Do you have the feeling Federal Government officials are running around in circles trying to figure out what to do with the economic meltdown while in turn covering their butts? You are not the only one. Millions of people around the world are wondering what went wrong as the value of their stock portfolio diminishes by the day. The answer, in my uninformed, self researched and conservative biased opinion, seems ludicrously simple: by Government mandate banks gave loans to people that should have never gotten loans and then failed to regulate and supervise what banks did with those loans. This in an of itself sounds too simple to have melted the economy right? Wrong. If only a few people had gotten loans they should never have gotten, the meltdown would have never occurred. Unfortunately a Government social experiment initiated the whole mess and in time, coupled with private sector speculators, made it worse.
Create the groundwork for the sub-prime market. It all got started In the late 1970’s with President Jimmy “peanut farmer” Carter, a Democrat, who came up with the Community Reinvestment Act. The CRA forced banks to give loans to people that were not credit worthy, based on race. People that would have never qualified under the old risk based banking system started receiving loans.
Jump in time to the 1990’s. Enter President Bill “slick willy” Clinton, another Democrat. During his tenure the CRA was put into high gear. In 1992, with warnings and resistance from the GOP, Congress gave it big fangs and huge claws. Banks that did not lend to unqualified minorities were going to be publicly labeled as racists, were not going to be allowed to merge with other companies or increase their lending portfolio or expand their number of branches. To top it off federal bank regulators would be checking up on banks to make sure they were giving out those questionable loans in the name of ending discrimination.
Enter Fannie Mae and Freddie Mac. Congress also allowed both institutions to buy the Government mandated bad loans banks were making, bundle up those loans in “packages” consisting of some bad loans and some good loans, and then sell the “packages” in the open market meaning Wall Street. In other words Fannie Mae and Freddie Mac were allowed to finance banks by laundering the bad loans they were giving out. That was the start of the so called sub-prime market, meaning below par, not Kosher, a little smelly. In 1994 the sub-prime market traded $ 34 billion. By 2008 when speculators had jumped in, it had grown to a $ 1 trillion marketplace.
In 1994 Wall Street traders picked up the sub-prime ball and ran with it. The packaged loans were now perceived to be backed by government sponsored mortgages from Fannie and Freddie. In reality there was no guarantee but as we have seen in the last few weeks the government did end up guaranteeing the mortages by bailing out both entities so as to prevent chaos in the financial markets. With the rule changes traders made out like bandits because besides there being almost no risk and making money by selling the loans they started making even more money betting on which loans would be defaulted. Greed took over as almost all business sense was thrown out the door and making money became the creed. Corporate as well as government policies are both to blame for the mess we are in right now.
Fannie, Freddie and others grew and grew and grew some more by selling an ever increasing number of mortgage-backed packaged loans as banks, by law, kept making more and more bad loans. Both entities were not always well managed and with behemoths of their size mistakes made tend to shake economies. For example some experts say that by early this year they had in cash and assets only $ 1 for every $ 30 they had loaned. In Wall Street speak they were over leveraged, in household speak they were drowning in debt and kept on lending money. Warning signs and alerts had begun surfacing as early as 1992 but by 2000 it had turned political.
Political, how? Both entities began investing in community development. Community development means giving money to so called “housing rights groups” who then use that money to further their political agendas. Imagine giving loans to people in the inner cities or in rural areas to buy properties so they like you and will vote for your party when election time comes around. These groups know the loans will never get paid back in full but they don’t really care. If anyone with a different agenda stands in their way they are publicly called that career ending word: racist. Who would dare stand in the way of minorities owning their own houses? In exchange for their generosity members of the housing rights group get elected by the community to local, state and federal positions and make sure more money is sent the groups way to build up their power base. After a while it seemed that those loans began to be given to anyone that asked for one.
Why housing prices went up. All those people who got loans obviously began building houses or buying up existing houses and lots. The value of everything went up as people with good credit competed against those that got race based loans. Houses, lots, building materials, labor costs all appreciated in an artificial way and kept on appreciating as more and more people entered the property market. Politicians love this because they get to collect more property taxes and brag home ownership is the highest in history, Wall Street loves this because they get to trade loans and earn commissions, homeowners love this because the value of their property goes up and can get a big mortgage to buy that nice car, a second home or a trip to the Caribbean. Everyone makes out like a bandit. Or so it seems.
Eventually the time comes for every loan to get paid back and the great majority of prople do pay back their loans on time. When a few loans are not paid it’s no big deal as they are already factored into the business model, the system can handle it. When the price of oil went up, everything else went up and kept going up. Eventually people that borrowed money had to make tough decisons about how to spend what money they had: pay back loans (car, home, college, etc.), put food on the table, buy gas for the car, maybe cancel the cable subscription, or use last year’s school supplies instead of buying new ones. With no one buying houses demand went way down and with so many houses on sale and tens of thousands others being built prices started going down all over the country.
Early on defaulters made up about 2.5% of the market, worrying but not an economy killer. Even that small percentage of defaults drove some companies close to the brink of banrupcy and made the US as well as the world economy tremble because they were worth billions and billions of dollars. When the percentage of possible deafults rose to 10%+ companies that backed those loans worth trillions of dollars began going bankrupt or their stock value diminished drastically, specially with the price of houses dropping as much as 30% or more in some markets. With so many people possibly defaulting and the price of houses going down the holders of those mortgage-backed bad loans Freddie Mac, Fannie Mae, Wall Street banks and others could no longer back those bad loans because there was no more money coming in and their house of cards, built on values printed on paper instead of assets, blew up.
No one told Fannie, Freddie, Wall Street banks and others to approve so many bad loans, just to diversify their portfolio. That’s where greed came into play; as long as the price of real estate kept going up they were in hog heaven making billions hand over fist. If Federal regulators and company management had been doing their jobs and kept the amount of lending reasonable there would also be no crisis, the speculating would have been kept under control. With little or no oversight Wall Street companies began running wild taking riskier and riskier gambles knowing Freddie and Fannie had their backs.
Attempts to reign in the out of control sub-prime market were made in 2000, 2003, 2005 and early in 2008 but by then it was too late. In 2003 the White House asked Congress to step in and regulate the mess, Congress declined. In 2004 the head of Fannie Mae, Franklin Rines, was fired while other top executives resigned because of accounting shenanigans reminiscent of Enron style accounting book-cooking manipulation. In 2005 John McCain along with 2 co-sponsors presented a bill, S 190, that might have stopped the mess, again Congress took no action. Every single time it was mostly Democrats in Congress with a few Republicans that stood in the way of reforms. Some say it was because of the big campaign contributions received by mainly Democratic politicians from Freddie, Fannie and Wall Street banks and their employees while others say that those companies provided enough paperwork proving they were doing things right.
Now the Government is studying giving a $ 700 billion bailout to prevent an even deeper crisis. Add to the $ 700 billion being considered the hundreds of billions already paid out to shore up some Wall Street companies, Fannie Mae, Freddie Mac and the world economy and the question becomes, how much more is needed to stop the bleeding? Can the US taxpayer support so much debt?
On a Fox News show this afternoon one of the guests said that the $ 54 trillion unregulated credit/debt-swap (I think that is what she said) market might be the next to go south. The FBI took too long to get involved and investigate what the hell is going on.