The combination of incentives, reinforcement, positive feedback loops, over-reliance on authority, and poor accounting contributed to the current mess. Bailing out these institutions, while necessary, creates a moral hazard going forward. And now, having lost money, institutions, like gamblers, will now be more likely to take risky bets with unfavorable odds in an effort to make up for lost ground.
How serious is the present mess?
Charlie Munger answered “Deadly serious.”
You can't tell what happens when people get disappointed enough of a dysfunctional civilization. The Depression led to Hitler. The government has been right to react vigorously.
What caused the mess?
It was an example of a lollapalooza effect: the result of a confluence of causes acting in the same direction.
Abusive practices in consumer credit, namely extending credit to people who couldn't handle it, knowing they couldn't handle it. Sometimes you have to resist sinking to the level of your competitors. But fomenting bad practices often becomes its own punishment. “If you do things that are immoral and stupid, there's likely to be a whirlwind” that sweeps you away.
The “scum of the earth” in mortgage credit who “rejoiced in rooking” their borrowers. “We had Wall Street go crazy,” pursuing any way of earning money short of armed robbery. In Merrill Lynch's last purchase of a mortgage outfit, they knowingly bought “a bunch of sleazy crooks,” thinking that if it makes money, who cares that they're crooks.
Poor regulation and legislation. Some of the legislators genuinely thought they were being pro-social in helping poor people buy houses, but they weren't; you need sound credit just as you need sound engineering. Some of the problem was Democrats pushing Fannie and Freddie to lend, some of it was “Republicans who overdosed on Ayn Rand” and thought unrestrained free enterprise was as good for the finance industry as for the restaurant industry.
The repo system of credit allowed this: “one of the best ways to create excess credit ever invented.” Credit default swaps that let you profit if someone else fails are a terrible idea; in buying life insurance, you're wisely required to have an insurable interest.
Mark-to-model accounting on derivatives let both sides show a profit; “the accounting was phoney because all the customers wanted it phoney.” But Charlie's never met an accountant who's ashamed of his profession. People like Greenspan made what was going on respectable by endorsing it, but “it isn't like free enterprise in restaurants”—more like legalized armed robbery. In the end, “We had to save a lot of these people whether we liked it or not.” To nationalize Fannie and Freddie and then lower interest rates so good borrowers could buy houses was “very smart government.” In the old days, regulators kept silent about banks until they had to act, then announced a fait accompli; “put me down as dubious” about the public stress-testing. Charlie probably won't like what Wells Fargo is made to do. Warren and Charlie think more highly of Wells Fargo than others do because of their low cost of funds. Charlie's willing to put up with less than perfection from the government; on the whole, “it's working out fairly well,” and “a lot of it has been done beautifully.”