Business: who is to blame for America's subprime fiasco?

By James Sturgeon
Convergence Spring 2008

Crises, by their nature, are usually preceded by a good deal of oversight.

The dithering of British Prime Minister Chamberlain on the eve of the Second World War, or more recently, the United States federal government's response to Hurricane Katrina's levelling of New Orleans stand as two examples of historic idleness.

In both cases, foresight was nowhere to be found, with devastating results.

It’s safe to assume the implosion of America's sub-prime mortgage market and the ensuing global credit crisis among the world’s pre-eminent banks can summarily join history’s long list of the grossly overlooked-until-it-was-too-late.

“People say over and over again, how could this collapse in the U.S. housing market, and in particular, the low end of the U.S. housing market cause this global financial meltdown, which is what we came pretty close to,” says David Olive, a senior business columnist at the Toronto Star.

“By the early fall [2007], you had Citibank, the biggest bank in the world, and Merrill Lynch, the biggest brokerage in the world, each declaring multi-billion dollar write-downs. That was unprecedented.”

Equally disconcerting was how easily the underlying cause of those write-downs failed to be noticed.

It’s become glaringly apparent in recent months that everyone – from American regulators to global bankers and, not least, media – was left holding their hats when the shaky foundation of America’s sub-prime housing boom began to crumble last year.

Some background may be useful here:

Without garnering much attention, a combination of unmitigated lending from suspect mortgage brokers and Wall Street greed approved and sold off an astonishing US$600-billion in risky mortgage-backed securities to institutional clients around the world by 2006, according to Inside Mortgage Finance, an industry newsletter.

“It was in effect, the passing on of credit from the original lenders,” says Michael Veall, chair of economics at McMaster University in Hamilton. “You’re not going to take the same care to ensure it was a safe loan.”

It was like playing hot potato with a hand grenade. When a trickle of U.S. sub-prime defaults grew into a torrent by the beginning of last summer, the value of those securities plunged.



Euphemistically, what followed has been called a ‘liquidity’ crisis. In reality, a panic shot through the global financial system as losses mounted, and stricken banks reined in lending money to one another – the lifeblood of modern global commerce.

“I must admit, I didn’t foresee this,” Veall adds.

Few did. After all, the sub-prime boom of the previous five years had been fuelling skyrocketing home values across the United States. Glowing real estate data amid robust economic figures beguiled the vast majority, including many journalists, even the experienced Olive.

“When things are going really well, it’s not the sort of thing you complain about,” he says. “The tide of euphoria was very powerful and you really don’t know for sure that it’s not justified.”

Only after two sub-prime-stuffed hedge funds, managed by the (formerly) fifth-largest investment bank on Wall Street, Bear Stearns, “utterly collapsed” in July 2007 did Olive begin to seriously doubt the spectacular housing boom south of the border.

“To have this happen to a company the size and of prestige of Bear Stearns meant this was trouble,” the former editor-in-chief of Report on Business magazine says. “It was at that point that I began to look at the health of the U.S. housing market.”

By the time summer turned to fall, the chilly repercussions of the failing sub-prime market, and the internationally held securities tied to it, became fully understood, and widely reported on.

Here in Canada, Canadian Imperial Bank of Commerce sent shivers through the market after it announced a $750-million write-down tied to sub-prime losses and warned of more (it has escalated to over $3-billion since).

“I blew it,” Olive says, offering a mea culpa of sorts. “I monitor the U.S. economy as closely as any financial journalist in Canada is able to, and I blew it … I did not see the warnings.”

In America, the story is much the same, albeit, intermittent coverage did prevail at times, says Jonathan Higuera, deputy director at the Reynolds National Center for Business Journalism at Arizona State University.

“This is how media work, we find something and write a story, even a great story, and then we move on to the next one. Unless someone else picks up the ball, we don’t stay on top of it,” he says. “This is one of the cases where we should have stayed on top of it.”

It’s true that The New York Times brought the entire ugly business -- the rising tide of slippery lenders and their tie to Wall Street -- into plain view as early as March 2000 in a far-reaching investigative report by Diana B. Henriques and Lowell Bergman.

But Higuera says: “I don’t think even they knew what they had on their hands or how deep this was going to go.”

More often than not, the glare emitted by the housing boom proved more attractive and easier to report than the avaricious lending that was at the core of it, Higuera, a former business reporter at the Arizona Republic, says.

“[As a reporter] am I going to write a story about predatory lending practices or am I going to talk about how housing prices have gone up 50 per cent?

"The other side was harder to write. It would take a lot more research, a lot more time and a lot more resources,” he says.

“Media in many cases opted to tell the up-side story — the one the real estate community and mortgage industry would rather have you write.”

But the degree of culpability among journalists, whatever it may be, fails to explain why America’s sub-prime mortgage industry was permitted to run amok in the first place.

That responsibility rests squarely on the rise of morally dubious lending practices, and negligence among politicians and regulators to mitigate it, argues columnist Eddie Roth of the Dayton Daily News.

“Here, I know our business reporters and reporters on the social justice beat were keenly interested in this,” the former civil lawyer says. “[But] unscrupulous mortgage lenders have been permitted to thrive in Ohio because of near complete absence of consumer protection.”

“What’s become obvious is that there were no controls in the end.”

Since 2002, Roth has written dozens of editorials decrying predatory lending in the state, one of the worst afflicted alongside Nevada, Florida and California. Ohio now suffers from the sixth-worst foreclosure rate in the country.

“State lawmakers weren’t interested in doing anything, federal lawmakers weren’t willing to do anything, regulators weren’t willing to do anything.

“They didn’t appreciate how bad it could get,” Roth says.

Wherever the blame may lie, there is one certainty: the fallout from America’s sub-prime debacle has yet to be fully meted out.

Bear Stearns’s well-documented demise will see the 85-year-old bank annexed and eventually dissolve under rival JP Morgan Chase over the course of the year. We’ll surely hear of more mega-write-downs, too.



CIBC revealed in late March it still has staggering exposure to the U.S. housing market and it’s far from alone. Congress is now tabling suggestions on the wholesale overhauling of that country’s lending and brokerage industries.

As for journalism, Olive, a cynic to the end, quips:

“I would like to say that we learned something new from all this. But regrettably, there’s that saying ‘it’s not one thing after another, it’s the same damn thing over and over again.’

“All I really learned is that we are apparently destined to be suckers every decade or so.”