It's becoming clear (to me anyway) that "easy credit" is the major player that led up to the current financial mess. It goes way beyond home mortgages. I'm thinking that our whole economy's "strength" has been a mirage, built on people spending their futures today and paying dearly for it. The complex financial infrastructure that arose to hide the resulting enormous debt while rewarding senior execs of lenders is a result not a cause.
Looking for the "root cause" of this, I'm led to only one conclusion: irresponsible personal spending habits. The right-wing says "tough s**t, you should have known you couldn't afford it" and the left-wing says "the government should have protected you from your own irresponsibility with laws" (prohibiting businesses which prey on the irresponsible). Neither outlook is useful.
Once again, I'm looking for a root cause: Why did people become so much less responsible in the last 10-15 years? Credit cards with teaser rates, payday loans, balance transfer promotions, pre-approved credit card offers, "selling cash" (a la MBNA before they died), "no interest till 2012!"... all that stuff naturally flourished in an atmosphere of irresponsible spending. I keep thinking of the theme song to that old TV show Good Times, which contained "easy credit ripoffs"... In other words, I'm looking at the demand side of the equation while others look at the supply side.
Stay tuned, I'll write next about my answer.
Easy Credit and Irresponsible Spending
Engineering Analysis of the Financial Crisis (updated)
(update: added new links at the bottom)
I'm an engineer at heart, so I always want to get to the root cause of a problem before trying to formulate or evaluate a solution. For what its worth, here's my analysis. I'm no financial or political expert so caveat - the following is my view based on my own fact-finding. I'm also a political moderate, so don't expect me to bash the right or left.
After considerable personal research, I believe I've found the root cause of the current financial crisis: a failed social program euphemistically called "Affordable Housing". It started toward the end of the Clinton administration (in 1999) with a move by HUD to encourage banks to make mortgage loans to people who would not otherwise qualify. See Fannie Mae Eases Credit To Aid Mortgage Lending - New York Times. Look at the dateline of this article (1999) not the date at the top of the page. This opened the door to pressures from activists and local politicians on banks. Banks rolled back their lending standards in response. This in turn opened the door to real estate sales using all sorts of dodgy loans to what should have been unqualified people with zero-down, teaser rates, etc. Result: a feeding frenzy.
The banks had Fannie Mae and Freddy Mac "Affordable Housing mortgage insurance" to lean on and sold their trashy paper to them. This was followed by an extremely complex "repackaging" process that wrapped these loans up into what appeared to be highly rated securities. See The Subprime Primer or How did I End Up Paying For My Neighbors Home? Suffice it to say that "Affordable Housing" is what created the housing bubble. And that in turn created the impression among younger and less educated people that "real estate always goes up in value", and that in turn made it seem OK to repeatedly re-fi their houses and use the cash for luxury items. An unintended result of a well-intentioned social program?
But no investment "always goes up". So when real estate started down a little bit, the bubble burst, leaving people upside down with no skin in the game (zero-down, remember?). At the same time, their teaser rates expired and their payments went up. Shame on them for signing up for such a deal. Greedy homeowners share as much of the blame as do greedy Wall Streeters (who were being compensated for the stellar performance of their companies on the back of the artificial wealth created by "Affordable Housing"). But the prime movers appear to be the politicians who pushed for affordable housing through easy credit in the first place. That's what opened the door to the abuses that followed.
Foreclosure was so easy, just walk away, you don't lose anything. It's just like moving from one rental home to another. What amazes me is how few foreclosures it took to bring it all down. It was a house of cards. In retrospect, the whole thing was artificial so I shouldn't have been surprised...
Anyway, Fannie Mae and Freddy Mac ended up with so much toxic loan paper they failed. So did all of the investment banks. We don't have any more investment banks and they disappeared in months, poisoned by toxic loan paper. First, us citizens were put on the hook for the $700 billion bailout. And now us citizens are going on the hook for stock in a wide range of American banks, along with investors from foreign countries. See White House Overhauling Rescue Plan - New York Times.
So now I have the following questions:
- Who has been promoting "Affordable Housing" for the last 10 years?
- Whose responsibility has it been to oversee the evolution of that program and its effect on the financial system?
- Is there anyone who has tried to rein it all in in the past?
- Is anyone addressing this problem now? Are these bad loans still being offered and guaranteed by the government?
(Jul, 1998) Banks Share Blame for Credit Card Burden Published op-ed by my spouse Stephanie
(Sep, 1999) Fannie Mae Eases Credit To Aid Mortgage Lending - New York Times
(Sep, 2003) New Agency Proposed to Oversee Freddie Mac and Fannie Mae - New York Times
(Jul, 2005) S. 190 [109th]: Federal Housing Enterprise Regulatory Reform Act of 2005(*) (failed)
(Oct, 2005) H.R. 1461 [109th]: Federal Housing Finance Reform Act of 2005(*) (failed)
(Feb, 2008) A National Homeownership Strategy for the New Millenium (Acrobat, paper by Wharton Fellow)
(Sep, 2008) The Subprime Primer or How did I End Up Paying For My Neighbors Home?
(Sep, 2008) In Financial Food Chains, Little Guys Can’t Win - Ben Stein, New York Times
(Oct, 2008) White House Overhauling Rescue Plan - New York Times
(*) courtesy of GovTrack.us database of federal legislation
