Good Layman's guide to the financial crisis

[Tom Odom]

There are thousands and thousands and thousands to blame, starting with the lenders who made foolish loans to those who took them and moving on up the line. All these people forgot about tomorrow and bet that things would always get better, always. It is as if "an institutional bias against rational thought" has become a national character trait. If it has, that is the big security risk.

True, Carl, and many at the lower end will pay by losing their homes. It does not however obviate reaponsibilty at the CEO level for pursuing those policies whether we are talking Fannie May, Mac, Lehman Bros, or AIG (and whoever comes next). Oversight has to mean penalty.

Tom

[120mm]

J Wolfsberger,

Someone is selling you a line. Do you honestly believe that the housing bubble was created because of gov attempts to extend mortgages to poor people? Really? Because, you know, I don't recall Flip That House visiting East St Louis or Brownsville. The housing bubble did not take place in the inner cities or even amongst low-income first time homebuyers in general, and the gov regulations you attest to only applied to thrifts and commercial banks.

The vast majority of subprime defaults were mortgages lent out by independent mortgage brokers, who were not covered by any Federal regulations at all, and certainly not any aimed at increasing home ownership amongst the poor (independent brokers put out at least 50% of such loans, twice the number as banks and thrifts).

Schmedlap, your targets are rather broad and miss out on two key ones: the massive expansion of capital available for investment in the past 20 years, and the extraordinary degree of overleveraging made possible by the growth of the "shadow financial system" that grew up to service that capital outside of the regulatory infrastructure that governs banks and thrifts. SIVs, hedge funds, private equity groups, etc. that became so profitable that the inevitably became enmeshed in and took over large parts of Wall St itself. That massive overleveraging is what has turned a standard housing bubble into financial apocalypse.

And who needs lobbyists or campaign donations when you essentially staff the Treasury Department?

In reality, BOTH happened. The government forced lenders to "find a way" to lend money to poor people who cannot really afford one, AND greedy lenders exploited the relaxation of rules to make all sorts of stupid loans.

And idiot consumers bought too much house because housing always goes up in value, and they'd always get a promotion at work, and they'd always be able to find a way to afford to pay the house payment.

[carl]

True, Carl, and many at the lower end will pay by losing their homes. It does not however obviate reaponsibilty at the CEO level for pursuing those policies whether we are talking Fannie May, Mac, Lehman Bros, or AIG (and whoever comes next). Oversight has to mean penalty.

Tom

The trouble is, most of what the CEO's did was probably legal. Bad judgement isn't against the law. The Congress always had the power to change the law, but they didn't. My opinion is they didn't because they also believed tomorrow would never come, or at least not until after the next election. No percentage in saying "No, you can't."

[Schmedlap]

Schmedlap, your targets are rather broad...

That was the intent. There are more guilty than innocent of bad judgment, bad faith, and negligence.

... and miss out on two key ones...

I think that my rather broad target set emcompasses those whom you more specifically cited.

And who needs lobbyists or campaign donations when you essentially staff the Treasury Department?

Good question. I can't discern the rationale used by Freddie and Fannie. I can only look at their actions and surmise that they had reason to judge that doling out campaign contributions and setting up a network of lobbyists was essential to further their goals. Then again, I guess their judgment is also pretty suspect, in retrospect.

[Rank amateur]

That was the intent. There are more guilty than innocent of bad judgment, bad faith, and negligence.

I can't agree. Mjustassive economic bubbles always pop and cause ruinous depressions. It is the government's job to "take away the punch before the party gets out of control." Blind faith in free markets caused the problem. We need common sense regulations.

Nothing personal, but I continued to be amazed by how many people think that as long as they vote for a "tax cut" they'll never need to pay for anything the government buys.

Re the security ramifications: I was just thinking that Bin Laden set out to destroy the US economy and we have caused far more damage to it than he ever could.

[jmm99]

Here is my "bible" on the current financial events.

The End of an Era
by Gary North
.....
This investment era began on Monday, August 16, 1982. On Friday the 13th, Mexico had threatened to nationalize all foreign banks and default on its debt. That weekend, the world's central bankers were meeting. They agreed to start pumping in new money. They negotiated new terms with Mexico. On Friday, the 13th, the Dow Jones Industrial Average bottomed at 777.

The week of September 14, 2008, will go into the textbooks as the end of an era. It marked the end of the investing public's confidence in the Powers That Be.
.....
CONCLUSION

Investors last week began to figure it out. A lot more investors are going to figure it out. They are going to have two years to figure it out. This is if things go well. They may have three years to figure it out.

Whoever is elected President in November is going to preside over the worst financial disaster in American history in the postwar era. Some lucky soul is going to lose this election.

You had better batten down the hatches.

http://www.lewrockwell.com/north/north654.html

While Gary North and I differ on religion, we do not differ much on economics. For the last few years, he has been predicting correctly in the economic arena. He also takes a practical, applied approach to things economic, and is no Ivory Tower theorist.

He also is not trying to sell you anything, only his views.

Clicking on the Gary North Archives (bottom of page), takes you here.

http://www.lewrockwell.com/north/north-arch.html

These (going back to 26 May 2000) may be helpful to your own planning.

----------------------------------------------

from cavguy
.... but I think this has huge security ramifications

Yup, in terms of what I call policy (national strategy), we will be seeing this for the next few years: dimE.

[CloseDanger]

The idea of bailing out a company really p----- me off.

Except:

1. We're in this mess because of the changes, in the 1990s, to force lenders to finance housing to low income borrowers. As anyone with a grain of sense could, and did, predict at the time:

a. housing prices in general would escalate
b. people would wind up in houses they could not, in reality, afford

2. The above required (again, thanks to Congress), a dramatic change in lending. "No-doc" loans, "low doc" loans, games with FICO scores, radical ARM mortgage loans, etc. I probably don't know all the games played. The bottom line is, to comply with the new federal requirements, lenders had to get very creative.

3. The killer, I think, was when the ARMs adjusted. Upward. In a sinking market. At that point, people started to default.

4. As they got close to default, they tried to sell their homes. And prices plummeted.

5. When prices began dropping, eventually financial institutions had to begin taking the losses.

6. To make a long story short, the losses piled up until the Federal Government had to step in to prevent a complete melt down.

No one has yet stepped up to suggest any of the actions that could allow the private sector (read "Market") to fix the problem. For example, reduce the reserve requirement on commercial banks. Or eliminate capital gains taxes on mortgage securities containing x percent sub-prime loans.

But then, that might involve, or lead to, the public actually figuring out who created this mess.

Not gonna happen.

And you had mortgage companies that found it cheaper to foreclose on a house and would not put it back on the market.

There are alot of good assets out there, they just need revaluation. The Government could even make money in this.
(which we don't want as a general rule) but short term with profit and they get out as soon a possible.

You could repeal Sarbanes Oxley. That may force liquidity in. You could also pass the fair tax, that would flood wall street.

Just saying.

[J Wolfsberger]

And you had mortgage companies that found it cheaper to foreclose on a house and would not put it back on the market.

There are alot of good assets out there, they just need revaluation. The Government could even make money in this.
(which we don't want as a general rule) but short term with profit and they get out as soon a possible.

You could repeal Sarbanes Oxley. That may force liquidity in. You could also pass the fair tax, that would flood wall street.

Just saying.

I had suggested "No one has yet stepped up to suggest any of the actions that could allow the private sector (read "Market") to fix the problem. For example, reduce the reserve requirement on commercial banks. Or eliminate capital gains taxes on mortgage securities containing x percent sub-prime loans."

Your points, which would involve having the banks voluntarily forego adjusting the interest upward on ARMs, or converting the mortgages to fixed rate at an affordable payment schedule, are also good.

And all of these would have required a bit more intelligence than the banking/finance community seems to possess.

[Ken White]

And all of these would have required a bit more intelligence than the banking/finance community seems to possess.

sums it up...

[Tom Odom]

The trouble is, most of what the CEO's did was probably legal. Bad judgement isn't against the law. The Congress always had the power to change the law, but they didn't. My opinion is they didn't because they also believed tomorrow would never come, or at least not until after the next election. No percentage in saying "No, you can't."

Agree 100% but there is a responsibility that comes with position and associated entitlements. If the Fanny Mac CEO can have an if fired clause with a golden parachute tied to it, we have gone the wrong way and as we all know this is hardly the first time. But in this case we are looking at the bill for the current wars all over again.

Tom

[carl]

Agree 100% but there is a responsibility that comes with position and associated entitlements. If the Fanny Mac CEO can have an if fired clause with a golden parachute tied to it, we have gone the wrong way and as we all know this is hardly the first time. But in this case we are looking at the bill for the current wars all over again.

Tom

You and I and all the people on this council believe responsibility comes with position I'll wager; but the elites don't. The anointed ones (sorry for the bitter tone) believer the rules that apply to us flyover people don't apply to them. They are better and they are different and what they get they well deserve.

There is something very wrong with so much of the leadership class in this country, business, political, academic, media etc. They have gone so wrong it is affecting the "we", the Americans. I wish I knew what we can do about it but I don't.

[tequila]

In reality, BOTH happened. The government forced lenders to "find a way" to lend money to poor people who cannot really afford one, AND greedy lenders exploited the relaxation of rules to make all sorts of stupid loans.

I cannot emphasize enough how much this did NOT occur. Again, the majority of bad mortgages in the current crisis were not sold because the government "forced" them to do it. Absolutely not.

Good question. I can't discern the rationale used by Freddie and Fannie. I can only look at their actions and surmise that they had reason to judge that doling out campaign contributions and setting up a network of lobbyists was essential to further their goals. Then again, I guess their judgment is also pretty suspect, in retrospect.

I was referring here specifically to the big investment banks, hedge funds, private equity, etc. that make up the shadow banking system that is in the process of collapsing. Goldman Sachs especially has a stranglehold on the Treasury Dept.

I had suggested "No one has yet stepped up to suggest any of the actions that could allow the private sector (read "Market") to fix the problem. For example, reduce the reserve requirement on commercial banks. Or eliminate capital gains taxes on mortgage securities containing x percent sub-prime loans."

Your points, which would involve having the banks voluntarily forego adjusting the interest upward on ARMs, or converting the mortgages to fixed rate at an affordable payment schedule, are also good.

And all of these would have required a bit more intelligence than the banking/finance community seems to possess.

Not sure if you guys have been paying attention, but it's not exactly like the "market" is begging for these solutions you proffer. The market is in the process of collapsing or folding up shop at the moment. Things like cutting capital gains taxes on MBS are rather beside the point when no one can accurately value them right now. Changing home loan payment terms would be nice if anyone could figure out who owns what terms on which set of loans --- the whole key to this process is the degree to which these loans were securitized and leveraged to a whole slew of different counterparties up the stream from the initial lender.

[Schmedlap]

I can't agree. Mjustassive economic bubbles always pop and cause ruinous depressions. It is the government's job to "take away the punch before the party gets out of control." Blind faith in free markets caused the problem.

What economic bubbles in the past 50 years caused ruinous depressions in the US?

I have no idea what you mean by the phrase "blind faith in free markets." That is so vague and invokes such an often tossed about term as to be almost meaningless.

I'm just guessing here, but I suspect that...

"It is the government's job to..." = if they don't do it, then the gov't is negligent.

"Blind faith in free markets" = bad judgment

If I got that much right, then I'm not sure what you were not agreeing with.

[Ski]

Spot on analysis here.

Mortgages have been bought and sold numerous times. Most lenders don't even know who actually owns the mortgage. That's a problem. You can't refi a loan because no one can identify what lending facility owns it.

There was an example I remember from a year or so ago. Dude in Miami owns a $3M house. Isn't making payments on the house. Lender calls him and says he owes. He says, "tell me who owns the mortgage and I'll pay them directly." Lender comes back two weeks later and says we don't know.

Dude is still living in his house.

I cannot emphasize enough how much this did NOT occur. Again, the majority of bad mortgages in the current crisis were not sold because the government "forced" them to do it. Absolutely not.



I was referring here specifically to the big investment banks, hedge funds, private equity, etc. that make up the shadow banking system that is in the process of collapsing. Goldman Sachs especially has a stranglehold on the Treasury Dept.



Not sure if you guys have been paying attention, but it's not exactly like the "market" is begging for these solutions you proffer. The market is in the process of collapsing or folding up shop at the moment. Things like cutting capital gains taxes on MBS are rather beside the point when no one can accurately value them right now. Changing home loan payment terms would be nice if anyone could figure out who owns what terms on which set of loans --- the whole key to this process is the degree to which these loans were securitized and leveraged to a whole slew of different counterparties up the stream from the initial lender.

[Rank amateur]

What economic bubbles in the past 50 years caused ruinous depressions in the US?

"Depression" = depression of asset prices. Dot com stocks is the most recent example. When the value of everyone's stocks slide, it's bad for the economy, so even people who don't own stocks get hurt. Same thing happened to stocks in the 20s and tulip bulb prices in Holland. I believe the same thing happened to gold in the 70s.

The only reason these things haven't caused another "great depression" is because economists have learned a lot since the 30s. The government needs to cool things off when they're hot - higher interest rates, lower money supply - and warm them up when they're cold through government intervention in the economy: social security, unemployment insurance, lower rates.

Basically, anytime people are buying things just because the price is going up - in this case mortgages they can't afford, because the house "will be worth more before the rates adjusts" - inevitably creates a situation where everyone sells as soon as the price drops and prices plummet.

Real estate developers were placing strict limits to keep speculators out of their development. When real estate developers show more awareness of basic economics than the administration, there's only one place to put the blame.

[Rank amateur]

I had suggested "No one has yet stepped up to suggest any of the actions that could allow the private sector (read "Market") to fix the problem. For example, reduce the reserve requirement on commercial banks. Or eliminate capital gains taxes on mortgage securities containing x percent sub-prime loans."

Your points, which would involve having the banks voluntarily forgo adjusting the interest upward on ARMs, or converting the mortgages to fixed rate at an affordable payment schedule, are also good.

And all of these would have required a bit more intelligence than the banking/finance community seems to possess.

Again, faith in market solutions has caused the problem. There are no capital gains, only capital losses. Therefore, tax rates are irrelevant; there's nothing to tax.

Anyone who wants to can ask to have their rate adjusted. (Or as pointed out, stop payments all together and stay in the house.) The problem is the value of their house has dropped so much that the rate is irrelevant. When you owe $300,000 on a house worth $200,000 the market solution is to walk away from the mortgage. When the bubble bursts, millions of people make the same rationale economic discussion and billions of dollars of wealth disappear.

None of that is up for debate. It's happened. The problem is how to keep the problem from spreading. Because when no one is buying furniture anymore it's rationale for furntiure manufacturers to lay off people. And it's rationale for people who think they're going to lose their job to stop spending money, which means sales drop even more, which means companies lay off even more people...... and you have a vicious circle ala the 1930s.

Vicious upward cycles always in vicious downward cycles unless the government breaks the cycle.

[Cavguy]

[QUOTE=slapout9;57154]

Sorry for the run of posts - but I think this has huge security ramifications.
QUOTE]

I think you are right about this. Care to be pontificate(learnt me a nu word) on that a bit?

Slap,

Sorry for the delay. Had a paper to finish. A thrilling essay on how "Japanese Piracy" along the coasts of 16th century China was really not Japanese in origin.

Bottom line in short form-

1) Global economic hits almost always cause political instability. The meltdown in China (who owns a lot of our bad paper) has been worse.
2) Budget deficit. The rising costs of this bailout directly affect our ability to continue to spend $12bil/month in Iraq/Afghanistan, and potentially the willingness of the US public to support a half trillion dollar defense budget. Thus, this crisis may force a less aggressive US foreign policy out of necessity
3) Weakening of US economic leverage. Our economic power the "E" in "DIME" is weakened significantly. Issuing an additional $700 billion in debt will continue to lower the dollar's value as a currency. Many more nations are looking at moving to another currency (Euro?) for stability. This has long term effects in reducing global ties to our economy, which may make us less secure. (this is a long term, not tomorrow, problem)

[Ken White]

Real estate developers were placing strict limits to keep speculators out of their development. When real estate developers show more awareness of basic economics than the administration, there's only one place to put the blame.

Which administration? This one? The one before? two or three before?

I think you're confusing 'the administation' (whichever one) with Congress whose pursuit of 'affordable housing for all' (and the concomitant campaign contributions from the lender including Fannie and Freddie) is far more responsible for this debacle than any one administration has been.

I suggest that government intervention thus far has done far more harm than good -- and the prognosis for the future is not good...

[Ken White]

I cannot emphasize enough how much this did NOT occur. Again, the majority of bad mortgages in the current crisis were not sold because the government "forced" them to do it. Absolutely not.

It is true as stated; however, replace the word 'forced' with 'allowed and / or encouraged' and your statement becomes quite erroneous.

Greedy lenders and equally greedy but risky purchasers both contributed but there was tacit government (read: Congressional) encouragement to do so. The Administration tried to rein in Fannie and Freddie in 2003 -- and Congress refused to allow it.

Same phenomenon that had lead to excessive credit card debt...

Vote 'em all out!!!

[Rank amateur]

Which administration? This one? The one before? two or three before?

I'm refering to the one that thought it there was a supply of millions of mortgages that people couldn't afford and demand for millions of mortgages people couldn't afford that could possibly go wrong?

I suggest that government intervention thus far has done far more harm than good

If a bridge has too many supporting beams, there's nothing wrong with removing a few, but it's stupid to remove all the support.