Thursday, October 16, 2008

What Caused The Economic Downturn

“Your congressman is trying to make mortgages more expensive. Ask him why he opposes the American dream of home ownership.”
So said a Fannie Mae sponsored commercial issued in response to some in the federal government calling for increased regulation or competition. Unfortunately, even after a $200 billion bailout and Fannie Mae going into federal conservatorship - along with the ripple effect largely responsible for the $800 billion "rescue" bill - expensive mortgages are the least of our worries.

What is Fannie Mae? They, coupled with Freddie Mac, are a Government Sponsored Entity (GSE). Which means they are private corporations created and sponsored by the federal government. Fannie was established during the Great Depression in order to provide more liquidity to the mortgage market. They did this by buying up mortgages that other banks made to consumers. They would then resell some of these, while holding on to others. This buying activity allowed banks to make more and more loans, because they didn't have to service them. It was generally thought of as a good idea because banks making lots of loans meant it was easier for average citizens to buy homes. In fact, through these programs, US home ownership steadily rose.

Steadily, that is, until the last decade, during which time home ownership rates increased quickly as interest rates fell and the buying and selling of loans increased. There were other entities that competed against Fannie Mae and Freddie Mac in the mortgage buying market, but, as the director of the Congressional Budget Office Dan Crippen said, "The debt and mortgage-backed securities of GSEs are more valuable to investors than similar private securities because of the perception of a government guarantee."

This government-induced value made Fannie Mae very profitable. So profitable that they were able to pay their executives tens of millions of dollars in salaries and bonuses. They were also able to use those profits to lobby Congressional leaders with millions of dollars.

As competition grew, Fannie became more aggressive in what kinds of loans they would buy. They had begun to lose market share to competitors, and naturally wanted to retake the lead. But they also had other motivators beyond profits,
“Fannie Mae faced the danger that the market would pass us by,”

“We were afraid that lenders would be selling products we weren’t buying and Congress would feel like we weren’t fulfilling our mission. The market was changing, and it’s our job to buy loans, so we had to change as well.”
And what was the underlying mission that Fannie felt pressure to fulfill? Artificially facilitate mortgages to ever more and more people. As a result, between 2005 and 2007 Fannie guaranteed three times as many risky loans (loans made without documentation of income or savings) as it had in all earlier years combined. And that doesn't even include subprime loans.

During this same period, it became apparent to some members of Congress and the financial industries that Fannie Mae was in danger. But because of Fannie's government mandated "mission" - facilitate more mortgage loans, no matter what - all attempts to regulate or otherwise reign Fannie in were defeated. Despite sharp warnings from officials like Federal Reserve Chairman Alan Greenspan,
"Enabling these institutions to increase in size...we are placing the total financial system of the future at a substantial risk."
And increase in size they did. By July of this year they owned or guaranteed half of the $12 Trillion mortgage industry. Their scope meant just about every mortgage lender in the country, both large and small, relied on Fannie and Freddie to help them continue to make loans. Worse yet, because of the government-backed nature of the GSE's,"
Although banks are typically prohibited from concentrating their money in the stock or bonds of any one company, those regulations create an exemption for debt issued by Fannie Mae and Freddie Mac, which have long been considered the safest of investments."
Not only were banks heavily reliant upon Fannie, but they were allowed to dangerously leverage themselves because Fannie was backed by the government.

So we set up a program whereby the federal government can influence the market (making it behave contrary to its nature), force that program to expand until it dominates that market, and then induce excessive risk taking because it's backed by the very same government.

That is what caused the economic crisis. It wasn't greed. It wasn't capitalism.

It was government.


Anonymous said...

For those who really care about this issue, only Bob Barr, the Libertarian Party candidate is moral enough and conservative enough to deal with this issue and the rest of the current mess.

Here’s a recent press release from Bob (who has the backing of Rep. Ron Paul):

Press Releases › Wall Street Benefits Twice from Bailouts

October 11, 2008 11:36 am EST

Senator John McCain attempted to disguise reality by calling the $700 billion Wall Street bailout a “rescue,” but it’s obvious that the only people he and his colleagues were rescuing were the executives who had made bad investment decisions, as well as the politicians who had pushed increased mortgage lending, irrespective of cost, triggering today’s crisis. Now it turns out that the companies getting bailed out will benefit twice.

Most everyone has seen the story of how executives at AIG partied at a resort after the taxpayers were stuck with the bill for an $85 billion bailout—now being supplemented with another Federal Reserve loan of $37.8 billion. But what’s $440,000, including more than $23,380 for spa services, among friends when the taxpayers are paying?

Normally politicians wouldn’t have any business complaining about the cost of a corporate retreat, but what might be unexceptional for high-flying companies in a booming economy becomes outrageous when taxpayers are getting stuck with the bill. In this case they are paying twice, with the company collecting a new loan because its bottom line is even worse than originally thought.

Loan-two to AIG is small change compared to the extra benefits that Wall Street will receive. Many of the largest firms will be going to the spa, figuratively, at least. You see, someone has to manage all of the securities and other assets that the government plans on buying with taxpayer funds. And who better to manage them than the very companies that bought the bad paper in the first place!

The Treasury Department has requested proposals for asset managers, and according to the Wall Street Journal, the government “wants large, established firms with significant assets to work for the government’s program.” That means managing at least $25 billion, and in some cases at least $100 billion, in private assets. There will be a lot of money in fees—typically 1 percent of the assets managed, which could come to as much as $7 billion a year or more if government purchases go past $700 billion, as is widely expected.

Wall Street is looking forward to milking this latest cash cow. Since government jumped into the investment business, the Journal tells us that “a range of firms—from large investment banks to boutique real-estate companies—have been angling to grab some of the advisory business.” Representatives of some companies showed up in Washington to lobby even before Congress approved the bailout. And who can blame them? The Journal reports that “sales, financing and other traditional forms of real estate business have dried up with the credit crisis.”

Of course, most of these firms helped cause that very crisis. Most of the companies bidding for government business are suffering big losses and preparing to unload lots of bad paper on the government. Bad paper that other big companies with big losses and lots of bad paper will manage.

And so the circle will go on endlessly, at taxpayer expense.

The only problem is potential conflicts of interest, since companies will, notes the Washington Post, “be managing the assets while also selling their own troubled securities to the government.” But officials say they will attempt to “minimize” any conflict. No doubt, Washington won’t let a little thing like ethics stand in the way of letting everyone on Wall Street profit.

Indeed, politics are starting even before the president’s signature on the bill is dry. One analyst predicts that the Treasury Department will focus bailout funds on regional banks and thrifts, thereby providing “critical political support for Treasury’s efforts.” After all, “Congressmen who had to swallow hard to vote for this think will feel a lot better about it if they see the impact in their local communities.” Which is just another name for pork, like the spending programs and tax preferences loaded into the $700 billion bailout bill to win votes for passage.

All of this is politics as usual in Washington, and it won’t change whether Sen. Barack Obama or Sen. John McCain is elected president. Both of them supported the $700 billion Wall Street bailout, as well as the many other bailouts that preceded it. Both of them are part of the political establishment that helped create today’s economic problems. Neither of them will take the steps necessary to ensure that this sort of economic crisis doesn’t hit again. Only Bob Barr and the Libertarian Party are offering the sort of fundamental change that the American people need and deserve.

And here’s an article about the upsurge of interest in Bob Barr from the Atlanta Constitution:

The Wall Street debacle and the Barr effect

Friday, October 10, 2008, 04:20 PM

The Atlanta Journal-Constitution

Just checked in with Russ Verney, the campaign manager for Libertarian presidential candidate Bob Barr.

Verney said the Wall Street crash and bailout has revived Barr’s standing as a factor in the 2008 presidential race.

“We’re seeing an enormous amount of activity coming in from the web site, from people opposed to the bailout,” Verney said.

Many are die hard Republicans, he said. “They’ve had it, they’re coming over and they’re bringing their friends.”

This low-key but effective criticism of the $700 billion Wall Street rescue, videotaped in Barr’s Smyrna headquarters and posted on YouTube, is driving much of the traffic.

Verney said Barr’s new standing in the presidential campaign remains hard to measure. “Most of the polling eliminates us,” he said — under the label of “other.”

Here’s Bob’s Web site:

Broncop3t3 said...

Here is a great link to non-partisan information about some factors that lead us to this financial crisis. You can listen to it.