for those mortgages. This was enabled by bipartisan deregulation during the 1990s and 2000s.

One of the key laws repealed was the Glass-Steagall Act, which had prohibited the same bank from engaging in both low-risk traditional commercial banking and higher-risk trading, insurance, and investment banking operations. The repeal of this Act allowed for the combination of traditional bank lending with trading, securities, and insurance activities, creating gigantic, sprawling, interconnected, global financial institutions.

The Commodity Futures Modernization Act, passed in 2000, also contributed to the fragility of financial institutions. This prohibited the regulation of the swaps derivatives markets, allowing derivatives speculation to balloon to more than $700 trillion.

Additionally, the years before the crash saw a dramatic increase in compensation schemes that incentivised high-risk short-term behaviour. For example, because leverage boosted a firm's return on equity, and executive compensation was based on this, leveraging a firm to near-fatal levels was lucrative for financiers.

The combination of these factors resulted in a financial system that was extremely vulnerable to collapse.

Did bankers' deregulation cause the crash?

Deregulation of the banking industry is widely considered a major contributing factor to the 2007-2008 financial crash.

The Glass-Steagall Act of 1933 separated commercial and investment banking, preventing commercial banks from engaging in high-risk activities. However, starting in the 1960s, federal regulators' interpretations of the Act allowed commercial banks to engage in an expanding list of securities activities.

In 1999, the Gramm-Leach-Bliley Act (GLBA) repealed two key provisions of the Glass-Steagall Act, removing the separation between commercial and investment banking. This repeal led to the formation of gigantic, sprawling, interconnected, global financial institutions that were "too big to fail".

The combination of traditional bank lending with high-risk trading, securities, and insurance activities resulted in increased risk-taking, irresponsible lending, and illegal conduct by these financial institutions. This reckless behaviour, enabled by deregulation, contributed significantly to the 2007-2008 financial crash.

Some commentators and economists, such as Joseph Stiglitz and Paul Krugman, argue that the repeal of the Glass-Steagall Act was a significant cause of the financial crisis. They contend that the removal of the separation between commercial and investment banking led to a culture of risky investments and short-term profit maximisation.

However, others, like Lawrence J. White, believe that the banking changes had no effect and that the financial crisis would have occurred regardless of the regulations in place.

Did bankers' fraud cause the crash?

The 2008 financial crisis was the worst since the Great Crash of 1929 and had a devastating impact on the global economy. It cost the US more than $20 trillion in lost GDP and caused massive deficits and debt, which have resulted in the ongoing underfunding of American priorities such as education, healthcare, science, and job creation.

The crisis was caused by a combination of factors, including Wall Street's too-big-to-fail financial institutions engaging in risky lending and, at times, massive illegal conduct. While some of this behaviour was legal, some of it was criminal.

In the years leading up to the crisis, Wall Street firms grew in size while taking on dangerously high levels of debt. They also originated or supplied funding for others to originate as many subprime mortgages as they could, creating an insatiable demand for those mortgages. This was enabled by the massive bipartisan deregulation during the 1990s and 2000s, including the repeal of the Glass-Steagall Act, which had prohibited the same bank from engaging in both commercial banking and investment banking operations.

The deregulation unleashed an acquisition spree that resulted in just four sprawling financial conglomerates. These gigantic, interconnected, global financial institutions threatened the entire economy if they ever failed, making them "too big to fail" and virtually guaranteeing they would be bailed out rather than failing like every other firm.

The collapse of the venerable Wall Street bank Lehman Brothers in September 2008 marked the largest bankruptcy in US history and became a symbol of the devastation caused by the crisis. The carnage spread across the financial sector, with IndyMac Bank becoming one of the largest banks ever to fail in the US, and the country's two biggest home lenders, Fannie Mae and Freddie Mac, being seized by the government.

The crisis was also exacerbated by the behaviour of bankers, who could have averted it. Evidence suggests that Wall Street bankers knew there was a bubble but chose not to act, instead opting to profit from it. This behaviour included deliberate concealment of financial transactions, assisting in major financial frauds, and committing frauds that worsened the financial bubble.

While there has been some attempt to prevent a similar crisis from happening again, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, bubbles continue to occur, and it is unlikely that there will never be another financial crisis.

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