Whew. And I was feeling bad about not having anything worthwhile to say.
That quote is from Steven D. Levitt. But Levitt gets Douglas W. Diamond and Anil K. Kashyap to explain many things, which they do very clearly, answering a series of questions:
1) What has happened that is so remarkable?
2) Why did these things happen?
3) Why did the Treasury and Fed let Lehman fail but rescue Bear Stearns, Fannie Mae, Freddie Mac, and A.I.G.?
4) I do not work at Lehman or A.I.G. and do not own much stock; why should I care?
5) What does it mean for the Fed and Treasury going ahead?
6) What does this mean for the markets going ahead?
7) When will the turmoil end?
Posts
125 comments:
Even Harry Reid was quoted on npr last nite as admitting that Congress could act if they knew what to do. (rough paraphrase there) Thats about the most honest thing Harry has said in a long time.
I was listening to NPR's Morning Edition in my car earlier, and heard the best explanation by Adam Davidson, at least of the AIG crisis.
I highly recommend it.
Yet we expect our politicians to know exactly what to do...
What it means is the re-regulation of the markets. And since the pendulum almost always overswings, the over re-regulation. But the goniffs on Wall Street have it coming. Derivatives! Hell, even the experts can't figure them out.
To be precise, Steven D. Levitt has become more of a freakonomist. How can we expect a freakonomist to understand an economic matter?
I got gold, prosperity is just around the corner, none of you will be out begging alms with a tin cup come Christmas time - Nostradamus would say " of 1/4th thy full cup into that which is puny place" so bolster what has slumped but don't get greedy and Harry Reid most likely would agree with that........
A more exact paraphrase: "Nobody here knows what to do".
Which is close.
They know it will take trillions more in taxes, but they still don't know what to do.
Joe Biden response to all this is that "paying taxes is patriotic."
Nuance!
Maybe the One has a plan to save us all.
Fannie and Freddie were weakly supervised and strayed from the core mission...
And what were these bozos doing while F&F went straying
Was just listening to
McCormick -Treasury Undersecretary on F&F mess.
EconTalk lastest podcast is on Shiller on Housing and Bubbles
Ann, there is no reason for your "feeling bad about not having anything worthwhile to say" about the economic crisis. It was just odd that until this post today you did not seem to have any interest about this huge news story. Concerning electing a new congress and president, voters should be focusing on this, not the usual trivial stuff that gets pushed by the media and that seems to capture your interest. These are serious times.
Taking Harry Reid at his word is risky--I suspect what he is saying is the democrats dont want to do anything, but they see the economy as their issue in the coming election. Not that they would make a political issue out of a possible financial "crisis." But thats just old cynical me speculating.
Obviously there is no easy solutions to this mess. If there were we would not be in a crisis. Crises get managed and then hopefully changes are made from what is learned to make sure it does not happen again.
The people who are smart enough to run huge corporations are generally smart enough to loot huge corporations.....Bubbles are endemic to capitalism. But who ever knew that a Florida condo would end up in the same asset class as Dutch tulips bulbs.
Who are all these after the fact experts? If these people knew what the hell was going to happen they would be making money off of it, not getting paid to talk or write about it. So just be sure that someone will be making a lot of money off of this and it probably won't be you.
Whew. And I was feeling bad about not having anything worthwhile to say.
Can not saying anything be worthwhile?
And when will George Bush go on TV to address and reassure the nation?
On second thought....
Yes, it's serious. The deregulation dogma has run it's (predicted) course. It turns out that we had to relearn the lessons of history AGAIN.
Laissez faire economics has run us up on the shoals. Our economy and nation are weaker for it. People who are not to blame are hurting while those who benefited are bagging loot. As fas as I know, not one of these crooks is under investigation, indictment or in prison for this debacle.
Blind faith in the marketplace was sorely misplaced. The free market fundies idealized business people and held a blind eye to human nature.
The ironic result is nationalization of insurance and finance companies.
go read the wiki on the Community Reinvestment Act
http://en.wikipedia.org/wiki/Community_Reinvestment_Act
My short summary:
1. banks were forced to expand their lending to reach "underserved communities" in the name of "increased home ownership"
2. the only way to make those numbers was to lend to riskier folks with less money down, etc (1977 Carter)
3. lines blurred between traditional banks and the rest of the financial industry, increased lending to bad risks (1995 Clinton)
4. Bush tried to rein in the GSE's in 2003. The dem's killed regulation of Fannie and Freddy
5. the GSE's were always a bad deal. If they made risky loans and profited, they got rich, if the loans went bad, Uncle Sam covered the bill.
6 the theory of the "greater fool" operated here at both the retail level (individual sales of overpriced homes) and the wholesale level (sale of bundled loans. Theory of the greater fools says, "doesn't matter how much overpriced your purchase is, IF you can find a greater fool who will buy the overpriced item from you at a profit." Ultimately all bubbles run out of fools
Other factiods
McCain spoke out for more GSE oversight
Obama took lots of money from the GSE's and his buddies ran it.
As fas as I know, not one of these crooks is under investigation, indictment or in prison for this debacle.
That's because some of them are Obama's economic advisors.
The most corrupt companies of them all were Fannie and Freddie. You wont see any investigatiosn because they were connected to Congress (some republicans but mostly democrats).
One of the things that deepened the Great Depression was Hoover kept the government's hands strictly out and allowed any number of business entities to fail.
Not that I am strictly in favor of rescueing them either.
I guess the question is; why do we allow an entity to get 'too big to fail'?
Freddie and Fannie as quasi-government entities maybe, but AIG or Bear Stearns?
Aren't we supposed to be regulating in order to protect the economy from a disaster like we are facing?
But apparently our regulating agencies were only being used to shakedown these businesses for campaign contributions so the regulators would look the other way.
What I want to know, and haven't seen anything on, is are we allowing the management (BoD; CEO; CFO and COO) keep their excessive compnsations from the last two years?
If I, as taxpayer, am dumping $85 billion into your company, i don't want to see you walk away with $85 million for running it into the ground.
If a firm is 'too big to fail' then the BoD et al should go to jail broke for leading it to failure.
Concerning electing a new congress and president, voters should be focusing on this, not the usual trivial stuff that gets pushed by the media and that seems to capture your interest. These are serious times.
Agreed: voters should use their commonsense understanding of the obvious danger to the financial system of widespread leveraged exposure to the CDS market to assess which candidate's economic plan best addresses this crisis. I'm sure they'll get to this as soon as they finish pondering the impact of the LHC on the future evolution of string theory. Is the standard model sufficient? I await the public's verdict.
Read some news people. This is rooted in the subprime mess where banks and financial companies sold thousands of loans to people who weren't able to afford them, using balloon payments and such.
Then they syndicated those loans (a.k.a. "shitpile") internationally, spreading the risk of these terrible decisions.
Bankers, loan officers, etc made money on churning the deals. That's where the greed came in that clouded their judgment. The stories of the loans being pushed are shocking.
That's a very condensed version.
But, no, in the right wing mind, it's all the fault of those terrible poor people.
Blame the victims. That's what you do.
In The Black Swan Nassim Nicholas Taleb points out that not only was the 1987 crash unpredictable, but the recovery from that crash was even more so.
What should Congress do? Who knows. I expect, after the dust settles, they will demand that banks buy tulips, or invest in huge airplanes made from plywood.
Here's an article providing overview of failed regulation. (hat tip, Atrios)
And the always enjoyable Atrios suggests a reread of JK Galbraith's book A Short History of Financial Euphoria. He quotes from his copy this line:
"All subsequent financial innovation has involved similar debt creation leveraged against more limited assets with only modifications in earlier design."
Requirements that mortgage originators actually obtain income verification might not be such a bad idea.
Credit rating agencies, being paid by the people who sell bonds under the current system, were basically being paid not to understand the risks of those bonds. That is in the process of changing and I think it's for the better.
Investment banks are now borrowing from the Fed as if they were commercial banks, and imposing commercial bank-like (if lower) capitalization requirements might not be a bad thing. There's no reason why investment banks needed to lever up 35:1. It's a service industry.
Oh, and regardless of how corrupt Fannie and Freddie may have been, or how close Obama's ties are to their executives, the big takeaway from this from a political perspective is that the deregulation uber alles crowd has their pants around their ankles.
What do you do now? Hold on and wait for the Morgan and Goldman buyouts. Oh yeah, also write Ben Bernake and ask him where your seat is in the AIG boardroom, since we all own it now...
This basically explains why this happened, but the short answer is credit derivatives in-and-of themselves are worthless. Ultimately they have to be backed by a real asset that is worth something... in our current case, those assets (McManisons) were grossly overvalued.
John McCain's answer is apparently to fire the SEC commissioner, which is about what you'd expect from a tough guy who has no idea what's happening.
Blame the victims. That's what you do.
Was this a pre-emptive strike or something? I didn't see anyone blaming the victims here. The closest I saw was blaming some politicians for pushing the loan programs in the misguided belief that they would magically make homeownership affordable to more people.
Wait, Doyle. AlphaLiberal just informed us via Atrios that it was all the SEC's fault.
You two need a consult.
Actually the link seems to be to Barry Ritholz, and it blames the SEC for allowing the ridiculous leverage, which I'm pretty sure I mentioned in my earlier comment.
But firing the current commissioner per se doesn't actually change those rules.
snarking away during a national crisis, Henry? You're just hurting America.
From the above-linked article:
You read that right -- the events of the past year are not a mere accident, but are the results of a conscious and willful SEC decision to allow these firms to legally violate existing net capital rules that, in the past 30 years, had limited broker dealers debt-to-net capital ratio to 12-to-1.
Instead, the 2004 exemption -- given only to 5 firms -- allowed them to lever up 30 and even 40 to 1.
Who were the five that received this special exemption? You won't be surprised to learn that they were Goldman, Merrill, Lehman, Bear Stearns, and Morgan Stanley.
As Mr. Pickard points out that "The proof is in the pudding — three of the five broker-dealers have blown up."
and....
The losses incurred by Bear Stearns and other large broker-dealers were not caused by "rumors" or a "crisis of confidence," but rather by inadequate net capital and the lack of constraints on the incurring of debt.
--Lee Pickard, former director, SEC trading and markets division.
And no one remotely up to speed would blame just one entity for the whole mess.
Agreed with VBSpurs. I also thought the NPR story on AIG was very informative. She has the link at top of comments.
And, Doyle, I did not blame one entity for the whole mess. Someone falsely assigned that to me.
Are you saying the SEC did no wrong whatsoever? Should I put those words in your mouth?
I was talking to Henry, AL.
Henry:
Wait, Doyle. AlphaLiberal just informed us via Atrios that it was all the SEC's fault.
Oh, I did? Post the quote where I said.
Fucken liar.
This is what happens when there is capitalism for profits, socialism for risks (i.e. corporate fascism).
Exactly the same way Medicare is set up. Thankfully, Social Security is set up entirely different; it's a classic Ponzi scheme.
But just guess how nationalizing health care will look in 20-30 years.
A year ago a huge interstate bridge collapsed in Minnesota, killing several people and costing many tens of millions of dollars to rebuild. It seems the expected scrutiny towards structural integrity was lax, and funds meant to be put aside for the future were taken and replaced with IOUs.
Sound familiar?
This is what happens when you mix markets with socialism. Instead of a few companies going under, many do, and all at once.
Taleb does have a point. His book would have made a great article. Anything written by JK Galbraith can be immediately discounted as bunk.
One place where this does effect most americans is their pocket book.
401k and retirement savings, ira accounts, stock portfolios just lost a decent amount of money over the past two days.
Also, the thought of the government taking over some of these huge companies is a little unsettling-but probably was the right thing to do.
If AIG went under many companies life insurance policies would be put in jeopardy and could of causes a major problem.
I feel bad for individuals that were planning on retiring soon. Probably not the best time to plan your retirement considering the loss that has taken place in many individuals 401k's.
I know a couple of retirees that lost over 100,000 over the past few days. That's not chump change.
This why all the "gets the government off our backs" from the rich is such BS. Our financial system is (and always has been) heavily regulated by the government. It is shot through with cronyism, sweetheart deals, loopholes, and graft.
As shown by recent Fannie Mae, Freddie Mac, AIG, nonsense, the profits are always privatized while the losses are publicly owned. The Democrats are in bed with Wall Street as much as the Republicans. So it will be the same old same old for the next 4 years.
The Drill SGT,
You do know that you will be called a liar and it is all a pack if lies don't you?
You cannot, in our modern society lay any blame on liberals for their failings. It is impolite and impolitic.
AlphaLiberal said...
Read some news people. This is rooted in the subprime mess where banks and financial companies sold thousands of loans to people who weren't able to afford them, using balloon payments and such.
All allowed under laws and regulations sponsored, endorsed, and approved by the Democrats so people who could not afford homes could live the American Dream.
Peter -
Do you think there should have been laws passed to prevent lending standards from getting as shoddy as they did? Or would that have been an unwelcome government intrusion in the free market?
Encouraging home owner ship has been government policy going back to at least the 1940s. The GI Bill from the post WWII era had a massive push to increase home ownership. But that did not lead to the problems that we are now seeing. Also, do people remember the current President Bush pushing "The Ownership Society"?
While Rush Limbaugh and his class is pushing the notion that somehow this crisis is the result of our society encouraging home ownership and too much government regulation it just won't fly.
It should be noted that both the Bush Administration and the McCain campaign is not pushing the Limbaugh line on this crisis. In fact they are saying the opposite. The Bush Administration knows that if they tried for political reasons to push the "too much regulation" line the markets would then really start to unravel. The McCain camp knows that if they pushed this line then the markets would further deteriorate the close he came to winning the election. At this point the markets want to hear an honest assessment, not some politically driven fantasy talk.
Take that to the bank.
But, no, in the right wing mind, it's all the fault of those terrible poor people.
Blame the victims. That's what you do.
Who bought the homes they knowingly could not afford? Who signed the contracts for those mortgages? Who had lawyers look over those contracts?
Why the so called poor people, the phony victims. That's who.
Peter -
If you knew what you were talking about, you'd realize that the actual victims were the holders of the securities backed by those mortgages. The borrowers themselves can always leave a home that's underwater and the bank has no recourse.
There was absolutely predatory lending going on (teaser rates, etc.) but that's really a separate issue from the huge financial collapse that's going on.
We're seeing a transition to the multipolar global economy and ultimately away from the dollar as the world's standard currency, a process that has been accelerated by our "casino economy, a term that might have been coined as long ago as 1985 by Business Week. That means "a nation obsessively devoted to high-stakes financial maneuvering as a shortcut to wealth." One hopes that the feds can help troubled multinationals parachute to safety instead of a engaging in total bailouts.
(As a corollary, remember 40 years ago most people did not have credit cards, much less home equity lines of credit. Charge plates were such a far-out concept that that's how the San Diego Chargers got their name. Credit will continue to dry up, making industrial and business expansion more problematic. There'll be no real estate turnaround until 2010 at the earliest, and average national residential real estate prices will fall another 10 to 20 percent.)
As fears regarding the strength of the dollar rise (as concerns about the US economy grow), gold will rise. On an inflation adjusted basis (based on 1979-1980 average prices of about $600-650), gold should be at about $1,400 today. Given the fear that's out there, it wouldn't be surprising if it went to $2,000 in a few years, if you also factor in gold's brief spike to $850 28 years ago. If things got really weird, we could see the Dow gold ratio approach 1:1, but let's not think about such unpleasantness.
Oil prices will stay low due to depressed demand. Interestingly, however, Iran recently turned control of its naval forces over to its Revolutionary Guards whose behavior has been quite provocative. In theory, it would benefit Iran if it could do something to retard oil supplies without getting itself smashed in the process. It's nice to know that we presently have two carrier strike groups in the Gulf (the Theodore Roosevelt and the Reagan), the British have one carrier strike group, and the French have a submarine there. Then again, that's nothing particularly new. If a significant terrorist event occurred in the US or against our interest, and it appeared that Hezbollah carried it out, we would probably schedule a play date with its financiers. One wonders if pre-election naval action in the Gulf would help or hurt McCain, whose grandfather was an admiral who commanded a carrier task force in the Pacific during World War II. (As a total aside, at the Battle of Leyte Gulf, without being ordered to do so, he ordered the ships under his command to change course and to launch air attacks against the Japanese fleet at extreme range. Of course, McCain's father commanded the Navy's Pacific operations from 1968 to 1972. It might be nice under current world conditions to have someone in charge who has a family tradition of martial valor.)
If I were Sen. Obama I would not be telling my supporters to get 'in people's faces," I would be trying to be soothing....like Franklin Delano Roosevelt.
The chickens, they are roosting.
Buck, buck, buck.
The good news is that out of this Schumpeterian process of "creative destruction" we will see the rise of new hitherto unimagined industries and the resurrection of presently somnolent sectors. The more government tries to slow the process and protect the losers the longer the pain will persist, which is not to say that Uncle Sam ought not play a role in infrastructure projects that boost trade such as port, highway, and bridge expansion and in the provision of tax incentives for newly emerging technologies, like thought helmets, in which we can ardently provide global leadership in a flash vis-a-vis our merciless Asian competitors.
Obviously, this crisis is further proof that we need to figure out campaign finance reform and stop influence buying in our government. McCain could actually make a legitimate claim to this-but I doubt he will out of fear of the Republican base.
McCain's predicament is very similar to that of Hubert Humphrey in 1968. Humphrey needed to run against the failed Vietnam policies of the Johnson Administration but found his hands tied. McCain needs to run against BOTH the failed economic and foreign policies of the Bush administration. I don't think he will be able to pull that off. But watch he will try.
Doyle said...
Peter -
Do you think there should have been laws passed to prevent lending standards from getting as shoddy as they did? Or would that have been an unwelcome government intrusion in the free market?
Doyle,
Wiki, that tool of the VRWC says this about who was on which side of GSE regulations:
In 2003, the Bush Administration recommended what the NY Times called "the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago." [5] This change, which did not pertain to the Community Reinvestment Act, was to move governmental supervision of two of the primary agents guaranteeing subprime loans, Fannie Mae and Freddie Mac under a new agency created within the Department of the Treasury. However, it did not alter the implicit guarantee that Washington will bail the companies out if they run into financial difficulty; that perception enabled them to issue debt at significantly lower rates than their competitors. The changes were generally opposed along Party lines and eventually failed to happen. Representative Barney Frank(D-MA) claimed of the thrifts "These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis, the more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing." Representative Mel Watt (D-NC) added "I don't see much other than a shell game going on here, moving something from one agency to another and in the process weakening the bargaining power of poorer families and their ability to get affordable housing."
It seems to me the problem started when the government ordered banks to give mortgages to people with bad credit on the grounds they were "underserved."
Man you two are touchy.
AlphaLiberal, when you linked to an article titled "How SEC Regulatory Exemptions Helped Lead to Collapse", I assumed you agreed with it. I do withdraw the word "all". Nevertheless, even a partially negligent SEC seems to justify McCain's position.
Anyway, not being an armchair Greenspan, I don't pretend to have the answers. Scapegoats are easier to come by, being legion, but I've never been interested in scapegoating.
I will say, with complete confidence, that however Congress or the President responds, they will not stop the next financial meltdown from happening, whatever its particulars.
Once we new regulations and personnel are in place, it might be interesting to make a long term bet on how long everything stays stable. It's been 21 years since the 1987 crash. Can we make it to 2029 before the next?
Maybe, but that would be a sucker's bet. The inherent randomness of the events that cascade into crises means that no one knows when to actually start shorting.
Drill Sgt.
That doesn't answer my question. I gladly concede that Democrats do not have a great record in this area. What I'm asking is whether conservatives would have favored stronger regulation.
And Paul, no one had to force mortgage originators to make loans to unqualified borrowers. They were eager to do so. Maybe you've seen Countrywide mortgage ads before "No one can do what Countrywide can"?
The mortgage business was a volume game. Didn't matter about the creditworthiness. That risk was passed along through a process called securitization which you might want to read about.
As fas as I know, not one of these crooks is under investigation, indictment or in prison for this debacle.
And you won’t because there are a lot of individuals in Congress, the current administration and the upcoming administration that will have to answer for more than a few things in how they either facilitated the processes which allowed for this crisis, ignored it or how they personally benefited.
While it’s very easy to lay the blame on the current administration, those tentacles reach far and wide and include a whole lot of ‘common folk’ who jumped on the greed wagon and tried to take advantage of the system by buying houses they knew were beyond their ability to afford. As was correctly pointed out, Bush was raising concerns and demanding action on Fred/Fan back in 2003 only be to told by Barney Frank ‘nothing to see here.’ Senator Obama also doesn’t want to dig too deep on this considering two of his top advisors, including his economic advisor were former CEOs of Fredddie and Fannie.
Now if you want to think that if President Bush would have come in office and tried to reverse all of the bank de-regulation which would include the refusal of mortgages for people less than credit-worthy (read: low income people) and believe Congress would have cheerfully gone along with it, you’re woefully naïve.
Since the beginning of the year been hearing of impending crisis in SIV credit default swaps as the next melt-down. Outstanding amount globally is $45 trillion or so. These derivatives started up in the mid'90's.
Just recently heard of another mortgage thing called option arms which will reset in the next 18 months or so.
The more rocks you turn over the more things crawl out.
If McCain can't make some noise about Obama's cozy Fannie Mae connections, he doesn't deserve to be president.
Good Point Drill,
It's also a fact that Obama was the largest recipient next to Frank of lobbying money from Fannie and Freddie. Moreover, Obama hired both Fannie's CEO and GC to assist him in his campaign.
Obama is part of the problem not the solution.
Both Bush and McCain tried to reform Fannie and Freddie, but the Democrats stood in their way each time.
OBH's financial advisor, Franklin Delano Raines..crook extraordinaire.
On December 21, 2004 Raines accepted what he called "early retirement" [2] from his position as CEO while U.S. Securities and Exchange Commission investigators continued to investigate alleged accounting irregularities. He is accused by The Office of Federal Housing Enterprise Oversight (OFHEO), the regulating body of Fannie Mae, of abetting widespread accounting errors, which included the shifting of losses so senior executives, such as himself, could earn large bonuses
In June 2008 Wall Street Journal reported that Franklin Raines was one of several politicians who received below market rates loans at Countrywide Financial because the corporation considered the officeholders "FOA's"--"Friends of Angelo" (Countrywide Chief Executive Angelo Mozilo). He received loans for over $3 million while CEO of Fannie Mae. [5] Franklin Raines is currently one of Barack Obama's chief economic advisers.
When the heat goes up, watch Franklin go under the bus with Jeremiah Wright.
Neither Obama nor McCain really have anything to do with it.
Both parties have crummy records regarding oversight of the financial sector.
That's part of the reason why both candidates stayed so quiet about all this for so long.
Even today's NYT has an unusually balanced article about the blame game and says that both parties are at fault.
"The Bush and Clinton administrations had tried to rein in Fannie Mae and Freddie Mac but that each time, Congressional Democrats beholden to the companies’ lobbyists quashed the regulatory proposals." (sez a former GOP treasury official Alan Hubbard)
"Mr. Hubbard did not note, however, that some well-known Republican lawmakers and lobbyists had also protected Fannie Mae and Freddie Mac. Both Democrats and Republicans have also taken turns in the companies’ executive ranks.
But Democrats especially have long favored the two companies, which enjoyed implicit government backing, given their responsibility to keep mortgage funds flowing to banks and support construction of affordable housing."
Dodd and Frank's careers are over because they let themselves be used by the financial sector and probably Rangel's too because he can't do his own taxes. The voter are going to go for blood in November.
Who's got the cleanest hands? Palin. She didn't have nuthin' to do with nuthin'.
Looks like there is enough blame to pin on everyone. I am sure we will end up applying HL Mencken's solution to a complex problem: it will be neat, simple, and wrong.
The one thing that is absolutely positively forboten is to assign any blame whatsoever to the poor. Somehow the poor, who we are told ad nauseum would not be poor but for racism, could not figure out that they wouldn't be able with a 25K income to make the mortgage payments on a 250K house. No. They were all tricked into signing. They're all victims.
R-r-r-right
Yikes. Verboten not forboten.
As if that was the big problem with the comment, LOL.
Yes Ricpic,
If only millions of the working poor in this country had not taken out loans they could not afford we would not be in this mess. It is not the few titans of Wall Street who spend millions to buy influence in government to keep it from providing proper oversight and regulation who are at fault.
Ricpic, it appears that you are a tool.
Neither Obama nor McCain really have anything to do with it.
McCain tried to reform it. Obama, instead of risking losing lobbying money, gave into the special interests.
Based on Obama's record, Obama won't do anything about it in the future if he was elected President
Here is the crisis in a nut shell:
1. Greenspan kept interest rates so low for so long that Wall Street was awash in cheap credit.
2. Unrelated to No. 1, somebody on wall Street figured out that if you (a) made a blended basket of mostly good mortgates, and a percentage of crap mortages (i.e. high risk - low chance of being paid back), and (b) got a rating agency to give it a blessing, and (c) added a "mono-line" insurance on it, that you could sell the whole thing as though it was all good mortgages. (These were called Collateralized Debt Obligations - a paper security.)
3. The return on the CDOs was a few percentage points above the rate at which banks and insurance companies could borrow money from Greenspan.
4. It was a no brainer. Borrow a lot, and buy a lot of CDOs, and sit back and reap the few percentages points each month.
5. This became so profitable and attractive that banks were borrowing 40 to 60 times the amount they themselves were putting in to buy the CDOs. That is like you buying an $800,000 house with $20,000 of your own money and 780,000 borrowed.
6. The market suddenly figured out that the CDOs weren't worth what they were selling for, because the trash mortgages were defaulting.
7. The whole CDO market crashed.
8. The drop in the CDOs first wiped out the amount the banks actually put in themselves, and then started to eat up the borrowed money too.
9. After that, it was just a matter of the owners fessing up as to how much they lost, which is coming out now.
Reason this happened?
It was a bubble caused by very cheap money (Greenspan), and very greedy Wall Street CEOs that bet their companies on CDOs on the desire to get that next huge quarterly or year end bonus. The difference between what they had to pay to borrow, and what they could make on the investment was too large to not take advantage and lay off the overpriced CDO investments.
the drill sgt said...
go read the wiki on the Community Reinvestment Act
I love the drill sgt....When he is screwed by the democrats he cries rape....when he is screwed by the republicans he calls it 'makin love'...
And the reason nobody knows what to do is because, what can you do when the world market valued X at $1.00 one day, then 2 weeks later values X at $0.40?
All you can do is stand around and watch the dollars go to money heaven.
Hey shmuck Lee, did I say the greedy rich aren't to blame? They are. What I said is that no one dare place any blame whatsoever on the poor, who are by definition innocent victims. Well they're not innocent victims. shmuck Lee. They're as complicit in this mess as you shmuck lefties.
If only millions of the working poor in this country had not taken out loans they could not afford we would not be in this mess.
Well they certainly didn't help the situation and pretending that they or the working middle class who also cast caution to the wind to own a home they couldn't afford as innocent victims is being willfully obstuse.
Roger J's comment was spot on in that there is plenty of blame to go around and it's not just centered on Wall Street CEOs but also John Q. Public and a host of our elected officials.
I for one don't subscribe to the theory that the rich are diabolically greedy any more than the working poor are inherently noble and beyond reproach. Both exhibited poor judgment and both should be called out on it.
My neighbor is a wastrel. He buys a house with 5% down for $100,000. He falls behind in his mortgage payments. The bank threatens to foreclose. He sells the house for $200,000, pays off the mortgage, and pockets a pile of money....I'm no fool. I observe this and decide to buy a new house. Everyone does, and housing prices rise. If my purchase works out, I live in a nicer house. If I fall behind, I sell out and perhaps even make money on the deal.....Beyond this, the builders, the bankers, the real estate agents, the painters, the washer-dryer makers, everybody on earth rejoice at my decision to buy a house. In this happy group I would include elected representatives and regulatory officials. Everybody's happy. Houses are not tulip bulbs or internet stocks. They are real things. The housing market could not possibly be a bubble.......Bubbles are seductive things. Isaac Newton took his money out of the South Sea Trading Co because he thought it was a bubble. The stock continued to rise. Newton put his money back in just in time for the collapse. If someone as bright as Newton could get suckered despite his better judgement, what are the chances that Frank, Dodd, and Bush would see through this. Bubbles are endemic to capitalism. If you think there is some legislation or regulatory agency that will forestall this, you are living in a bubble.
Fannie and Freddie weren't under-regulated or under-oversighted or whatever, they did exactly what the politicians who created them wanted them to do. Without political pressure to create "affordable" (i.e. "unaffordable" in realspeak) housing, the subprime market would never have existed, and Lehman and AIG wouldn't have gotten sucked into it.
All this yammering by politicians about "greedy Wall Street" is disgusting. If you build a casino, you can't blame people for gambling in it.
Concerning electing a new congress and president, voters should be focusing on this,
But if we don't understand all of this, much less know what's best to be done about it, how can focusing on it be helpful in terms of making a decision on whom to elect? If we don't know what to make of it, how do we filter out the relevant from the irrelevant--or even know by what standards to determine relevance and irrelevance? How, then, can we possibly determine what information--what information set or sets--to bring to bear in terms of making a decision about the election? If we don't know what to make of it or what's best to be done, how can we even begin to evaluate who's plan might be better? How is it better to bring to the evaluation table stuff you don't understand, that even an array of experts either don't understand, disagree about, or both?
I mean, it sounds all fine and wonderful to say the American people should be focusing on "x" as they approach the election, but let's be a little practical and realistic. Why would it be a good thing for people to pretend they know more than they do and then base a decision on that shaky foundation?
Seriously. I'm not getting the logic of the prescription, in context.
And Doyle's 12:57 is spot on.
All this yammering by politicians about "greedy Wall Street" is disgusting. If you build a casino, you can't blame people for gambling in it.
Try telling that to Gamblers Anonymous. They do it everyday.
All my comments are spot on.
William,
The problem with your comment is that Bush DID see through this but was hamstrung by the Dodd/Frank/Reid/Pelosi group in congress. He may have people in charge but his hands are tied by Congress in this one. McCain also saw through this and for a change he and Bush both tried to do something about it. And Obama, as usual, went along with the other dems. Same old, same old.
Well, you're one up on me, then. What can I say?
Do you think there should have been laws passed to prevent lending standards from getting as shoddy as they did? Or would that have been an unwelcome government intrusion in the free market?
Doyle: the lending standards were perfectly adequate until the Democrats started messing around by trying to social engineer the banking industry. CRA under Carter. Weakening of Glass-Steagall under Clinton. Refusal of Congress controlled by Dems to reign in Fannie and Freddy. The SEC for relaxed short selling rules and little oversite of the actual credit quality within the derivitives.
The finger of blame can be pointed all kinds of direction. Greedy borrowers, speculators, lenders, Congressional kickbacks by the derivitive companies. Follow the money.
Expect that credit gets tight in the near future and possibly for quite some time.
Arturius is right - greed is not confined to any one class or party.
What a tiresom joke to see the two parties try to blame each other for acts and results that have nothing to do with Republican or Democrat.
As Solzhenitsyn wrote in the Gulag Archipelago, after many years in the prinson camps: (paraphrasing) I realized that the line between good and evil does not seperate countries, or cultures, or religions, or parties. The line between good and evil runs through each man and women's heart.
I think Ann should post on the topic of naked short selling. Seems timely, and would hit a couple of her sweeter tags.
The government took other measures Tuesday to help alleviate the turmoil in the markets. The Treasury said it will start selling bonds for the Fed to aid it with its lending efforts, while the Securities and Exchange Commission said it will strictly prohibit naked short-selling starting Thursday.
DBQ -
So put you in the pro-mortgage regulation camp, then?
Ricpic,
You really are the tool. The working poor are losing their houses and their savings. They were encouraged, including by Bush himself, to keep spending money. That is what kept the economy growing (though anemically) during the Bush years. The working poor are suffering and will suffer more due to what has happened. The manipulators on Wall Street on the other hand have walked with tens of millions of dollars in bonuses. For you to even equate the working poor and the Wall Street fat cats just shows that you are foolish tool. If my pointing that out makes me a "schmuck," so be it.
L.E. Lee:
The working poor who are losing homes bought more home than they could afford- probably at the urging of a real estate agent or morgage broker- and after a year or two of trying to keep going lost it all.
Is it the fault of the working poor? Maybe- if they had had a budget and stuck to it they wouldn't have wound up in a loan they couldn't afford.
One statistic I want to see (and can't find anywhere) is what percentagae of the loans that have gone sour were initiated through mortgage brokers as opposed to an actual lending bank. My guess is they broker loans are maaybe 75-80% of current defaults.
So I also see the banks that bought these bundles loans as victims as well (although less sympathetic ones).
redneck said The working poor who are losing homes bought more home than they could afford- probably at the urging of a real estate agent or morgage broker- and after a year or two of trying to keep going lost it all.
In most cases we are talking about buyers who put little or no money down. They are now walking away from these homes. Have they really lost it all? Did they have any skin in the game to lose?
So I also see the banks that bought these bundles loans as victims as well (although less sympathetic ones).
The banks are not victims, except of their own greed. They are fully capable of running the valuation calculations, of reading the contracts for each mortgage security, and they are all fully knew the risks, pitfalls, and downsides. They are not victims.
So why did they do it, you ask?
Because they couldn't lay off the immediate profit right in front of them, even if it meant risking the entire operation.
With the advent of derivatives on Wall Street (derivatives are unique and often one off packing of underlying securities, which creates a new security with very unique pay off conditions and amounts.) - with the advent of derivatives comes risk return profiles wherein a moderately good return can be had across a lot of scenarios with a potential for a company-breaking loss in a very narrow, remote situation.
But this was a perfect storm where the buy and the sell sides were perfectly aligned as long as the game was going up.
The sellers (people that bought up mortgages and packaged them into mortgage securities) were able to convert tin mortgages to gold. It was huge profit for them. They were buying questionable mortgages for 60 cents and reselling them for $1.
The buyers (the banks that bought and held) loved the mortgage securities because they paid several percentage points return (interest) above an amount they could borrow for. They borrowed at X and invested at Y (Y > X) and it was easy profit.
The mortgage brokers loved it because they could turn around and sell every loan they wrote, good, bad or otherwise. They didn't care either.
And while the low income person feels like they were screwed, i would wager that mostly whey weren't. True, for a time they lived in a home that was beyond their means, so their expectations were set higher, and were then shattered. But were they really financially hurt? I argue no. They normally wouldn't have ever been able to afford that home. Further, the homes they later lost, my guess is, were mostly bought with zero down.
Isn't there some percentage of affected owners who fall into the category of having bought second homes and/or investment properties and now find themselves in straights?
Should that situation/those situations be viewed, judged and handled differently?
Was it only the working poor who stretched the limits?
Is all stretching the same, much less equal?
Those questions were intended seriously, by the way. I'd be interested in some serious responses, starting with some weigh-in on the first question. (I've not boned up on it.)
"straits," not "straights"
Laissez faire economics has run us up on the shoals. Our economy and nation are weaker for it.
Except there was nothing Laissez faire going on. This was and is a heavily regulated industry, except the regulators were and are crooks and mostly in the pockets of those being regulated.
Look at FHA loans. You need 3% down, but you NGOs routinely loan or give people that 3% and the FHA does nothing. Or the bank gives you a second mortgage and the FHA does nothing. Congress could have closed these loopholes. In fact, several bills were written to do just that, but got nowhere.
Paraphrasing Churchill; true capitalism may be cruel and stink, but it's still better than everything else.
(In the long run, it probably would have been best to let Fannie Mae, Freddie Mac, Bear Sterns and AIG all fail. Politically untenable, but politicians don't care about the long term for good reason.)
PS. I agree with quayle: Much of the blame for this technically lies with Greenspan who made credit too cheap. But, he was appointed, so I blame Clinton (and to a smaller extent, Bush, but by the time he was elected the damage had been done.)
Hey Ann, Love the new hair...Hot!
All:
How about that world changing, earth shaking, somebody do something, anything, market drop yesterday ... Well nevermind.
Doyle said...
All my comments are spot on.
The wet spot.
Thank you for posting the link. I hope to read it tonight. I heard the NPR piece this morning -- while half-asleep -- so any additional explanations are welcome.
And Obama, as usual, went along with the other dems. Same old, same old.
Go along to get along; the biggest reason he is qualified to be president.
The working poor are losing their houses and their savings. They were encouraged, including by Bush himself, to keep spending money.
This is a load of shit. The notion that the working poor are so dumb that they spend money because some distant bureaucrat encourages them too is absurd in the extreme.
Furthermore, very few were conned into overbuying homes; they knew damn well they couldn't afford them, but they didn't care.
A few months ago, NPR ran a series on interviewing home owners who were in trouble. I didn't hear ONE story where it was obvious the owner knew they had overbought. Yet, in every case they'd have a "but" clause that was so lame, it would make me laugh.
The vast majority of these people knew loaners were being fools. Many bragged about it on the very news programs that now want to make them victims.
Yes, there are genuinely innocent people caught up all this mess. The challenge is how to help those people, without letting the dishonest assholes off the hook.
So put you in the
More or less. The government shouldn't be encouraging institutions to lend to less than good credit quality borrowers as it has been in the past. Interfering with good business pratices and encouraging predatory lending. The need to regulate the appraisal process as well as the lending process to make sure that the quality of loans by institutions that depend on depositor and shareholder funds remain sound. If an individual or independent group wants to make bad loans....so be it and if they fail through bad business practices they should pay the price.
When the loans are packaged into the derivitive instruments, there needs to be much more transparancy. Speaking as a person who makes a living in the financial industry, I would assume that the analyists and the packaging entities (FMAC etc) have done their due diligence and kept the tranch or group of loans to a high credit quality. This was not the case and I quit selling individual FMAC or FNMAe about 2 years ago and wouldn't touch a Countrywide note with a ten foot pole. Unfortunately this shit was peppered (and still is) throughout mutual funds and money market funds and this explains the overall dropping of not just the faling institutions but also the market in general. It's everywhere.
I hold the SEC responsible for much of this debacle because they didn't enforce their own rules and didn't require clear and transparant disclosures of the composition of the derivities. At least they have finally woken up to the dangerous naked shorting that has been going on.
Doyle said...
Drill Sgt.
That doesn't answer my question. I gladly concede that Democrats do not have a great record in this area. What I'm asking is whether conservatives would have favored stronger regulation.
And Paul, no one had to force mortgage originators to make loans to unqualified borrowers. They were eager to do so. Maybe you've seen Countrywide mortgage ads before "No one can do what Countrywide can"?
Doyle,
plenty of blame to go around. In general the GOP wants to de-regulate more than the Dems, and in particular deregulate the financial industry. However, the GOP wanted more regulation of home loans and was opposed by dems (see that NYT piece)
Now on Obama, the Fannie Mae money flows to him, and you ought to ask why. Obama was only in the Senate for 4 years, but pulls down almost as much as Kerry nd Dodd,who were there 5 times as long. What value did Obama bring to te deal?
Top Recipients of Fannie Mae and Freddie Mac
Campaign Contributions, 1989-2008
Name
Office
Party/State
Total
1. Dodd, Christopher J
S
D-CT
$133,900
2. Kerry, John
S
D-MA
$111,000
3. Obama, Barack
S
D-IL
$105,849
4. Clinton, Hillary
S
D-NY
$75,550
5. Kanjorski, Paul E
H
D-PA
$65,500
As shown by recent Fannie Mae, Freddie Mac, AIG, nonsense, the profits are always privatized while the losses are publicly owned. The Democrats are in bed with Wall Street as much as the Republicans. So it will be the same old same old for the next 4 years.
At least with Fannie Mae, the Democrats were far more in bed with them than were the Republicans. Both President Bush and Sen. McCain tried to put rein in the two agencies five years ago. Obama has two former Fannie Mae CEOs advising him on his campaign (and Clintonista Jamie Gorelick of Wall/ 9/11 Commission, Duke University fame was co-Chair). In this case, it appears that most of the Democrats, and some of the Republicans were in on it, and only some lonely Republicans, including Bush and McCain were trying to do something to address this (then) looming scandal.
I think that one of the worst parts of it though was that the two organizations were actively lobbying Congress, with paid lobbyists, to limit oversight. This is from quasi-public organizations who depended on federal guarantees for their lowered costs of borrowing.
We need to gather a commission, get the two sides together and tell them to stop the bullshit.
That doesn't answer my question. I gladly concede that Democrats do not have a great record in this area. What I'm asking is whether conservatives would have favored stronger regulation.
During 2005 and again in 2006 the administration made concerted efforts to cause legislation to be sponsored that would increase the equity requirements for residential mortgages, improve Freddie and Fannie's accounting system, and reign in some of the especially egregious lending practices. There was Republican support for the legislation, but the Democrats uniformly opposed the effort.
Quayle said: As Solzhenitsyn wrote in the Gulag Archipelago, after many years in the prinson camps: (paraphrasing) I realized that the line between good and evil does not seperate countries, or cultures, or religions, or parties. The line between good and evil runs through each man and women's heart.
What a great take home message Quayle. Thanks!
So according to this analysis, it appears that all leads back to Fannie Mae and Freddie Mac. If that is so, how is that an indictment of laissez faire capitalism?
Fannie and Freddie were, as Pogo has said, entangled with the government and allowed to keep their profits but have losses guaranteed by the taxpayer. That is not capitalism. That's is socialism.
Government entanglement in business is a huge problem. It's corporate welfare. Those who are calling for more regulation: Can you not see that this invites even more business-government special deals and favors? Why encourage corruption?
Both parties went for deregulation of the financial industry, partly because the lessons of the Depression were forgotten and partly because some industries became less internationally competitive or were destroyed, finance became the hot sector for innovation. Why? Partly because of the push for free trade, which both parties favored, more or less
"As we practice it, free trade has profoundly destructive results for the United States and other Western nations. First, nations that do not play by our rules practice unequal competition. Second, free trade puts us in direct competition with low-wage nations, countries that have a lower standard of living than the United States. Third, by allowing these nations to take over big sectors of our market, we permit the permanent interruption of an important relationship between demand and supply that has been the main engine of economic growth in American history....
"We have elevated the economic theory of free trade to the status of a national theology, and we follow its simple dictums as if they were immutable laws. We appear prepared to follow the precepts of free trade wherever they lead us, even if that means plunging lemminglike to our economic ruin."
That's former Fed Governor John Culbertson. In 1986. This has all been building for a long, long time, and it will be playing out for the next 20 or more years, too.
Get deleveraged.
The Old man and the Sea:
"The regulators were asleep, my friends," McCain said. "The chairman of the SEC serves at the appointment of the president. And in my view has betrayed the public trust. If I were president today, I would fire him."
Unfortunately, while the president nominates the SEC chair, with Senate approval necessary...they be removed by the president.
*Oh, and the President of Spain confirms this.
And can you sea what I'm talking about?
Left out of the discussion, in this thread, so far at least, are the large number of house flippers, buying real estate on good terms like no body's business, driving up the cost of housing beyond reason, beyond the reasonable reach of disadvantaged and first-home buyers, for whom the good terms were intended in the first place, in the good and fine hearts of our representative politicians, be they of the left or be they of the right. This is an area where I see regulation to be useful -- to make sure it is actually the poor who are receiving favorable low interest loans and not second or third home owners who are greedily flipping houses and inflating their costs through their hyperactivity. There are even television shows about how to do this profitably. Not that house flipping is bad in itself, but hobbyists doing it by the tens of thousands and mucking up the market in the process, is most unfortunate.
This concludes my single contribution to this financial crisis thread.
The first thing we should all be able to agree on is that private citizens (executives at Freddy and Fannie and on Wall Street) should not be allowed to take huge bonuses during up cycles, and then skate away free while the taxpayers foot the bill during the down cycles.
One thing that most disturbs me lately is how Freddy and Fannie appear to be private institutions, but have all the markings of political ties, in which you need a political connection to be able to get hired at the top.
Case in point: how did Jamie Gorelick and Franklin Raines get from the Clinton admin to those plush jobs at fannie? Gorelick had no previous experience in finance, and she ends up as vice chair and rakes in $26M in six years.
To me, that fact stinks to high heaven. It has all the appearances of a political appointment wherein Fannie becomes a place - a candy jar - to which Washington DC powerful politicians can shuffle their friends to so their friends can make a few quick millions.
Gorelick makes millions runing fannie into the dirt; you, lucky tax payer, gets to pay to fix the mess.
The whole thing stinks. And this kind of crap will continue until we finally get sick of it; get sick of being hurded by party politics and partisian scare tactics, and throw each and every last bum out of DC, republican or democrat.
I say throw every last one of them out.
Was it only the working poor who stretched the limits?
Of course not. I haven't seen figures but I'll venture a guess that the working poor aren't a sizable percentage of people who are being foreclosed. Toss in the number of regular middle and upper middle class who also bought more house than they could reasonably afford, as you mentioned, people who bought investment properties or took out second mortgages then you have the house flippers. Think about it, when cable runs shows called Flip This House where John Doe buys a house, does a few renovations and sells it for a $50K profit in 30 days should have been everyone's first clue something was afoot.
As for the 'working poor', they of all people probably walked out no worse for the wear. Most were sub-prime borrowers with lousy credit to begin with and most likely put zero down. They simply pack up and go back to renting. The middle class and up are the ones screwed if they went with an ARM because they're struggling to pay or get foreclosed and their credit takes a hit to boot. The banks who everyone seems to think made out big time on all this, are now sitting on a piece of property that they can't unload and now are responsible for maintenance and taxes. Those that won't end up failing that is.
In short, everyone lost.
I say throw every last one of them out.
While Obama and McCain signs adorn the houses in my lovely neighborhood, I plan to buck the trend and am designing one that says Anti-Incumbant.
garage mahal said...
We need to gather a commission, get the two sides together and tell them to stop the bullshit.
Now that is the most intelligent point made today. Too bad. It is simple common sense; something severely lacking in D.C.
I would go one further. Everyone who took ten cents from these orgs must resign their offices immediately.
I third garage's proposal.
Wait a minute. Steven Levitt, PhD awarded by MIT, tenured faculty member in the Department of Economics, University of Chicago, cannot explain the events leading to the current debacle in the economic sector?
WTF? Milton Friedman must not only be spinning in his grave, he must be set to warp speed spin.
Doyle said...
Neither Obama nor McCain really have anything to do with it.
Obama received $105,000.00 from Fan/Fred. BULLSHIT. He is a US Senator. His guy Raines made 90 million dollars working for one of those outfits. BULLSHIT again. What part of corrupt Chicago politician don’t you understand.
Doyle said...
Peter -
If you knew what you were talking about…
If you did not have your head up your ass…
Arguing with idiots like you is a waste of time.
they be removed by the president.
Hey Mikey,
You talk just like those gang banging community organizers I used to know.
Alpha was half right when he said this all traces back to the mess in the subprime market, but he fails to mention the crucial connection: that Fannie and Freddie bought and paid for the right to expand their bottom line by getting into the subprime market.
And who were they paying off? Everybody here knows the answer - some aren't willing to admit it - but the biggest recipients of their money over the last decade or so are Chris Dodd, John Kerry, Hillary Clinton and Barack Obama.
[Barack got so much money in his short time in office that he landed himself in the top money receipients list despite only having been in office 3 years while the others in the top ten had been there for much longer.]
Are there Republicans on that list? Sure there are: but this collapse is happening in 2008 when the chief legislating committee which was run by their top money recipient: Chris Dodd has had full power for the last 2 years.
Both Bush and McCain tried to take steps to rein in their excesses by introducing legislation to create oversight for these agencies, but guess who blocked it? That's right. The Democratic leadership of the Senate.
Now we have ex-Fannie CEOs who made a killing profiting off their ill-gotten gains at the top echelons of Barack Obama's campaign, and they have the nerve to blame this on Republicans?
There's blame to go around to be sure: but it's nowhere near 50-50. This is a chicken coming home to roost in the Democratic barnyard. The only question is if Republicans decide to put out the ads to make it clear to the public what has been going on. Lord knows the media isn't going to...
What Jim said.
I (used to) build homes for middle-income families. I witnessed an increasing deterioration of the lending requirements from about 1996 through 2007.
Before then all lenders followed fairly prudent lending guidelines in terms of income verification, loan-to-value ratio, buyer's debt-to-income ratio, credit history, work history, etc. Those guidelines were imposed by Freddie Mac and Fannie May. Primary lenders who sold their mortgages to Freddie and Fannie followed those lending guidelines to assure that they could sell their mortgages.
In 1996, HUD set affordable housing goals for Freddie Mac based on income and population diversity. The goals required that a certain percentage of the mortgages Freddie Mac purchased from primary lenders (banks, mortgage brokers, etc.) support financing for housing low- and moderate-income families. Effective in 2001, HUD increased the original affordable housing goals for Freddie Mac. The previous qualifications for mortgage loans were substantially lowered.
The result was a flood of underqualified borrowers into the market, and an overheated demand for housing that fueled a rapid run-up in home prices that in turn fueled an epidemic of re-financings.
Freddie and Fannie were buying nearly any kind of loan. Income verification was no longer required; lenders just took the applicant's word that he or she was employed and earned X amount of money. Credit checks were no longer mandatory. Income ratios went out the window, as did value ratios. Some lenders eagerly made loans for more than the cost of the home.
Speculators and criminals got into the act. Home flippers infected areas that had especially hot markets.
Freddie and Fannie lifted the ceiling on jumbo loans, and dual-income, upwardly mobile households went deeply in debt to support the purchase of McMansions.
Fannie and Freddie sold bonds to raise liquidity in order to buy ever more mortgages. Bonds were purchased by overseas investors flush with dollars that needed to be repatriated. But even the bond market couldn't support the massive demand for capital, so Fannie and Freddie sold 'pieces' of mortgages to investment banks, flush with cash and newly enabled to engage in commercial banking thanks to changes in the Glass Stegall Act.
The investment banks believed the mortgages were guaranteed by federal government, so the bankers threw their brains out the window and leveraged their indebtedness as much as 40 parts debt to 1 part equity.
And the mortgages continued to flow in, so the investment bankers threw them into a blender and out came all kinds of derivatives that were sold to insurance companies, pension funds, etc. Now parts of individual mortgages were scattered across the market. If the John Doe mortgage went into default, for example, multiple investors owned parts of the loan. And no one investor could make a decision about what to do with the Doe residence because multiple investors each now owned a part of the collateral.
This mess was not caused by a lack of government oversight. It was caused by the federal government (Congress especially) requiring the Fannie and Freddie make loans to people who were not qualified borrowers. Senators and Representatives wanted to bask in the glow of "helping" minority and low income people buy homes.
Think of it as affirmative action admission into the mortgage university.
More.
The mortgage market worked very well for decades. It was efficient. It priced interest rates to risk. Lenders qualified borrowers, and borrowers had an economic stake (10% to 20% equity) in their homes when they moved in.
Groups like ACORN saw this as a discriminatory practice. ACORN and others asserted that having loan requirements discriminated against those (often minorities) who didn't meet those requirements.
ACORN lobbied Congress for an end to what ACORN called discriminatory lending, and voila! the Community Reinvestment Act became law in 1977.
The CRA mandates that each banking institution be evaluated to determine if it has met the credit needs of its entire community. That record is taken into account when the federal government considers an institution's application for deposit facilities, including mergers and acquisitions. The CRA is enforced by the federal government's financial regulators.
In 1995, as a result of interest from the Clinton administration, the implementing regulations for the CRA were revised to focus the financial regulators' attention on institutions' performance in helping to meet community credit needs. These changes were very controversial and as a result, the regulators agreed to revisit the rule after it had been fully implemented for five years.
The Clinton Administration's regulatory revisions with an effective starting date of January 31, 1995 were credited with substantially increasing the number and aggregate amount of loans to small businesses and to low- and moderate-income borrowers for home loans. Part of the increase in home loans was due to increased efficiency and the genesis of lenders, like Countrywide, that do not mitigate loan risk with savings deposits as do traditional banks.
That's key. A lender like Countrywide didn't need to worry about protecting it's depositors' money because it didn't have depositors. It's mortgages could be sold to Fannie and Freddie, without recourse to Countrywide.
In 2003, the Bush Administration recommended what the NY Times called "the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago." This change was to move governmental supervision of two of the primary agents guaranteeing subprime loans, Fannie Mae and Freddie Mac under a new agency created within the Department of the Treasury. However, it did not alter the implicit guarantee that Washington will bail the companies out if they run into financial difficulty; that perception enabled them to issue debt at significantly lower rates than their competitors.
The changes were generally opposed along Party lines and eventually failed to happen. Representative Barney Frank(D-MA) claimed of the thrifts "These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis, the more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing."
Representative Mel Watt (D-NC) added "I don't see much other than a shell game going on here, moving something from one agency to another and in the process weakening the bargaining power of poorer families and their ability to get affordable housing."
The mortgage market mismanagement and the resulting collapse of the housing market and distress in the entire financial sector are a direct result of Congress tampering with a previously efficient system.
There are at least 3 separate issues:
1. Eroding lending standards leading to sub-primes and Alt-A's.
2. Selling of mortgages by originators to secondary markets which packaged them indiscriminately into investments vehicles, received high quality grading by rating agencies and in turn sold to individuals, investment houses, hedge funds.
3. Creation of new sophisticated derivatives by investment houses known as Structured investment vehicle (SIV) such as credit default swaps
Congressional oversight failed on all fronts - mortgage lending standards. S.E.C failure to manage all the new investment vehicles and sophisticated derivatives being created.
Derivative activity was known in 1994 and reported on a quarterly basis:
NYT 1994 G.A.O. Seeks Sweeping Rules for Derivatives
NYT 1994 Report on Derivatives Said To Seek New S.E.C. Power
OCC's Quarterly Report on Bank Derivatives Activities
I would add one thing to the recent excellent, detailed posts.
The rating agencies that rated the CDOs are the customers of the CDO sellers. It is a blatent conflict of interest that they get paid by the person that stands to benefit most from a high rating.
Charlie Rose interview of Hank Greenberg about AIG takeover.
Spitzer and AIG
Michael Bloomberg Economy in Crisis
Video 55 minutes
IBD editorial The Real Culprits In This Meltdown
audio
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