Tuesday, September 15, 2009

A Year After the Lehman Collapse

It has been a year since the Wall Streeter, Lehman Brothers, filed for bankruptcy. It has been a year since the magnitude of the "toxic asset" situation was really exposed to sunlight. And, it has been year since we finally realized that the world's banking system was on the verge of becoming the economic equivalent of the Titanic.

While Obama seems to tout that it was his actions, since taking office, that kept our economy stabilized, the true savior of our economy was those actions that were taken by then-Treasury Secretary, Henry Paulson, and the current Fed Chairman, Ben Bernanke, in October of 2008. Their simple, but very expensive solution, was to use bailout money for our banks in what we now refer to as TARP. If those remedies had not been implemented as quickly as they were, we truly could have had a complete pancaking collapse of the world's banking systems; not just ours. That's because, at the time, there was a massive amount of world banking interdependency that was built heavily on a massive amount of extremely toxic home loans. The money that was infused by the Treasury and the Federal Reserve in October of last year provided just enough cover for any massive bank losses that could have resulted; and, that simply helped to prevent the potential domino effect of one bank collapsing after another as millions of mortgage loans began defaulting.

So, that disaster was averted. However, we are not out of the woods yet. Banks continue to go belly up and foreclosures are an ever-present problem; especially when commercial loans start defaulting. The FDIC, who is responsible for insuring our banks against any depleted funds, is becoming depleted, itself.

On Monday, Obama proposed new, more stringent regulation of our banks. However, to me, the need for new regulation isn't really warranted. We just need to restore those laws that were replaced during the Clinton Administration and to eliminate one very glaring law that was passed under Jimmy Carter. Then, too, we need to make sure that oversight is re-established to prevent any of this from ever happening again. Laws are fine as long as they are enforced; otherwise they are just another hidden piece of paper in a file cabinet.

Just remember, it wasn't the lack of laws that allowed Bernie Madoff to defraud all those people with his Ponzi scheme. Instead, it was the lack of oversight and investigation that allowed him to steal millions upon millions of people's hard-earned money. The same is true for the housing collapse and all those subprime loans that were allowed to go forward with many of our government agencies and lawmakers ignoring the impending doom.

As I alluded to before, the problem of the subprime loans goes back to the Community Reinvestment Act that was passed by Jimmy Carter and the dominant Democratic Congress at that time. That was really the genesis of all these toxic loans that have permeated our banking system and that nearly brought it to its knees. It is the law that allowed groups like ACORN and other activist groups to push banks into giving an increasing numbers of low income and high risk loans. Loans that would have otherwise been denied.

Then, too, you have to go back to the Clinton Administration and one Republican Senator by the name of Phil Gramm to see how some new laws were passed that allowed the banks to get involved in even riskier loan behavior. Because of Clinton and Gramm, some of the regulations and protections that had kept our banks from getting into risky behavior were totally abandoned. One such law, the Gramm-Leach-Bliley Act, that Clinton signed in 1999, completely repealed the protections of the Glass-Steagal Act of 1993 and is said to have been directly responsible for much of the subprime mortgage problems as it relates to Credit Default Swaps.

Further, after Clinton left office, some progressives from his Administration populated both Freddie Mac and Fannie Mae and they pushed these agencies into offering high risk loan sub-prime, Adjustable Rate Mortgages. George W. Bush, too, was part of the problem. He kept pushing a low-income home ownership agenda and Democrats, like Barney Frank, as a senior member of the Senate Banking committee, gladly obliged.

But, let's not forget, the Bush Administration knew that pushing too hard was going to be a problem and that's why they, on more than a few occasions, issued warnings that many in Congress seem to have ignored. Again, this was a failure of oversight. Efforts to reign in Freddie Mac and Fanny Mae were tactically blocked in Congress and it's banking committee because of the ideological whims of people like Barney Frank.

Finally, the real crack in the banking system started to show up as the Federal Reserve Bank, under Alan Greenspan, started to rapidly raise rates in 2004 through 2006 (Click to see a very telling graph). Prior to this, rates were kept unattainably low in order to fight the recessionary effects of the Clinton-recession and the attacks of 9/11. During that time, interest rates were kept so low that millions of Adjustable Rate Mortgages at subprime rates were established with near zero down payments for people who otherwise couldn't have afforded them. Further, as rates started to rise, people naturally rushed in to take advantage of low interest loans before they went higher; thus aggravating the subprime loan situation. Things really started to unravel when an increasing number of those sub-prime loans began to take on their annual resets and those holding those mortgages found themselves falling behind on their mortgage payments. Eventually, the holders of the loans began a process of foreclosure and the housing market started to collapse completely. Ultimately, the housing bubble had completely burst by the end of 2007 and there were signs that we could have a massive recession on our hands.

While there are those who are quick to blame Wall Street, it was a lot of government deregulation and the "gaming" of existing laws that caused the mess we are now in. All those banks, that are now in trouble, were being pushed by a government who saw low-income home ownership as a political tool and neither the Democrats or the Republicans are blameless for that shameless behavior. Congress, more than anything, should be blamed for ignoring the warning signs and for allowing the risk.

A lot can be done, and done quickly, to reestablish order in the mortgage loan and banking system in America. Much of this should have been done by Obama when he took office. Instead, he went on to the less important things like the reform of health care. He was more concerned with closing Guantanamo and paying back his campaign donors than modifying the laws that would protect Americans from another banking collapse.

First and foremost, we need to do something with the Community Reinvestment Act. Either rescind it or modify it in such a way as to insure that it doesn't become an overriding factor for traditional, disciplined loan activity. Whatever is done, this law should no longer be used as a "hammer" by outside groups, like ACORN, to force banks to abandon ethical loan behavior. Secondly, all those Gramm/Clinton laws should be looked at and modified to insure that loan loss reserves are being maintained and aren't being undermined by derivative investment instruments like the Credit Default Swaps. Glass-Steagal should be pulled out of the trash, dusted off, and at least partially reenacted. Lastly, it is paramount that oversight be restored. No one person, like a Barney Frank, should be able to push banks into giving loans that are outside the norms.

Freddie Mac and Fannie Mae should probably be divorced completely from the influences of our Senate Banking Committee. I think these two semi-government agencies should report to a Board of Directors who is partially nominated by the stockholders and partially nominated by the Executive Branch of Government and approved by Congress. The General Accounting Office (GAO) should conduct annual audits and those results should be made public without any prior Congressional review or tampering. Further, an independent non-government auditing firm should continue the normal quarterly audits.

We don't need new laws. We just need the laws put back in place that adequately protected us from the 1930's forward; like Glass-Steagal. We also need to shore up the ones that were passed in the late 1990's because the laws must be current for a modern banking system. Somewhere we need to make sure that there is clear oversight and protections of an annual audit of our banking system.


The Inquisitive said...

How can ACORN force a bank to make a bad loan? I have worked in the banking industry and it usually takes an armed robber to take money from a bank in an expected losing transaction. So how ACORN's advocacy translates into forcing business decisions I would like to know.

Cranky George said...

There are numerous descriptions on the web of how Acorn used the Community Reinvestment Act to force banks into low income loans.

Here's a quote from the site:
"So-called "community groups" like ACORN benefit themselves from the CRA through a process that sounds like legalized extortion. The CRA is enforced by four federal government bureaucracies: the Fed, the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Deposit Insurance Corporation. The law is set up so that any bank merger, branch expansion, or new branch creation can be postponed or prohibited by any of these four bureaucracies if a CRA "protest" is issued by a "community group." This can cost banks great sums of money, and the "community groups" understand this perfectly well. It is their leverage. They use this leverage to get the banks to give them millions of dollars as well as promising to make a certain amount of bad loans in their communities."

Any expansion by a bank from a new ATM to a new branch could be blocked until a minimum amount of community loans were given -- usually low income and low downpayment loans. This was further assisted by the introduction of products like the Credit Default Swaps and through the assistance of Freddie Mac and Fannie Mae. The CDS were able to provide poor rated loans the look and feel of a triple-rated loan using the provider's rating; the provider being someone like AIG.