The global financial crisis needs the hope that US mortgages are trustworthy.
The world's finance officials will huddle this weekend in Washington to deal with the worst financial crisis since the Depression. Many leaders have already decided that the source of global fears lies in the US economic model. But which part of that "model" really needs fixing?
The German finance minister predicts the US will no longer be the "superpower" in global finance. The French president said the model of laissez-faire economics is "finished." Russia's president said the dominance of the US economy "has been consigned to the past."
Indeed, this crisis can be traced to US financial institutions taking on borrowers who signed mortgage contracts they could not afford. Those loans were then passed up the food chain to investors worldwide with little oversight over whether the home buyers might default if prices fell.
The housing bubble – caused in part by these iffy loans – did finally burst, revealing the false hope that foreign investors had placed on an ever-rising US housing market.
Who gave them that hope? It did not arise primarily from a lack of regulation. Rather, it was the wrong kind of regulation – the kind that tries to redistribute wealth by forcing private financial institutions to fulfill a government goal of providing inexpensive homes. US laws such as the 1977 Community Reinvestment Act and those that support government-backed Fannie Mae helped push banks and mortgage brokers into the business of handing out loans on easy credit.
The result? Too many subprime loans were given to too many people with inadequate income. A market fear was planted that home prices were not based on the real American model of letting markets determine the worth of assets.