The previous exchange on this subject got lost in the weeds a bit, in my view, so I am go to restart both the discussion and my own digression.

First among the things that I think got lost is that, like an airplane crash, a situation like this is almost never the result of a single cause. There is usually a root cause, but it is very rare for that root to have grown to a serious problem without other contributing factors. While we can argue about whether “mark to market” was a contributing factor, I think we can dispense up front with the idea that it’s the only factor. I would say that should be the default position for any discussion of a root or contributing cause, unless specifically argued otherwise.

I am not interested in seeking a “villian” unless a successful such search would improve things in the future by enabling the removal of the villian’s power to do harm or discouraging future imitators. If we can’t do either of those, even if we find a villian, then it’s not a productive pastime.

As with villians, to me the point of finding contributing factors is to find ways to ameloriate or prevent them in the future. An important corollary of that is that factors over which we have no control are pointless to debate. One that comes to mind is the “greed” or “shareholder value maximization”. There’s nothing one can do about that short of massive genetic engineering so I find it pointless to discuss. One needs to design any financial system under the presumption of greed by basically all of the participants and designs that don’t deal with that fact of life are doomed to miserable failure.

After all this, I still see the FMs as the seed crystal of the problem. These entities basically created the mortgage security market by first dealing with them large scale and by providing de facto guaranteed liquidity for them. Without that government backing the problem would not have been able to grow so large.

The FMs were also used to engage in social engineering, in terms of home ownership, and as usual the long term result was a crash and burn.

Beyond that, however, a major contributing factor that doesn’t seem to get much play is the large amount of fiduciary malfeascance that was going on at the FMs over the last decade or so. This is actually what the efforts of President Bush (2003) and Senator McCain (2005) were aimed at, much more than the previous two items. If there’s one group of people who need to be named villians and prosecuted, it’s that crew.

To me, the proper preventative measure is simple. Don’t provide government backing for derivatives. Don’t mix public and private in the FM way, which created the worst of both worlds — all the greed of the private sector with the sclerotic reactions and impenetrable corruption of the public sector.

UPDATE 1: I will state that I think the repeal of Glass-Steagall is irrelevant to this issue. One can see this by noting how the liquidity problems have spread throughout the banking system, and indeed internationally. Either all of the local and regional banks that avoid the MBS market are not in danger, in which case we don’t have a real problem, or they are, in which case the division that Glass-Steagall enforced an obviously artificial one with no relevance in the real world.

UPDATE 2: Some claim that a New Deal style regulated banking system doesn’t suffer from crises. One might make the counter-claim that such regulation merely stores up trouble for the future, the way the USSR’s economy, rather than enduring periodic problems, simply collapsed catastrophically after many decades (hmmm, about as long as the New Deal financial system…). That’s a style as common to government intervention as periodic panics are to capitalism, so it would seem just as reasonable a claim.