Thursday, September 18, 2008

They All Kept Feeding the Monster

I have read many news articles and opinion columns about the collapse of the housing-related credit markets that have literally destroyed the likes of companies such as Lehman Brothers, Freddy Mac and Fannie Mae, Countrywide Credit, Washington Mutual, AIG Insurance, Merrill-Lynch, and more to probably come.

Some of the more political say it was greed, hubris, and arrogance on the part of Wall Street. Some say it was the lack of government regulation. Many technically blame the repeal of the Glass-Steagall Act with the Clinton-signed, Republican-sponsored Gramm-Leach-Bliley Act of 1999. Others think the house-flipping fad of the last 10 years was at fault, too.

To me, it was all of the above. But, the biggest problem, like all boom-bust scenarios, was that it was rooted in the fact that money was trying to find a place to go in order to make more money. The housing market became a "monster" in terms of making money. The money flowing into this market caused home prices to rise at rates that, by any measure, could not be sustained and were doomed to collapse. For years, independent investment experts were predicting that collapse. But, those in the real estate industry poo-pooed those claims because they, too, had their greed. Wall Street companies fed that monster with cheap and low or no money down home loans. Our Congress threw the lending protections out the window when it replaced Glass-Steagall with the Gramm-Leach-Bliley Act. A law that was vetoed once by Bill Clinton until it met Clinton's demand for the easier loan availability for minority and low income borrowers. That Clinton requirement, alone, put a lot of unqualified people into the housing market and situated them for possible foreclosure situations once the market collapsed. To further this problem, numerous ex-Clinton Administration personnel like Jamie Gorelick joined the likes of Fannie Mae and further pushed the low income home buying concept on an internal basis within these psuedo-government run companies.

As long as the monster kept growing, things were fine. Wall Street was happy to blindly make profits by feeding the growing disaster in the making. The Federal Reserve, following the Clinton-recession and economic disaster of 9/11, had lowered interest rates to historic lows to try and get the economy to recover. The historically low interest rates kept money flowing into the housing market as more and more unqualified buyers bought homes at low mortgage rates. The rapidly rising market value of homes attracted more and more investment capital and house flippers. The home builders saw a seemingly endless market and kept building homes and extending their inventories to meet the demands.

But, the party stopped when the Federal Reserve stopped keeping the rates low and, then, began raising rates on a constant two-month clip as Greenspan believed he was fighting inflation. Inflation that was never really seen. The rapidly rising rate increases by Greenspan did not give our economy and the home buyers a chance to adjust. It was analagous to pulling the rug out from underneath the housing market. Once those rapidly rising interest rates reached a tipping point, the market started to dry up and the boom was effectively over. Interest rates were high and a lot of homeowners, that were holding sub prime, floating loans (adjustable rate mortgages), got caught with new monthly rates that were more than they could ever afford. As loans defaulted at a rapid rate, the lenders like Countrywide, were stuck with borrowers walking away from their loans. Those homes were now worth 20 to 50 percent less than the value of the original loans. The banks and lenders ate the difference and they had inadequate loan-loss reserves to cover the massive defaults. This resulted in the potential of bankruptcy for numerous lenders.

During the boom, more than 20 million new home owners were created. Today, 10 percent of those homeowners are in or near foreclosure. It's those foreclosures that have killed the credit market and driven home prices into the ground to a greater extent then if the market demand for housing had just dried up on a normal basis. Also, as a result of the collapse, many of those new homeowners have loan amounts that are now 20 to 30 percent higher than current value of their homes. If they lose their jobs as a result of the weakened economy and can't afford to continue to pay or payoff their inflated mortgage amounts, the foreclosure rate is sure to continue to go up.

What went wrong? A lot of things did. They all contributed to creating a "perfect storm" in the credit markets. You could say the Republican Congress and willing Democrats and Bill Clinton were at fault. You could say that Wall Street greed was at fault. You could say the system of allowing banks to sell off their loans to other lenders so that they could take on more unsecured debt was at fault. You could say our system of loan-loss reserves was too weak. You could say that the Federal Reserve kept rates low for too long and, then, raised its rates too fast. You could blame Hollywood for all those TV shows on "house flipping" and making a quick buck in the housing market. You could blame the lenders for giving people low interest loans with little or no down payments and not enough of a valid credit history to qualify for those loans. Certainly, there were signs that the collapse was coming as early as six years before it actually happened. But, no one acted.

I hardly think that the management of all those companies that are now tanking, like Lehman Brothers, planned for this state of affairs as some politicians would have you believe. We now have lost some business institutions with over a 100 year history of operations in this country. Our government, as usual, has perfect hindsight in these situations but, was never ever willing to act until the worst actually happened. They were more concerned with having hearings on the Bush Administration failings and drug usage in Major League Baseball than having hearings on the housing market. So, we now have the blame-game going on. Sadly, the government regulation that is due to come out of this fiasco will do nothing but hamper our economy and it may take years upon years for us to actually recover than if we simply repealed the measures within the Gramm-Leach-Bliley Act that were at fault. There are plenty of other measures that exist in regulation that were waived that should be back in force, once again, to take risk out of the credit and housing markets. We don't need a whole series of new regulation.

The subprime mortgage problem actually started to rear it's ugly head in late 2006. I find it very telling that the Democratically-controlled Congress has not acted with their typical and constant public hearings and, even, the creation of a commission to look at all the causes. Do you get the feeling that some guilt is being hidden by not having full-blown hearings and a commission to investigate it?

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