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Are the bankers to blame for our woes?

December 8, 2011: 3:36 PM ET

Occupy Wall Street says yes. But it takes two groups of willing parties to make a financial crisis. One group was Wall Street, and the other was borrowers and buyers.

By Geoff Colvin, senior editor-at-large

FORTUNE -- It's a bit odd that the most popular Occupy Wall Street sign says, WE ARE THE 99%. The statement doesn't make accusations or demands. It just sits there, loaded with a narrative that the viewer has to unpack. Much is revealed by unpacking it, so if the protesters had more room on their signs, here's what they'd say:

"We've been through the worst recession in 70 years, and the economy is still terrible. Millions of us can't find jobs, and millions more are taking any low-wage, part-time, no-benefits job we can get just to make ends meet. All this was caused by a financial crisis that originated right here on Wall Street through the slimy machinations of you financiers, you who make more money than 99% of all Americans. When your incompetently built financial system blew up, you got bailed out while we got fired and foreclosed on. A vast crime has been committed, and you got away with it. Now you're getting rich while we suffer."

The heart of the narrative, the source of the Occupy rage, is that last assertion: that Wall Street committed economic murder and not only got away with it but also was rewarded. Which leads to an obvious, critical question: Is it true?

In finding the answer, let's not be constrained by legal niceties, asking whether specific persons violated statutes. The central issue is whether Wall Street—the biggest investment banks, commercial banks and brokerages—deserves the Occupiers' rage for collectively causing the financial crisis and subsequent economic misery. To get started, we have to be clear on exactly what Wall Street did.

What happened on Wall Street

The big-picture answer is not complicated, even though some of the details are. Over the past two decades, Wall Street bought millions of mortgages from banks and other lenders around the U.S., then combined them, thousands at a time, into securities that investors could buy. To make the securities more attractive, the banks divided them into tranches (French for "slices"), representing levels of risk. The riskiest loans—those to borrowers who put the least money down or had the lowest incomes or credit scores—were in the lowest tranche, which thus paid the highest interest to investors. Each ascending tranche was less risky and so paid a lower interest rate. Investors could buy whatever mix of tranches they liked.

Occupy Wall Street

Excerpted from What Is Occupy? Inside the Global Movement, a new book from the editors of TIME. To buy a copy as an eBook or paperback, go to time.com/whatisoccupy.

The basic idea wasn't new. Salomon Brothers had invented the business of securitizing mortgages in the 1980s. But this time around, several elements of the business were unprecedented. One was the nature of the mortgages; in the old days they were mostly plain-vanilla, fixed-rate loans to borrowers who had put down at least 20%, but now far more of them were exotic instruments with floating rates, interest-only options and other features that enticed borrowers who couldn't qualify for a traditional loan. More broadly,  lending standards declined sharply; lenders were giving mortgages for more than the value of the property ("We pay you at closing!" said the ads) and giving them to borrowers without even checking their incomes. Subprime loans exploded from $35 billion in 1994 to $795 billion in 2005.

Why were banks willing to make such obviously dodgy loans? Because Wall Street was begging to buy them. How come? Because investors in the U.S. and around the world—not mom-and-pop but sophisticated institutions—were crazy in love with those mortgage-backed securities that paid returns 2 to 3 percentage points higher than more traditional securities, the risks be damned. In 1996, $493 billion of mortgage-related securities were issued; by 2003 the volume had mushroomed to $3.2 trillion. Mutual funds, pension funds and other investors sent word to Wall Street: Give us more of those mortgage bonds. Wall Street, in turn, said to America's mortgage lenders: Give us more mortgages to repackage. If you have to lower standards … well, just do what you have to do.

Occupy Wall Street: Yes, there is organization

When those mortgage-backed securities went bad, precipitating the disastrous financial meltdown, investors screamed: How could you sell us this junk? Wall Street responded, Look, before we sold you a bond we gave you a massive prospectus. It told you everything we're supposed to tell you. The decision to invest was yours—nobody forced you. Sorry it didn't work out.

While that response sounds evasive, plenty of evidence says it wasn't. The warning signs were visible well before the crisis, and some people recognized them. Hedge fund manager John Paulson saw what was coming and made $3.7 billion personally by betting the right way. Analyst Meredith Whitney and money manager Steve Eisman shouted from the rooftops that cataclysm was ahead; so did economist Nouriel Roubini. None of them had access to insider information. They just had those prospectuses and publicly available data, same as everybody else. If more people had studied as hard as the Cassandras did, there wouldn't have been much demand for Wall Street's mortgage-backed securities, so lenders wouldn't have pushed mortgages on every grownup with a pulse. The subprime debacle and subsequent crisis would have been a minor event, not a major one.

It takes two groups of willing parties to make a financial crisis. One group is lenders of money and sellers of securities—Wall Street—but the other is borrowers and buyers. If either group refuses to play, there's no crisis.

Not that they did it alone. Several other players were required in a crisis as big as this one. Rating agencies had given those mortgage-related securities high marks, in some cases triple-A, which is why the investors who bought them believed they didn't have to bother reading the fine print. The agencies later explained that the ratings are merely opinions that happened to be off the mark in this case; the agencies didn't mention that they're paid to rate securities by the companies that sell them.

Mortgage brokers, mostly small-time operators, got paid whenever they persuaded someone to borrow, regardless of whether the loan proved good or bad; some of them misled borrowers or plain lied, and many others just worked extremely hard originating mortgages. Washington policymakers, Republican and Democrat, created government incentives for mortgages to low-income borrowers, people who'd have a hard time making their payments if the economy tanked. Regulators failed to anticipate a once-a-century, system-wide blowout. Accounting rulemakers encouraged rampant lending by letting mortgage originators report profits as if they were getting all the income from a mortgage's entire life—up to 30 years—in the year the mortgage was written.

What happened on Main Street

And then there were the borrowers: Americans of every station, from top executives to housekeepers. They bet that home prices would never stop rising or interest rates falling—knowing that if either trend turned on them, then their no-down-payment, interest-only, adjustable-rate mortgage could wipe them out. But they took the loans anyway. When the carousel stopped turning, they went to new websites like YouWalkAway.com, which explained how to abandon a home that had negative equity and stick the bank with the loss.

All those players combined to form a giant system that required each of them in order to function. Every player gained by being a part of the system, at least until 2007. None of them individually worried much about what the system as a whole was doing, which was just one thing: creating debt. Way too much debt.

American Express CEO: Pay attention to OWS

That is the economy's fundamental problem now. Total U.S. mortgage debt increased from $3.8 trillion in 1990 to $6.8 trillion in 2000 to $14.6 trillion at its peak in 2008, a ballooning such as we'd never seen before. But we weren't just bingeing on real estate. Other consumer debt grew almost as fast, from $800 billion in 1990 to $2.6 trillion in 2008. Falling interest rates fueled the debt party by making loans easier to afford, and our main assets, homes and stocks, were appreciating, so we could add debt yet maintain our net worth. Many Americans were also in denial about their stagnating incomes; borrowing kept their living standard on the rise, at least for a while.

To spiraling personal debt add government debt, which has exploded since 2001. America's gross debt, meaning debt held everywhere in the economy, has risen from about 200% of GDP in 1990 to almost 400% today, as economist Kenneth Courtis points out. That "crushing debt load," he says, is "the core of the problem facing the U.S. economy."

It's the main reason the economy can scarcely grow and unemployment won't come down. We snap back quickly after old-fashioned inventory recessions (too much stuff and not enough buyers), but debt-based funks drag on. When virtually all the players in the economy are trying to reduce their debt at the same time, growth becomes almost impossible. And we've got ourselves deeper in the Valley of Debt than ever in our history.

With that perspective, it becomes clear what isn't the problem. Though the Occupiers complain about Washington's bailout of the banks, it didn't bring us to where we are. It averted financial Armageddon, and the banks repaid the government with interest. As taxpayers, the Occupiers made money on the deal.

Nor is our problem the appalling malfeasance of various lenders and mortgage brokers around the country. Yes, some of them pressured poor and elderly people into taking loans they didn't understand and couldn't hope to repay. Some blatantly misrepresented the terms of loans. Some banks broke laws by improperly foreclosing on borrowers, and some even repossessed the wrong homes. They should be prosecuted, and some have been. But those activities didn't cause the crisis and recession and 9% unemployment.

Buried by debt

Our problem is too much debt. When the growing burden became unsustainable, when the market finally read the prospectuses and the economic data and realized that some of that debt wasn't worth much, we had a crisis and then a recession. We're still suffering because the problem hasn't even begun to go away. Consumers have reduced their debt slightly since the 2008 peak, but increased government borrowing has more than compensated. Gross debt is worse than ever. It's still unsustainable and has to be cut back, and that's the foundation of today's economic misery.

So, are the bankers to blame? Of course they are. This couldn't have happened without them. They were a major element in the giant system that produced so much debt. It's clearly just as true that the system wouldn't have worked without all the other players as well, so each of them is also to blame, at least to some extent. That raises the question of why the Occupiers are camped out in Wall Street's front yard rather than somewhere else.

But the answer is obvious. The Occupiers are enraged by the perception of injustice. Wall Street got bailed out; we got laid off. Wall Street is making billions; we're on unemployment benefits, which are running out. One could make a strong argument that the injustice isn't quite so stark. Wall Street got whacked harder than any other industry, with two of the industry's five major players (Bear Stearns and Lehman Brothers) out of business; just in New York City, tens of thousands of employees, from executives to secretaries, are jobless, the great majority of whom never went near a mortgage-backed security. The industry has made no more money over the past five years than it was making 15 years ago, and in 2007 and 2008 it suffered the greatest losses in its history.

Wall Street is now subject to the most massive new regulation to be imposed on it since the 1930s, the 2,300-page Dodd-Frank act. It mandates hundreds of new rules, many of which are still being written in late 2011. Industry lobbyists are pushing to soften those rules, further infuriating the Occupiers, but the end result will still constrain the industry in important new ways. One of the most significant new rules, the Volcker Rule prohibiting banks from trading on their own account, takes effect next year. It's 300 pages long.

It's worth noting too that the government bailed out plenty of the ordinary Americans who participated in the giant system, first through a federal mortgage-refinance program two years ago. Not many people signed up because it required evidence that borrowers could actually afford a mortgage, so a new program does away with all that. It offers new mortgages without proof of income at the lowest rates ever seen. If you were a responsible borrower and have more than 20% equity in your home, you don't qualify. The program bails out the most irresponsible borrowers, among others. Sounds familiar.

Of course that doesn't matter. Wall Streeters are the least sympathetic of any group in the giant system, and they don't deserve sympathy; the surviving bankers still make tons of money and know their business is more volatile than almost any other. And they helped the system work. They bear responsibility.

As we watch and hear the Occupiers' rage, let's just remember why our economy is suffering. We have too much debt. Everyone who contributed to that is to blame.

Excerpted from What Is Occupy? Inside the Global Movement, a new book from the editors of TIME. To buy a copy as an eBook or paperback, go to time.com/whatisoccupy.

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