Sunday, October 26, 2008

The Melt-Down, My Thoughts

In the USA the Republicans blame the Obama and the Democrats for the global financial crisis. McCain charges that Fannie Mae and Freddie Mac made risky loans “with the encouragement of Obama and his cronies…in Washington.” McCain and Palin point to Obama and the Democrats not supporting the Senator’s Chuck Hagel’s (R) effort to in 2005 to pass legislation regulate to a greater level in Fannie Mae and Freddie Mac. This is the same legislation that McCain claims he helped author. McCain did not author the bill, he signed on as co-sponsor nine months after it was voted on by the Committee and shortly before it died when Senate Majority Leader Bill Frist (R) refused to bring it out of committee to the Senate for a vote. Though he signed on to the bill, he did not actively work for it to be brought to the Senate or to lobby his peers to vote for it.

Republicans, McCain and Palin included, claim that both these institutions were dominated by Democrats. Their Boards of management being dominated by Democrats is true. What Republicans fail to note is that since 2004 Freddie Mac’s political arm was headed by Republicans who hired a Republican lobbying firm for $2 million to target a short list of seventeen Republican Senators to persuade them not to support Hagel’s bill. McCain’s campaign manager, Rick Davis and his lobbying firm, received $2 million from Freddie and Fannie to help lobby Republicans and kill various regulatory efforts.

It should also be noted that since 2004 all Freddie Mac’s political contributions have been given to Republican candidates, including a small sum of $2,800 to McCain. Hence, for political purposes McCain and the Republicans obfuscate the picture.

The Democrats are not much better. They quickly point to Republican efforts to deregulate the banking and insurance industry as the cause. Republicans pushed for increased deregulation, McCain included. They point to Republican Senator Phil Gramm who retired in 2003 who as a banking lobbyist legislation that withdrew several oversight provisions and blurred the distinctions between insurance and banking institutions. Gramm, also McCain’s financial advisor, persuaded his former peers to support the deregulation.

Democrats also rightly note Senator Dodd leading an effort to keep derivatives/swaps/hedges from coming under regulatory oversight. What Democrats are not noting is that President Clinton supported several of the bills that helped deregulate the financial industry.

There is blame to be shared by all. No single legislative action created this mess. Those claiming otherwise are putting forth self-serving and disingenuous effort at oversimplification. Such oversimplification is an act to wash away the guilt that rests in their hands.

When former Federal Reserve Chairman Alan Greenspan testified on October 23 before Congress he admitted that he was shocked by the credit market meltdown. When Fed, Capitol Hill and other officials provided warnings, Greenspan dismissed their concerns as being unfounded. Part of the problem is that he did not question his economic modeling or pay attention to signals that showed that there were some flaws in his model that needed adjusting.

Greenspan dismissed efforts to regulate mortgage backed derivatives/swaps that were founded upon the assumption that property values would continually increase at a steady rate of 5 to 15% per year. Questions raised by some, including Obama, about what would happen if there was a wide spread decline in housing values was not worth consideration. The shine has clearly come off of the Oracle of Wall Street and history will have just as many harsh words for him as complementary ones.

Greenspan’s and the Republican efforts to deregulate the finance industry was both correct yet deeply flawed. It was correct that a host of regulations put in place since the 1929 crash were out of date. They needed to be rewritten, not tossed aside wholesale. The deregulation effort was based upon two flawed assumptions, that when the wealthy become wealthier the rest of the population will benefit, and that the financial institutions will look after their best interest without government involvement.

History is replete with examples of the wealthy becoming wealthier on the backs of the poor who they keep repressed. No industry has adequately regulated itself unless there is a real threat of government stepping in to do so, and even then it will do only the minimum needed to keep governmental involvement at bay. Greenspan and the Republicans overlooked a critical factor, that humanity is self-centered. When we have unchecked capitalism abuse trickles down, not wealth. When safeguards are removed questionable and fraudulent products will be sold by golden tongued people to those who they can beguile. Republican fiscal philosophy of deregulation has been found wanting.

Banks themselves must shoulder a significant part of the blame. Fannie Mae and Freddie Mac were not the main issuers of poor banking loans. These institutions were the purchasers of loans banks had already made. With regulations lifts Fannie and Freddie required less documentation on loans and were allowed to assume subprime loans (interest only loans). Banks issued loans that in the past if they had to hold onto the loans would not have issued.

With increased availability of mortgage money a housing boom caused home priced to climb rapidly. It was not uncommon to have a house go on the market in Northern Virginia and in other hot markets at the beginning of the week and by the end of the week have two or three people trying to out-bid each other. Rapidly increasing home prices, and the building of a greater number of “luxury homes” increasingly pushed people into buying homes they could not afford.

Home buyers too must shoulder some of the blame. Though real estate and bank officials were able to show buyers how they could afford homes they really could not, it is the home buyer who signed on the line. When a deal seems to be too good to be true, it normally is. When we forget the phrase “buyer beware” we are headed for trouble. I know of individuals who did not buy because they questioned the assumptions upon which the subprime loans were based. Unfortunately, there were too many who did not question those assumptions and have found the road is paved with worthless dross, not gold.

No single group, individual or legislation is to be faulted for the failure. The confluence of greed, deregulation and blind faith that has created the financial meltdown. Hopefully we will have new leaders who will have the wisdom to rebuild a balanced financial industry that has appropriate regulatory oversight that will protect the industry from its own bent toward greed, as well as protecting the general public and the nation in the process.


Seven Star Hand said...

Hey Dave,

So, why should all of humanity be forced to suffer and struggle any longer, now that the entire global financial system has been exposed as a mind-boggling deception within many other deceptions? No one in their right mind would continue to be enslaved by a proven deception, which is also proven to be undeniable slavery-by-proxy !!!

The derivatives scams alone have grown to more than 10-times the entire global GDP (at last counting) and are now failing because the scam/pyramid scheme broke and exposed the deception for all to see. A significant portion of global wealth and power was created and propped-up using these and other now-proven smoke and mirrors and house of cards illusions and delusions.

These deceptions have grown many times larger than the rest of the entire world economy. Consequently, there is no way that all of the world's governments combined, who themselves borrow so-called "money" from other central-bank smoke and mirror deceptions, can solve this debacle, by using more smoke and mirrors money scams. The only solutions they are offering will take centuries to repay, if ever.

Here is Wisdom...

Evie said...

One key to restructuring should be to recognize that "institutions" are not individuals. The people who constitute institutions will almost always act in their own self-interests, not the interests of the "institution." These people may think that their interests and those of the institution coincide, or they may not care about the institution at all as long as they can make their individual killings and get out before everything collapses - which a number of people did in this case.

Greenspan failed to recognize this simple truth about human nature: people act for themselves more often than not. Individuals in lending institutions make risky loans in order to meet their quotas and get their commissions. Individuals buying houses they can't really afford will do so as along as someone will give them the money to do it. Senators writing or blocking legislation will do so in order to please particular constituents, and perhaps even get some money in their re-election funds. The list goes on and on. Any new financial policies will have to recognize the essential selfishness that is inherent in human nature, and legislate accordingly.

Dave said...

Seven Star .... the financial scheme was not a pyramid as such. The whole plan was based upon increasing house values and low interest rates. When assumption was flawed as interest rates were bound to increase and house values decline.

As for the GDP issue, what you are forgetting is that the derivatives are still tied to real property. The ten-times global GDP figure is assuming that the property has zero value. The problem is that the property value is below the value of the mortgage and mortgage holders are unable to pay the difference between the real value of the home and face value of the mortgage. On a much higher dollar value it is the equivalent of being upside down on a car loan where the loan is greater than the value of the blue book value. With the house value being below the base loan value, the banks are taking a huge lost on each home under foreclosure.

Subprime loans should be outlawed.