Economic "crisis," cause and effect

[cannon_fodder]

The government determines that home ownership should be available and affordable for everyone.

As a result, the government mandates loan quotas and encourages reckless lending.  Liquidity is injected to assure cheap loans.  Tax laws are structured to encourage ownership of the most expensive home possible.

A housing boom and bubble builds during the cash flush dot com era.  When it bursts, government redoubles its home ownership effort.

Lending institutions, taking note of the policy, lend accordingly with reckless abandon.  The mortgage securities have special tax and bankruptcy treatment granted by the government, encouraging institutions to exuberantly buy them up.  The quasi governmental Freddie and Fannie prop up this market as buyers of last resort.

As a cumulative result home ownership rises and more cheap sprawling subdivisions are built (simultaneously exhausting the nations infrastructure budget).  The ownership demand outstrips available supply in many markets that are running out of building space (most notably Western cities surrounded by Federal no-build enclaves: San Diego, Los Angeles, San Francisco, Portland, Seattle, Las Vegas, Denver).  Housing prices soar in many markets on the artificially inflated demand (created by governmental incentives of cheap loan availability).

Inevitably the artificial liquidity puts inflationary risk into the market and rates are raised, thus ending the spiral.  The glut of home building provides an excess amount of housing as the raised rates begin to cause foreclosures.    That puts downward pressure on the housing market and home prices fall below the loan amounts.  Triggering more foreclosures, which puts downward pressure on the now flooded market, and causing trouble for people who were leveraging their lifestyle on inflated real estate.

So the government proposes (another) cash injection into the economy in an attempt to keep liquidity and lending practices alive.  More liquidity should enable banks to make more loans so people can afford to pay inflated prices for homes.  Thus sustaining the housing market at artificially high levels.
- - -

Government goal:  affordable home ownership

Result achieved:  record increase in home cost.

But Congress and the President assure me that government is going to fix this problem.  so thank god.


* Greed is of course a factor also.  On Wall Street and on Main street.  I'm not tossing the Republicans nor the Democrats under the bus, I'm tossing them both.  The political boat was happy floating high on the flooded river and neither party wanted to bother looking to see what was down stream.  Now that the flood they helped create and certainly didn't try to stop is hitting populated areas they'll throw money at the problem.

This is no great depression (economic fundamentals are sound:  manufacturing, agriculture, and most service sector jobs are doing just fine).  It is a large market correction of everything artificially inflated or bet (direct or indirectly) on the inflated housing.  The best thing the government can do is allow it to land softly - don't try to save it.

[Conan71]

Just so you don't think this fell on deaf ears.  

I miss the good ole days before you had a real job and could keep everyone well informed from somewhat of a centrist perspective. []

[we vs us]

I think you summarize the consumer and housing side of the crisis pretty well, though I think it's far from certain that Clinton era affordable housing initiatives propped up this bubble . . . I think it's way more likely that lack of oversight and an easy money policy (low, low interest rates) from the fed spurred it on.  

What you're not talking about much is how these bad mortgages were securitized, rated, and sold, and how that contributed much more directly to the bank failures we're seeing today.  

One of the main problems here is that mortgage lending became divorced from its main purpose, which should be to help an individual consumer secure a home.  In fact, that purpose became secondary.  The primary purpose became simply to make enough loans -- good, bad, or middle of the road didn't matter -- to bundle and sell off as a Collateralized Debt Obligation.  And CDOs were virtually all bought and sold by investment banks, almost all of whom are now nonexistent.  

CDOs came into being in an effort to 1) find a new way to make mortgage debt into a security and 2) to diffuse the risk enough amongst the various counterparties so that no one could take a hit.  These securities have become enormously popular because they are unregulated and because the housing boom guaranteed incredible gains. Figures I've seen vary, but anywhere from 1 to 2T$ globally is invested in these securities.  

One of the unspoken problems here is the collusion of the bond rating agencies (Standard and Poor's, Moody's, etc.)  These agencies are the Consumer Reports of the bond markets, and are trusted implicitly to rate the quality of a company's debt (which is in essence what a bond is).  The problem is that these agencies are for-profit, and take payment from the entities who float bonds.  In the case of CDOs, the rating agencies neither understood them nor assigned them accurate ratings.  Typically, CDOs were given excellent ratings, and hence became excellent investments.  

Most investment banks had no qualms about investing in these vehicles that 1) had excellent ratings, 2) were unregulated, 3) were structured explicitely to be risk free, and 4) were based on a booming housing market. This also explains the global rush to invest in them.

Problems start occurring when the underlying loans (the mortgages) start defaulting.  Individual homeowners cease payment on a variety of different loan types for a variety of different reasons, but the effect on the security is to destabilize it.  Because the CDO risk was supposedly diffuse, no one now understands who is left holding the bag.  Who will take the final hit?  Who will pay?  No one knows, and consequently their value fluctuates wildly, because if you can't accurately assess risk, you can't accurately assess value. So these CDOs now have a value anywhere between 0 and infinity, but no one knows exactly how much.  

So while the problem is occurring on an individual level -- a homeowner who may or may not be facing foreclosure due to a bad decision -- the problem is amplified into the credit markets because banks own and have invested in hundreds and thousands of these bad mortgages-as-securities, and now must dedicate all their capital to paying down these securities.  

There're more facets to this discuss, but I have to go to work now []

[sgrizzle]

[waterboy]

Good stuff WeVus.

A knowledgeable veteran of economics told me recently that he was very impressed with how the players in the financial markets had managed to take what was basically an asset and transform it into a liability and did so without regulatory oversight. When you hold a mortgage it is an asset, a source of future revenues backed with an interest in real property. When you combine it with 1000's of other mortgages and sell them as a security on a market, they are now a liability. You must rely on the ratings of others as to the strength of that security and since the ratings companies are being paid by the security sellers, its value is suspect. All this occurred out of the purview of regulators.

Then I saw guests on MSNBC relay the same thought this morning. They noted with incredulity that now it is difficult to know who is even on the hook for these liabilities. Meanwhile the culprits who securitized these packages as CDO's took their profits and live in Manhattan totally financially protected.

It took me a while to understand but it highlights that this was not the result of loosened lending requirements, was not the result of a Clinton/Bush era focus on an "ownership" society. It is the reflection of how a weak economy was masked with a hot mortgage market that was being grown and exploited by unsupervised bandits. These guys were smart but lacked any self restraint.

More and more I am doubtful of the re-structuring plan being proposed and modified. Who does it benefit most? We need credit flow in the system but is this the best way to do it? Who the hell am I? We're just as much at the mercy of Congress as the economy was at the hands of investment bankers. Just making note.

[Conan71]

Wevus, packaging and re-selling debt is an old practice, though packaging it as securities is a newer idea to broaden investment in our debt and to make more cash available for more loans.  Tulsa, unfortunately figures prominently in the history of "debt for securities".

The way it used to work was Bank A in Tulsa would decide they wanted out of the rural real estate business, so they would package up all their loans in rural areas into one bundle and sell it at a discount from the remaining balance to Bank B or another lender.  Or a retail lender like CitiFinancial or AIG might decide to get out of the furniture finance business and sell off their furniture loan portfolio at a discount to another retail lender.

Unfortunately, Wall St. had a glimpse of the perils of consumer debt-backed securities when CFS crumbled right about 10 years ago.  Charged-off credit card debt was bundled and sold on Wall St. as securities.  The only real "collateral" on the bundles of securities was CFS's reputed ability to collect the debts.  I believe CFS owned around $15 bln at face value of "signature" debt (iow- there was no security other than the borrowers promise to repay).  Naturally, they owned it for pennies on the dollar.  If I had to guess, CFS's total investment was maybe 20% or less of face value.

I guess Wall St. figured it was an aberrition and Bill Bartmann was just a huckster from Muskogee who got lucky.  Certainly wouldn't happen in the mortgage business, after all there were sticks, bricks, and dirt ultimately securing those loans, but they still could create a hedge, just in case.

Wall St. realized that when real estate markets peaked and inevitably cooled off, that the ultimate value of the "collateral" on the debt they were buying could be worth less than the debt they were holding.  Instead of following common sense, mathematicians and physicists were ostensibly employed to write out formulas which would create collateral out of other financial instruments to offset the risk of lower hard collateral values.

The claim now is that hardly any of the  financial experts understand how these securities work(ed), nor could they figure out how to tell if they were shielding bad debt or not.  It's somewhere between a shell game and ponzi scheme.

For those of you who missed the 60 Minutes segment on the debacle Sunday night, it's one of the better presentations of the mess put into layman's terms:

"Altman says one of the biggest problems is uncertainty about how much bad debt Wall Street has hidden away.

"You know I have heard that some of these financial institutions were hiring mathematicians and physicists to write the mathematical formulas that underlied some of these investments, and pretty soon nobody understood what was going on any more," Pelley said.

"Well yes, a level of financial exotica ensued, which boggled the mind and which almost everyone involved didn't understand," Altman replied.

Federal agencies that regulate Wall Street didn't understand, and neither did the companies that rate the quality of investments.

"You're telling me that the credit rating agencies didn't understand these investments?" Pelley asked Altman.

"We had the first instance, at least in my memory, where AAA rated instruments, the highest rating, actually defaulted while rated AAA. Now there's something wrong with that," he replied. "

http://www.cbsnews.com/stories/2008/09/28/60minutes/main4483612_page3.shtml

Wall St. creating artificial collateral is most defintely a part of the debacle, as is lack of government oversight on the bureaucrat, legislative, and executive levels.  

Still, you cannot discount the effect of several hundred thousand home owners not paying their mortgage obligations back to the street level lenders.  If all those loans were still performing, there would have never been a chain reaction.  In this case, **** has definitely run up-hill.

Watching Congress fumble this so badly this week and everyone being afraid of losing their job over how they vote is all anyone needs to know that USHOR and the Senate should no longer have any direct oversight of securities and banking.  Too many financial institutions have spread money around to keep this orgy going for years.  It appears that just about every Republican and Democrat has fed from this trough of corruption.

I hate bureaucracy with a passion, but this is one case where Congress is showing their limitations in a crisis because some members are afraid to do the right thing.  You can see clearly that legislators are trying to figure out which way to vote on this which will equate to the least amount of votes lost on Nov. 4.

[we vs us]

Debt's been sold forever -- what's a bond, really, but a purchasable debt?  But CDOs are by all acounts much different beasts, and their intentional complexity is the crux of the problem.

More broadly, it's important to me to fully explain Wall Street's role in this; otherwise the individual mortgage holder ends up taking all the blame and this crisis becomes nothing more than a morality tale that reinforces certain ideological biases.  I don't think the individual is blameless in this, but there're bigger players here who had means and motive to keep the mortgage money flowing, and at any cost.  

I'm not sure how this is an argument for less regulation, however . . . or for less government.  I can think of several places where even the broadest of rules -- so long as they were enforced -- could've mitigated elements of this disaster.  One place would be in mortgage lending standards, which could use more transparency in documentation and more plainly stated terms with the borrower. Another would be in finding ways to normalize the bond ratings system and to remove the rating companies from conflicts of interest. Another would be in making sure that CDOs are constructed with better integrity and that risk and reward are specified clearly.

None of these things have to do with market manipulation or somehow corrupting entrepeneurship; all of them are strictly about improving the flow of information to the markets.  

And as for the politics of the bailout, I think our congressmen and women are getting very mixed messages from their constituents, and because the American people are confused and angry, the congress is mirroring that.  It doesn't help that this is happening a little more than a month before a major election.

I've been kinda of taken aback by the class warfare angle that Republicans in the House have been working the last couple of days.  A lot of the Main Street vs. Wall Street flogging is a bit shocking and more than a little hypocritical, especially when the conservative critique is about how personal responsibility on the homeowner side is the root cause of this debacle.

[iplaw]

Wasn't it Obama that criticized McCain and the Republicans for NOT mentioning Main Street enough?

[we vs us]

quote:Originally posted by iplaw

Wasn't it Obama that criticized McCain and the Republicans for NOT mentioning Main Street enough?

You're the guys who get the vapors every time you hear the words "class warfare" or "income distribution."  I'm just pointing out that a significant contingent of House Republicans had to choose either the rock (Big Business in its hour of need) or the hard place (Mr. and Middle Class, furious and possibly ignorant of  repercussions).  The House Republicans chose Mr. and Mrs. Middle Class. Too bad that pitts them directly against Big Business.

[we vs us]

Effect:

Schwarzenegger to US:  State may need $7 billion loan:

quote:SACRAMENTO -- California Gov. Arnold Schwarzenegger, alarmed by the ongoing national financial crisis, warned Treasury Secretary Henry M. Paulson on Thursday that the state might need an emergency loan of as much as $7 billion from the federal government within weeks.  

The warning comes as California is close to running out of cash to fund day-to-day government operations and is unable to access routine short-term loans that it typically relies on to remain solvent.

So credit for everything -- not just for houses -- is going bye-bye.  The article is about short term payroll loans, but car loans have been taking a big hit, and credit card companies are closing or tightening credit to consumers.  

And then there college and university investment funds:

quote: An investment fund that serves about 1,000 colleges and private schools has partially frozen withdrawals amid the nation's credit crunch.  

That move is forcing many schools and colleges to develop new plans to pay bills.  

Wachovia Bank is the trustee for a 9.3-billion dollar Short Term Fund offered by Commonfund, a Connecticut-based nonprofit that advises colleges and schools on money management.  Wachovia announced plans this week to terminate the fund and establish a process to ensure the orderly liquidation and distribution of the fund's assets.

Among other things, this crisis has pointed up just how important lending and credit is to the smooth function of our economy.  Without it, EVERYBODY -- consumers, institutions, government, and business -- is out in the cold.

[Conan71]

Here's my take, Wevus:

Lending and credit is important to the healthy  GROWTH of the economy.

When it's needed for the smooth operation of our economy, that's an indicator it's been over-used for expansion and/or we've over-expanded.

[Crash Daily]

Check this out. Even, former President, Bill Clinton knows exactly who is to blame. Now if only Clinton would speak up about how dirty Obama's hands are, on this issue. [}:)] He's just as guilty as Barny Frank.

http://www.foxnews.com/story/0,2933,432501,00.html

quote: WASHINGTON —  Unqualified home buyers were not the only ones who benefitted from Massachusetts Rep. Barney Frank's efforts to deregulate Fannie Mae throughout the 1990s.  So did Frank's partner, a Fannie Mae executive at the forefront of the agency's push to relax lending restrictions.  Now that Fannie Mae is at the epicenter of a financial meltdown that threatens the U.S. economy, some are raising new questions about Frank's relationship with Herb Moses, who was Fannie's assistant director for product initiatives. Moses worked at the government-sponsored enterprise from 1991 to 1998, while Frank was on the House Banking Committee, which had jurisdiction over Fannie.  Both Frank and Moses assured the Wall Street Journal in 1992 that they took pains to avoid any conflicts of interest. Critics, however, remain skeptical.  "It's absolutely a conflict," said Dan Gainor, vice president of the Business & Media Institute. "He was voting on Fannie Mae at a time when he was involved with a Fannie Mae executive. How is that not germane?  "If this had been his ex-wife and he was Republican, I would bet every penny I have - or at least what's not in the stock market - that this would be considered germane," added Gainor, a T. Boone Pickens Fellow. "But everybody wants to avoid it because he's gay. It's the quintessential double standard."  A top GOP House aide agreed.  "C'mon, he writes housing and banking laws and his boyfriend is a top exec at a firm that stands to gain from those laws?" the aide told FOX News. "No media ever takes note? Imagine what would happen if Frank's political affiliation was R instead of D? Imagine what the media would say if [GOP former] Chairman [Mike] Oxley's wife or [GOP presidential nominee John] McCain's wife was a top exec at Fannie for a decade while they wrote the nation's housing and banking laws."  Frank's office did not immediately respond to requests for comment.  Frank met Moses in 1987, the same year he became the first openly gay member of Congress.  "I am the only member of the congressional gay spouse caucus," Moses wrote in the Washington Post in 1991. "On Capitol Hill, Barney always introduces me as his lover."  The two lived together in a Washington home until they broke up in 1998, a few months after Moses ended his seven-year tenure at Fannie Mae, where he was the assistant director of product initiatives. According to National Mortgage News, Moses "helped develop many of Fannie Mae's affordable housing and home improvement lending programs."  Critics say such programs led to the mortgage meltdown that prompted last month's government takeover of Fannie Mae and its financial cousin, Freddie Mac. The giant firms are blamed for spreading bad mortgages throughout the private financial sector.  Although Frank now blames Republicans for the failure of Fannie and Freddie, he spent years blocking GOP lawmakers from imposing tougher regulations on the mortgage giants. In 1991, the year Moses was hired by Fannie, the Boston Globe reported that Frank pushed the agency to loosen regulations on mortgages for two- and three-family homes, even though they were defaulting at twice and five times the rate of single homes, respectively.  Three years later, President Clinton's Department of Housing and Urban Development tried to impose a new regulation on Fannie, but was thwarted by Frank. Clinton now blames such Democrats for planting the seeds of today's economic crisis.  "I think the responsibility that the Democrats have may rest more in resisting any efforts by Republicans in the Congress or by me when I was president, to put some standards and tighten up a little on Fannie Mae and Freddie Mac," Clinton said recently.

[RecycleMichael]

First Crash...

He wasn't "a top executive", he was an assistant director of product initiatives. That is like saying he was the assistant to a middle manager.

Secondly, Barney Frank and your "suspect" broke up ten years ago. These two government finacial institutions were in pretty good shape back then.

Thirdly, what part of this "foxnews" story mentions Obama? You just throw in his name with this story hoping posters associate them together?

[Crash Daily]

First of, they were still together when this went down.

Second off, even clinton said he was obstructing regulation.

Thrid, I'm just mentioning Obama because he IS tied to Freddie and Fannie. I didn't say it was this particular issue. if you don't know how dirty his hands are in this mess, go find it yourself.

[Hoss]

quote:Originally posted by Crash Daily

First of, they were still together when this went down.

Second off, even clinton said he was obstructing regulation.

Thrid, I'm just mentioning Obama because he IS tied to Freddie and Fannie. I didn't say it was this particular issue. if you don't know how dirty his hands are in this mess, go find it yourself.

Kinda like the lobbyists working for McCain still taking money up until August *cough*RickDavis*cough*