07/12/2011 10:25 pm ET Updated Sep 11, 2011

Who Caused the Crisis and Why Is the Recovery Taking Forever?

What is constraining consumer demand and preventing an economic recovery and thus causing unemployment to remain at high levels? Consumers have too much debt.

What is depressing the housing market in which approximately one third of homes in the US are worth less than the mortgage balance leading to increased foreclosures? Homeowners have too much debt.

What is the biggest problem with the global financial system? Banks have too much debt.

What is one big thing wrong with our federal government? It has too much debt.

What is wrong with our local and state governments? They have too much debt.

What is wrong with the governments of Greece, Ireland, Spain, Italy, Portugal, Japan, Iceland, Belgium, Singapore, France, the United Kingdom, Egypt, India, Hungary and Germany? They all have too much debt.

What are we doing to our young people who graduate college with enormous amounts of student loans and huge government liabilities facing them? They have too much debt.

When I say a person or a bank or a city or a country has too much debt I mean literally they have so much debt that it is unlikely they will be able to pay it all back from their expected future cash flows.

The sixty trillion dollar question, which is just about equal to the total debt in the world, is how did we get into this mess and whose fault is it.

Some economists argue that debt levels are not relevant to societal well being because for every borrower there is a lender, so with each loan made, no wealth is created and with each default, no wealth is lost. While intellectually pure, this line of reasoning does not hold if much of the lending is coming from outside your country (China) or if by lending the money to someone it increases the likelihood that they will piss it away. Think of Greece borrowing to pay its government workers to take eight weeks vacation, U.S. homeowners taking second mortgages against their houses to buy cars, boats and vacations or our government borrowing to finance two trillion dollar wars halfway around the world.

We have heard some espouse the theory that with regard to mortgage debt, the homeowner is just as guilty as the bank because he or she signed the mortgage note and agreed to pay it back.

But wait a second, when someone offers you $500,000 in low cost financing to buy a $500,000 house with no money down and gives you the contractual right to put the house back to them in foreclosure if things don't work out, how is this the homeowner's fault? This is free money. You should take as much of this as the bank is giving away, and that is pretty much what Americans did during the housing boom.

No, when loans go bad there is only one entity truly responsible: the lender. The borrower may have done some incredibly stupid things with the money, but it is up to the lender to anticipate and prevent these actions by conducting thorough due diligence, determining the credit quality of the borrower, judging his or her character and future earnings prospects, limiting the borrowing amount or by enacting tough restrictive covenants in the loan agreement.

When banks make bad loans, they don't fire the banking client who borrowed the money, they fire the banker who extended the funds on such loose terms.

So the answer to why all these entities; consumers, homeowners, financial institutions, local and sovereign governments and students have too much debt is because some stupid lender gave it to them. And in most circumstances the lender was a commercial bank.

I used to have a good friend back when I worked on Wall Street who went to cocktail parties with me and when asked what he did for a living said, "I am a commercial banker and I am sorry". I often think his greeting would be even more appropriate today.

To those of you who mistakenly believe that the government caused this crisis, you are partly right. They didn't do their job in properly regulating the banks. But they were paid by lobbyists of the banks and they garnered campaign contributions from the banks not to regulate. They in effect were, and still are, paid employees of the banks. Bankers make tens of millions a year, congressmen make a couple of hundred thousand. It was the banks who were successful in removing any meaningful regulation on their lending activities, their derivative activities and their balance sheet leverage. It is the banking lobby that is preventing any meaningful reform of our financial system. Heck, the Fed which is supposed to monitor the banks is owned and controlled completely by the banks.

To those of you who think Fannie and Freddie caused this crisis on their own, please realize that this is a global crisis brought on by banks worldwide even in countries that have never heard of Fannie and Freddie. Certainly they played a role, but it was because they were organized just like the banks as for profit companies with executives compensated with management stock options. They really are not part of the government but are stand alone entities that benefit from what were implied debt guarantees. Congress didn't tell Fannie and Freddie what to do, Fannie and Freddie told Congress what to do as they were the two biggest lobbyists in Washington D.C. Fannie and Freddie didn't go into subprime lending because Congress told them to because Congress was getting incredible lobbying pressure from poor people to increase home ownership rates (what a joke), they went into it because that is where the short term profits were. They begged Congress to throw them into that briar patch and then they giggled and ran away just like B'rer Rabbit. (By the way, poor people didn't cause this housing crisis as the biggest percentage of mortgage defaults were in our wealthiest cities of Los Angeles, San Diego, Phoenix, Las Vegas and Miami).

So, a smart reader like yourself would have to ask, why would a bank which is a for profit entity do something stupid and over-lend to almost every person, corporation, government entity and sovereign credit on the face of the earth? The banks have a number of unfair tax advantages and subsidies that lead them to do stupid things such as depositor insurance, tax deductibility of interest expense, low government mandated interest rates and the belief that they are too big to be allowed to fail.

But I think the greatest error made by bankers is in matching the silly lending terms of the aggressive banker across town because they know they must or they will go out of business. Unlike other industries, banks deal in such long maturity assets and liabilities that their mistakes are not revealed as bad loans for many years in the future, long after most of the current crop of bankers have retired and moved to the Hamptons. This long-lived nature of the bank's balance sheet is the primary reason the free market does such a poor job moderating their activities and why government regulation is required in banking, just like it is in the insurance industry, another long lived asset/liability business. The profits and bank fees happen up front in the short term, but the true costs of stupid lending don't show up until the next crisis or recession, and then they all show up at once. Collective action problems like this are never managed well by a completely free and unregulated market.

So how do we get rid of all this debt in the world? Well, we missed a perfect opportunity. We should have allowed these overleveraged banks to fail and then restructured them with new managements and much reduced levels of debts. As part of the restructuring, the banks would have set up reserve accounts to allow for the restructuring of all their bad loans, in effect they would have created a pocket to put all their bad loan losses in and thus would have been much more motivated to restructure troubled mortgages, underwater homes and even underwater nations' debts. They would have taken their lumps and moved on. It is crazy to insist that anyone who lends money to a bank deserves to be repaid at the rate of 100 cents on the dollar when the bank has invested the money in bad loans and has lost it.

By continuing to not recognize the bad loans, the banks limp along, restricting their new lending and assuring that the economy limps along with them. Consumers, governments and yes, even the banks stagger along under their crippling debt loads. And yes, I was a banker once, and I'm sorry.

John R. Talbott is a best selling author and consultant. His new book is mandatory reading for anyone interested in learning the real reasons for this crisis and how to protect yourself going forward. You can read more about John and the new book at or at