In examining the current economic mess, one looks for culprits. Certainly there are enough around, some are easy to see high profile CEO’s with massive bonus and unbelievable salaries while others, less visible, are *gosh* homeowners or should I say former homeowners.
In times of crisis everyone heads to a cave to peer out and look for “the one” who did it. But this crisis has been building for years and the signs of the collapse has been public since at least 2005. So a little research on the subject turned up a few tidbits.
Well first of all what really started this ball rolling downhill? Every journey has a start and this one started back in the early ’90s with Congress. Freddie Mae and Freddie Mac were set up by the Federal Government to guarantee home loans. The idea was to expand the housing market by making more funds available. the housing market is a key growth area for the economy and more important and important sense of well being factor for most Americans.
The problem with them both was that they were political animals that congress could dictate terms to and they did. Make it easier for everyone to own a home was the mantra. And along with that manta came the politicizing of the loan process. It now became a political tool to push a political agenda, and for those who ran Freddie Mae and Mac a route to higher bonuses. It was a classic tale of high short term profits that killed the long term business of the company.
In this case the congress pushed for lowering standards for granting loans under the guise of lowering the bar to entry to new home owners. Even to the point of allowing a previously banner program of home owners receiving down payment of a third party with donations made by the lending banks themselves!
You might asked how that worked. Well the receiving bank made a “donation” to a non-profit in the amount of the required downpayment that in turn was used by the receipient to make the downpayment! And guess what, the loans made were typically 3% higher because of it! Suprise – didn’t think the bank was going to lose money over that one did you? And now the fun part – who guaranteed the loan made by the bank? Well Freddie Mae and Mac. So what happened – more loans! Bigger bonuses for a job well done.
Well you can see where this leads can’t you. Right down the drain which is where the 5 trillion dollars worth of loans guaranteed by Freddie Mae and Mac are.
So didn’t someone see this coming ?
Yes a lot of people did, several congressmen, senators and a few responsible people in the government did too.
Didn’t hear a lot about that did you. Well here is one report issued by the GAO last year. The same consultant sounded the alarm in 2005.
http://www.gao.gov/htext/d071033t.html
So another interesting thing about this group at Freddie Mae and Mac is even though they were a government established companies, and were acting on behalf of the US Government. They lobbied congress! Amazing guess what, the more liberal the loan policy became, the more loans they underwrote, the bigger the bonuses got!
Well it doesn’t just end there either.
It starts with the real estate companies who started making higher property assessments to cover the higher costs of the new loans, pushed by the banks and morgage brokers who wanted to write more loans (which they had no liability for after all they were “guaranteed” by Freddie), and sought after by people who couldn’t afford the loan they were getting.
So how did these new homeowners (many of you might be reading this blog) “afford” these new loans? Variable rate morgages with no down payment. So like all the credit cards – “NO INTEREST FOR THE FIRST YEAR” come ons, the variable rate morgage did the same thing. Get in easy low payments for the first year then boom – reality comes to bear. Of course the new home owners look at escalating property values and think, well by the time reality comes I will have sold my home for a profit and can afford my new house.
Well that works when the market is moving your way, but let it slow down or stop and then you have disaster.
Which brings us to today.
Disaster.
What makes this disaster doubly bad is not only did Freddie Mae and Mac do this but a lot of private investors did the same thing, then Wall Street came up with a new idea. Lets take the morgages and think of them as real money and use them to back up loans and other finacial instruments and raise even more money.
So we have money that might not be paid back because we KNOW that the people getting this loan can’t really afford it, but maybe it will work out in the future….
Then we pretend that there is 100% chance all will be ok and then use that to guarantee other loans.
Does that sounds like Financial Russian Roulette to you? Yep problem is that 5 of the 6 chambers has bullets in it and your survival is more an act of God than reason.
Reminds me of that famous line “What were they thinking!!”
Bonuses friend bonuses, they hyped the market into buying these things and the money flowed and the bonuses flowed to these financial geniuses.
Does anyone remember Michael Milken, the junk bond king? Even he is astounded by the subprime morgage crises. At a recent appearance in HK he said at my company we were leveraged at a maximum of 4 to 1 and these banks were leveraged at 20 -30 to 1!
So then we ask who do we blame for this mess?
All of you. The congress that mandated that loan requirements had to be “easier” so that people who couldn’t afford homes could buy them anyway. The Freddie Mae and Mac guess that guaranteed these loans so that they could get higher bonuses. The banks and morgage brokers and appraisers that allowed and in many cases “helped” these questionable loans be made and then passed the liability up the line to Freddie Mae and Mac. And last but not least those of you who bought these homes not by saving and getting a home but by “betting on the come” buying a house you couldn’t afford (and knew you couldn’t afford) but hoping to sell it off at a profit before the bill came due.
Well the bill is coming due now, only problem is the bill could be as high as 5 trillion dollars and everyone (and their children) will be paying this one for a long time to come.
Tags: crises, depression, Election '08, financial, Financial Crisis, mc cain, obama, world finance
