I am not enthralled with the positions of either of the two major Presidential candidates on this topic. One of them appears completely clueless. The other has a better handle about the causes and potential remedies for the problem, but --- to stretch the Star Wars analogy to its breaking point --- insists upon casting his analysis as some kind of war between the Good Side versus Bad Side, with the implication that all of our present problems are the result of evil people doing evil things. I will let you, the reader, debate which candidate is which, but the one I wish to challenge today is the one who would like us to believe that these problems were entirely cooked up on the Death Star (there I go again).
There is a likelihood that, by the time that the definitive history of this episode is written, instances of actual fraud will be found. There was undoubtedly a culture of mutual reinforcement between what is now the late, lamented Wall Street and the corridors of power in
At a minimum, the following good intentions help to contribute to disastrous results:
1 ) It is a good thing to want lower income families to be able to live in dignity in a house that they own and in which they can take pride of ownership.
2 ) It is a good thing to shape public policies that might control fraudulent behavior.
3 ) It is a good thing to want to keep the economy out of a recession.
Yet from each of these good intentions came a piece of the witches’ brew that became part of the current financial mess. Let me elaborate:
1 ( home ownership). Loans to buy houses are called mortgages, and banks have traditionally been very cautious about them. “Prime” home mortgages require significant down payments and credit analysis. In the 1970s during the Carter administration, federal regulators began watching banks to insure that they followed equal processes in considering mortgages from low income areas. By the 1990s, the
2 (keeping the economy out of a recession). In 2000, part of the
3 (accounting regulatory reforms) Following the corporate scandals of the 1990s, federal regulators adopted new accounting standards that required certain types of firms to report their assets at market value, not at what the firms believed that the assets would actually return.
So how did this perfect storm of good intentions get us to where we are today? Well, when the Fed finally began to unwind their easy credit conditions, interest rates went up. This began to burst the housing price bubble. As housing price quit rising at their unsustainable levels, the next John Doe who lost his job was not able to get out from under his mortgage. More and more subprime mortgages went into default, which exacerbated the housing price slowdown, which led to more John Does having problems. All of this meant that suddenly sub-prime mortgage backed securities were not performing as advertised, and the prices of these assets began to fall. But as the prices of these securities began to fall, the new federal regulations on market pricing kicked in, and this threatened the balance sheets of many firms (including Fannie and Freddie). In order to raise cash, firms began trying to dump their toxic sludge mortgage securities, meaning that the prices began to fall faster, causing more firms to have balance sheet problems, and so forth. Companies that sold what was in essence “insurance” against such fluctuations got slammed, and their survival was threatened (AIG being the big example). When enough assets, now not just securitized sub prime mortgages but also insurance contracts, corporate debt, and equity, start crashing together, nobody can sell anything because no buyer can come up with enough liquid assets to make a purchase. This is the liquidity crisis panic that has hit the
There are plenty of lessons in humility to go around here. I suspect that a lot of people with economics training were mistaken in their analysis of six years or so of data on subprime mortgage securities. Federal accounting regulators didn’t see the broader effects of their new accounting standards. No adult in the