Saturday, December 8, 2012

How Did We Get Here?

I have been mulling a longer piece on the causes of the 2008 fiscal meltdown, but really haven't been able to motivate myself to get it done.  But this piece in the Washington Examiner lays out a couple of the causes that have been largely neglected in the media.

The media narrative has been that the 2008 meltdown was caused by greed; specifically corporate greed.  I happen to agree that corporate greed played a huge role in the collapse of the housing market.  Companies like Countrywide created mortgages where there was a significantly reduced probability of repayment.  Companies like Goldman Sachs....primarily Goldman Sachs...monetized those loans and then created worthless derivatives based on those loans.  When the fiscal house of cards collapsed, they were left holding all the money.

A nice deal....if you are Goldman Sachs.

I also think that individual greed played a role.  Specifically, the individual desire to have more than you can reasonably justify based on your income.  It isn't enough to just be able to "make the payments".

I can recall discussing mortgages back in the early 2000s with a friend.  Someone in his family had just taken out a mortgage where they would not be required to repay any principle.  They just had to make the interest payments.  We both thought they were nuts.

How did the market develop loans for which there was no expectation that the principle would ever be repaid?

It turns out that there was a program created during the Carter administration called the Community Reinvestment Act.  It was designed to help some folks obtain mortgage financing that might not otherwise be able to do so.   A big deal to those that qualified, but not really a big deal in the larger home finance market.

The Clinton administration took that program and put it on fiscal steroids with his National Homeownership Strategy.  The Bush administration changed the name, but otherwise kept the same program in place.  This program broadened the pool beyond otherwise credit worthy poor people to include people who had no rational expectation of repaying those loans.

I don't have the video, but I do recall seeing Mr. Clinton on TV in the fall of 2008 saying that perhaps his administration had been a little too aggressive when it came to boosting home ownership.

With more people buying homes, the price of homes went up.  Speculative investments were made on speculative investments.  Leveraging of debt occurred.

You would still think that the private risk incurred in creating such debts would cause financial institutions to shy away from the so-called "sub-prime" mortgages.  Here is where the government doubled down on a bad idea.

The amount of private risk was minimized by the federal government.  At the time of the meltdown, the U.S. government was almost the sole purchaser of sub-prime mortgages due to the efforts of Fannie Mae and Freddie Mac.

Essentially, the government created the mandate for the loans and then created a market that would offer the loans.  The net result is a tale that should have grown old by now; privatized profits and public risk.

From the article linked above:

"All of us participated in the destructive behavior -- government, lenders, borrowers, the media, rating agencies," said Warren Buffett. "At the core of the folly was the almost universal belief that the value of houses was bound to increase."
There are naturally other elements to the saga.  The influence peddling between members of Congress and companies like Countrywide that prevented the Bush administration from limiting the number of risky mortgages that Fannie and Freddie were snapping up.  The lax enforcement of investment laws by the SEC during the Bush administration.  The gutting of the Glass-Steagall Act (passed by a GOP led congress, signed by a Democrat President) may have also played a role.

It is corporatism...government imposed policies that favor certain corporate interests...writ large.

And the results were unsurprising to anyone that has spent more than a few moments studying American history.

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