The Daily Scoop: 5 myths of the great financial meltdown


FORTUNE — It’s hard to believe, but it’s been five years and a day since the U.S. financial system’s problems surfaced, and we’re still not even remotely close to being able to feel good about the economy. There’s a long way to go before the economy, and people, recover from wounds inflicted by the financial meltdown.

How should you think about the past five years? What can we learn from them? And what can we as a society do to minimize the chances of a recurrence?

I’ve been writing about the financial meltdown and its aftermath almost continually since I joined Fortune the month after the symptoms surfaced. Now, five years into the problem, I find myself getting increasingly angry and frustrated watching myth supplant reality about what happened, and seeing fantasy displace common sense when it comes to fixing the problems that got us in this mess.

Myth No. 1: The government should have done nothing.

There’s an idea gaining currency that everything the government did, from the Troubled Asset Relief Program (the now infamous TARP) to the Federal Reserve’s innovative lending programs and rate cutting, just made the problem worse. And that we should have simply let markets do their thing.

Wrong! Wrong! Wrong!

Myth No. 2: The government bailed out shareholders.

The real beneficiaries of the government bailout of financial institutions weren’t their stockholders — it was their lenders.

Myth No. 3: The Volcker Rule will save us.

Let’s get one thing straight. Washington is unwilling to change the financial system drastically, the way it was changed in the Great Depression’s aftermath. We’re trying to legislate the problems away.

The major one: the Volcker Rule, which is supposed to let insured banks do securities transactions on behalf of their customers but not speculate for their own accounts. That sounds great. But it won’t work. As I predicted, differentiating between market making and speculating is proving impossible to define in a simple, enforceable way.

Instead of the overhyped Volcker Rule, we need the severely underhyped Hoenig Rule. I’ve named it for Tom Hoenig, former head of the Kansas City Fed and current acting vice chair of the FDIC.

In a marvelous paper presented in May of last year Hoenig (pronounced ha-nig) proposes breaking up banks by function, not size. It’s so simple, it’s brilliant. He would eliminate all trading and hedging by banks. Hoenig is simple. And workable. And would infuriate Wall Street and its fellow travelers. It’s too bad that Tom Hoenig’s imprimatur is nowhere near as valuable in Washington as Volcker’s is. Hoenig would probably fix “too big to fail.”

Myth No. 4: Taxpayers are off the hook for future failures.

Dodd-Frank reform legislation passed in 2010 is being touted in Washington as a way to deal with future meltdowns of big financial institutions without risking taxpayer dollars or giving creditors a free pass.

Myth No. 5: It’s the government’s fault.

Yes, there were plenty of reckless and immoral borrowers taking out mortgages they knew (or should have known) they couldn’t afford. And yes, you can make a case that the federal government’s zeal to increase homeownership levels was partly responsible for lowering lending standards. But the idea that the government is primarily to blame for this whole mess is delusional. It was the private market — not government programs — that made, packaged, and sold most of these wretched loans without regard to their quality. The packaging, combined with credit default swaps and other esoteric derivatives, spread the contagion throughout the world. That’s why what initially seemed to be a large but containable U.S. mortgage problem touched off a worldwide financial crisis.

We’ve had more than enough shrieking and demonizing since this mess erupted in 2007.  It’s time — after five years, it’s well past time — for us to stop pointing fingers at one another, and to fix the excesses that almost sank us.

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One Comment to “The Daily Scoop: 5 myths of the great financial meltdown”

  1. On its surface, not sure how this Tom Hoenig rule is much different from Glass-Steagall. Then again, I’m not as familiar with Hoenig and his proposal. I’ll have to research to find out. Thanks for posting this.

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