(photo: Rev Dan Catt)

I guess news outlets are still pushing the line that the S&P debt downgrade is what has driven the stock market volatility over the past week or so. They have to neglect that the market was falling before the downgrade to come up with this rationale, but no matter, I guess.

In planet reality, there are two plausible explanations for the market crash. One concerns Europe:

The most obvious alternative explanation for the plunge in the market is the risk that the euro could break up as the debt crisis spread from relatively countries like Greece and Ireland, to the euro zone giants, Spain and Italy. The prospect of a euro zone break-up raises a real risk of a Lehman-type freeze up of the world financial system. It is far more plausible that this prospect led to the plunge in the stock market than the downgrade by one of three major credit rating agencies.

While the ECB intervention in the bond markets seems to have stabilized, for the moment, debt yields in Italy and Spain, the attention has now turned to French banks, in particular Société Générale, which rumors of financial difficulties and exposure to sovereign debt sent plummeting. Of course, you have interconnectedness between all these banks, which have only gotten bigger since Lehman. So a drop in any part of the financial system has implications for all of it. I have no idea why France is considering further austerity measures to respond to a bank crisis; maybe they’re just making room for the inevitable bailout.

But there’s another reason here, one that’s also very familiar. Look at the list of 30 stocks that make up the Dow. You may notice JPMorgan Chase and Bank of America. We know that Bank of America has been hammered recently, losing 36% of its stock value in three weeks. We’ve put them on a death watch. Extreme volatility in one of the 30 Dow stocks is going to ripple throughout the whole market.

And we do have a notion of why this is happening. New York Attorney General Eric Schneiderman’s intervention in the Bank of America settlement, where they were trying to get away with resolving all their Countrywide legacy MBS issues and chain of title problems for three cents on the dollar, finally pushed to the forefront the legal argument about improper conveyance of mortgages into the trusts that created the securities. This blows the whistle on the failure to properly create the MBS in the first place, exposing BofA to charges that that MBS they issued aren’t even real. Within a couple days, AIG was suing BofA (now there’s a lawsuit with no public rooting interest) for 35% of the face value of the MBS.

BofA has tried very hard to rid themselves of their liabilities on their mortgage loans, and between private actors, investors, judges and state law enforcement officials, they haven’t been able to do it. And the market has noticed just how vulnerable they are. So have regulators; the Financial Stability Oversight Council held a meeting on BofA just this week. And of course you have interconnectedness there as well.

In that sense, you’re basically talking about the same problem of over-exposure to bad mortgages that characterized the financial crisis. It never ended; the toxic assets were never taken from the books, the too big to fail banks never had their balance sheets resolved. Daniel Indiviglio catches this:

In fact, this entire problem is just a continuation of the toxic mortgage security disaster that led to the first financial crisis. At that time, Treasury Secretary Hank Paulson conceived of a bailout plan through which the Treasury would purchase troubled mortgage securities to sort of suck the poison out of the financial system. Unfortunately, the former CEO of Goldman Sachs couldn’t figure out a way to implement this strategy quickly enough to respond to the growing crisis. So instead, he threw money at the banks until the market relaxed, assuming that the government wouldn’t let any fail.

But if he had managed to get these mortgage securities off of the balance sheets of banks and investors, then we might not be worrying about this problem right now. Instead, the government would own the bulk of these securities and probably wouldn’t be going after the banks so aggressively to cover its losses. After all, the entire purpose of a bailout is to rescue banks, not try to squeeze as much money out of them as possible.

Instead, these toxic securities continue to plague the financial system. And now that their disease is back, with home prices continuing to give way, investors are trying to push them back to the banks. If the market can’t come to a quick, tidy solution itself over the next couple of months to end this problem for good, then the government may have to intervene again — if it can.

Analysts are kidding themselves by saying that banks are better equipped to handle the financial crisis this time. In a worst-case scenario, the accumulated exposure from MBS will wipe out whatever capital reserves BofA is holding, and it’s impossible to protect the rest of the system from a giant failure like that.

So this is not the next financial crisis; it’s the same one. And it’s a result of a huge failure on the part of the banking system going back a decade, a failure for which they are resisting paying the price.

…I don’t want to discount the fact that the economy is shitty and there’s no real hope that policymakers will act to do anything about it. But you can just layer that on top of the European situation, and the same financial crisis.