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.

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?