The Economic Crisis

[Jaguar]

The financial crisis of 2008, which we are still experiencing today, has been the worst “melt down” since the Great Depression of the 1930’s. Many have tried to point at a single element of the economy as the culprit, while others assert it is the very nature of capitalism itself that caused the near collapse. Neither is correct for the economy of the United States, which produces approximately 25% of the worlds GDP. The collapse started in the US and because of the immense interdependence of world economies on the US dollar, the world followed.

The story of the market crash of ’08 is the culmination of 4 separate but connected events. To understand what happened, one must understand each event, who the main players were and how they connect to the other events. This post is a short forensic explanation of those events.

1. In 1977, the Community Reinvestment Act (1) (CRA) was passed by a Democrat Senate and House under President Jimmy Carter. The purpose of the act was to address alleged discrimination by banks against making loans to minority and poor peoples. (2) The act states that banks, which are private corporations, have “…shall not take into account an applicant's age (provided that the applicant has the capacity to enter into a binding contract) or whether an applicant's income derives from any public assistance program.”

2. In 1992, under a Democrat Senate and House, The Housing and Community Development Act of 1992 (3) codifies within its language the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 that creates the Office of Federal Housing Enterprise Oversight, and mandates HUD to set goals for lower income and under served housing areas for the GSEs Fannie Mae and Freddie Mac. What this did was force these GSE’s to buy up 45% of privately held high risk loans to spread risk, while, in opposition to that goal, they made even more funds available for high risk loans. The pending disaster was already in the making. When as early as 2001 the Bush Administration attempted to rein in the pending catastrophe, they were fought by and lost to the Democrats. (4)

3. As a result of this regulatory interference in the natural and sound loan practice of the housing markets, the “Derivative” came into being. This is a contract where one party sells the risk associated with a loan or mortgage to another party in exchange for payments to that party based on the value of the loan. A wall Street frenzy of betting on the default rates of loans began as investors looked for means to protect themselves in less regulated areas of the market. AIG invested heavily in derivatives. (5)

4. All the while, as the amount of very high risk loans was totaling trillions and trillion of dollars, the Federal Reserve Board slashed interest rates from 6.5% in 2001 to 1% in 2003. This influx of cheap money even further exasperated the high risk situation. Between 2003 and 2006, the FRB again raised rates to 5.25% in an effort to slow the housing markets. They knew the very precarious situation the economy was in but the damage was done. In 2008, the situation hit critical mass and the housing bubble burst, triggering the meltdown.

It would be nice to point at one person and say that was the cause. But this isn’t accurate or realistic. It was caused by a combination of events, parties, political philosophies and the combined poor judgment of all involved. The answer is not in a government take over the housing markets or of Wall Street. Too much influence in too few hands is what led to the catastrophe. The answer is in the return to the sound and proved practice of making loans available based on the ability to repay them, not on government policy that everyone should own a home.
_________________________

Apparently one can only post an URL after having made 15 or more posts here. I do not yet qualify, therefore my footnote links will not show.

 

[Neubarth]

Remember first and foremost that most of the high risk loans need never have been made. Sadly the system was set up to allow corrupt elements to profit quickly from outrageous mortgage loans.

It is the corruption that brought about the collapse, not just the legislation intended to put more minorities in houses.

When people do not have the means of making the house payment, they never should have been given the loan. Most of those people taking the corrupt loans were too dumb to even understand that they could not make the payments.

That corruption from the lending institutions needs to be punished with death.

 

[Jaguar]

Remember first and foremost that most of the high risk loans need never have been made. Sadly the system was set up to allow corrupt elements to profit quickly from outrageous mortgage loans.

It is the corruption that brought about the collapse, not just the legislation intended to put more minorities in houses.

When people do not have the means of making the house payment, they never should have been given the loan. Most of those people taking the corrupt loans were too dumb to even understand that they could not make the payments.

That corruption from the lending institutions needs to be punished with death.

It would appear that you missed the points I was trying to make. Corruption may have been a factor, but it stemmed from government policy, not corporations.

 

[Toro]

There isn't one thing that caused the financial crisis, but it certainly wasn't the CRA.

http://www.usmessageboard.com/economy/70006-cra-not-to-blame-for-housing-debacle.html

Its a nice narrative to reinforce right-wing talking points, but it isn't true. If it were true, then CRA-funded home prices would have risen faster than the market, CRA-funded home prices would have crashed harder during the crisis, and CRA-funded loans would have defaulted at a higher rate. All must be true if you believe in the efficacy of markets. Since none of them are true, there is no way the CRA could have even remotely been a cause of the financial crisis.

Since right-wingers are always looking at government for the source of all problems, then the financial crisis offers up one very huge target, the Fed. The Fed is most responsible because they enabled the excess creation of credit. They are the ones that kept interest rates too low and gunned the money supply.

But the market itself bears much of the blame as well. De-regulation of capital adequacy ratios leading to excess leverage, Wall Street and derivatives all played a major part as well. Sometimes markets fail.

 

[Neubarth]

Remember first and foremost that most of the high risk loans need never have been made. Sadly the system was set up to allow corrupt elements to profit quickly from outrageous mortgage loans.

It is the corruption that brought about the collapse, not just the legislation intended to put more minorities in houses.

When people do not have the means of making the house payment, they never should have been given the loan. Most of those people taking the corrupt loans were too dumb to even understand that they could not make the payments.

That corruption from the lending institutions needs to be punished with death.

It would appear that you missed the points I was trying to make. Corruption may have been a factor, but it stemmed from government policy, not corporations.

None of those hundreds of thousands of outrageous loans would have been made were it not for the corruption in the industry.

Put the corrupt to death within a few days of detecting what they are doing, and POOOF! the corruption will stop or, at least, diminish drastically in the matter of a few days.

When corrupt financiers have a choice between making a quick thousand dollars with ensuing death, OR doing business by the book, they generally follow the book.

 

[Neubarth]

There isn't one thing that caused the financial crisis, but it certainly wasn't the CRA.

http://www.usmessageboard.com/economy/70006-cra-not-to-blame-for-housing-debacle.html

Its a nice narrative to reinforce right-wing talking points, but it isn't true. If it were true, then CRA-funded home prices would have risen faster than the market, CRA-funded home prices would have crashed harder during the crisis, and CRA-funded loans would have defaulted at a higher rate. All must be true if you believe in the efficacy of markets. Since none of them are true, there is no way the CRA could have even remotely been a cause of the financial crisis.

Since right-wingers are always looking at government for the source of all problems, then the financial crisis offers up one very huge target, the Fed. The Fed is most responsible because they enabled the excess creation of credit. They are the ones that kept interest rates too low and gunned the money supply.

Toro, the CRA was the enabling legislation that make all of those thousands and thousands of illegal loans possible.

The FED was in no way responsible. That is just total bullshit.

 

[topspin]

The legislation allowed snake oil salesman to pare idiots mortgages sold to grannies? Got it

 

[Granny]

I was just reading an article in National Review on this same subject. It discussed some of the pitfalls with investments today and said gold is a better indicator of investor concern about government's finances than are interest rates on government bonds. The article went on to discuss other specifics about various investment options. Also in the article were statements on:

George Soros - "Granddaddy Democratic donor" - doubled his gold purchases to make that investment 7.5% of the $8.8 billion fund.

Eric Mindich - formerly with Goldman Sachs - gold investment 4% of his fund - doled out around $94,000 all to Democrats.

John Paulson - shorted housing market, more recently named in SEC's lawsuit against Goldman Sachs, started separate fund holding only gold investments - is another major donor to Democrats.

David Einhorn - another donor to liberal candidates and causes. Einhorn is very critical of the administration's fiscal management. In part, his speech before the Value Investing Congress last fall he said, "When I watch Chairman Bernanke, Secretary Geithner and Mr. Summers ... other major currencies ... I conclude that picking one of these currencies is like choosing my favorite dental procedure ... holding gold is better than holding cash.

The rest of the article is just ... thoroughly scary and depressing.

 

[topspin]

I'll buy gold when I hit 70.

 

[boedicca]

Don't forget the role of the Boston Fed in the early 90s. They published a white paper "encouraging" banks to adopt subjective standards for lending to people who do not qualify for traditional mortgages.

 

[Toro]

The legislation allowed snake oil salesman to pare idiots mortgages sold to grannies? Got it

That's very true too.

 

[editec]

The financial crisis of 2008, which we are still experiencing today, has been the worst “melt down” since the Great Depression of the 1930’s. Many have tried to point at a single element of the economy as the culprit, while others assert it is the very nature of capitalism itself that caused the near collapse. Neither is correct for the economy of the United States, which produces approximately 25% of the worlds GDP. The collapse started in the US and because of the immense interdependence of world economies on the US dollar, the world followed.

The story of the market crash of ’08 is the culmination of 4 separate but connected events. To understand what happened, one must understand each event, who the main players were and how they connect to the other events. This post is a short forensic explanation of those events.

1. In 1977, the Community Reinvestment Act (1) (CRA) was passed by a Democrat Senate and House under President Jimmy Carter. The purpose of the act was to address alleged discrimination by banks against making loans to minority and poor peoples. (2) The act states that banks, which are private corporations, have “…shall not take into account an applicant's age (provided that the applicant has the capacity to enter into a binding contract) or whether an applicant's income derives from any public assistance program.”

2. In 1992, under a Democrat Senate and House, The Housing and Community Development Act of 1992 (3) codifies within its language the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 that creates the Office of Federal Housing Enterprise Oversight, and mandates HUD to set goals for lower income and under served housing areas for the GSEs Fannie Mae and Freddie Mac. What this did was force these GSE’s to buy up 45% of privately held high risk loans to spread risk, while, in opposition to that goal, they made even more funds available for high risk loans. The pending disaster was already in the making. When as early as 2001 the Bush Administration attempted to rein in the pending catastrophe, they were fought by and lost to the Democrats. (4)

3. As a result of this regulatory interference in the natural and sound loan practice of the housing markets, the “Derivative” came into being. This is a contract where one party sells the risk associated with a loan or mortgage to another party in exchange for payments to that party based on the value of the loan. A wall Street frenzy of betting on the default rates of loans began as investors looked for means to protect themselves in less regulated areas of the market. AIG invested heavily in derivatives. (5)

4. All the while, as the amount of very high risk loans was totaling trillions and trillion of dollars, the Federal Reserve Board slashed interest rates from 6.5% in 2001 to 1% in 2003. This influx of cheap money even further exasperated the high risk situation. Between 2003 and 2006, the FRB again raised rates to 5.25% in an effort to slow the housing markets. They knew the very precarious situation the economy was in but the damage was done. In 2008, the situation hit critical mass and the housing bubble burst, triggering the meltdown.

It would be nice to point at one person and say that was the cause. But this isn’t accurate or realistic. It was caused by a combination of events, parties, political philosophies and the combined poor judgment of all involved. The answer is not in a government take over the housing markets or of Wall Street. Too much influence in too few hands is what led to the catastrophe. The answer is in the return to the sound and proved practice of making loans available based on the ability to repay them, not on government policy that everyone should own a home.
_________________________

Apparently one can only post an URL after having made 15 or more posts here. I do not yet qualify, therefore my footnote links will not show.

Nice encapsulation of the financial mechanics of what went wrong in the world of banking.

But I still think there's more to the story than just that

And the more to the story is the erosion of middle class purchasing power and the growing income distribution inequity which prompted the markets to create these goofy mortgages to begin with.

The above is not directly responsible for the currrent meltdown, it is, however, the underlying problem that is keeping this economy from recovering as it might have under happier circumstances.

We have been making people redundant for decades now.

Some of this is the inevitable outcome of increasing technology but some of it (the lions share) is our goofy notion that FREE TRADE (as currently practiced) is good for this nation overall.

It isn't.

 

[Jaguar]

Remember first and foremost that most of the high risk loans need never have been made. Sadly the system was set up to allow corrupt elements to profit quickly from outrageous mortgage loans.

It is the corruption that brought about the collapse, not just the legislation intended to put more minorities in houses.

When people do not have the means of making the house payment, they never should have been given the loan. Most of those people taking the corrupt loans were too dumb to even understand that they could not make the payments.

That corruption from the lending institutions needs to be punished with death.

It would appear that you missed the points I was trying to make. Corruption may have been a factor, but it stemmed from government policy, not corporations.

None of those hundreds of thousands of outrageous loans would have been made were it not for the corruption in the industry.

Put the corrupt to death within a few days of detecting what they are doing, and POOOF! the corruption will stop or, at least, diminish drastically in the matter of a few days.

When corrupt financiers have a choice between making a quick thousand dollars with ensuing death, OR doing business by the book, they generally follow the book.

You're quite misinformed about this. The Clinton administration pressured backs, with threats of audits and such, to make these loans. No banker in his right mind would lend money to someone who can't repay it.

 

[boedicca]

Steve Malanga wrote an excellent piece: The Long Road to Slack Lending Standards. It is one of the best summaries I have read regarding the proximate causes of the financial bubble and melt down.

Quoting from a study which declared that “underwriting guidelines…may be unintentionally racially biased,” the Boston Fed then called for what amounted to undermining many of the lending criteria that banks had used for decades. It told banks they should consider junking the industry’s traditional debt-to-income ratio, which lenders used to determine whether an applicant’s income was sufficient to cover housing costs plus loan payments. It instructed banks that an applicant’s “lack of credit history should not be seen as a negative factor” in obtaining a mortgage, even though a mortgage is the biggest financial obligation most individuals will undertake in life. In cases where applicants had bad credit (as opposed to no credit), the Boston Fed told banks to “consider extenuating circumstances” that might still make the borrower creditworthy. When applicants didn’t have enough savings to make a down payment, the Boston Fed urged banks to allow loans from nonprofits or government assistance agencies to count toward a down payment, even though banks had traditionally disallowed such sources because applicants who have little of their own savings invested in a home are more likely to walk away from a loan when they have trouble paying.

Of course, the new federal standards couldn’t just apply to minorities. If they could pay back loans under these terms, then so could the majority of loan applicants. Quickly, in other words, these became the new standards in the industry. In 1999, the New York Times reported that Fannie Mae and Freddie Mac were easing credit requirements for mortgages it purchased from lenders, and as the housing market boomed, banks embraced these new standards with a vengeance. Between 2004 and 2007, Fannie Mae and Freddie Mac became the biggest purchasers of subprime mortgages from all kinds of applicants, white and minority, and most of these loans were based on the lending standards promoted by the government. ...