The Avoidable Financial Crisis

The government brought us to the point of financial ruin with the 2008 financial crisis, the official review is in. If negligence and greed can blow a bubble why would there be any political will to prevent it from bursting? We need to re-evaluate big governments arrogance and their (in)ability to micromanage the economy at the extraordinary expense of the taxpayer and the country.

From the commission’s inquiry you’ll find light blame spread almost evenly across a broad spectrum – much too complicated for the average taxpayer to understand of course.

Why are those responsible not shut down, fired or in jail? Because a commission dampened that expectation by concocting an assessment of wide-spread blame and Chris Dodd/Barney Frank concocted legislature that appeared to address the wrong-doing fall guys.

Financial Crisis Inquiry Commission – concluded that this crisis was avoidable—the result of human actions, inactions, and misjudgments. Warnings were ignored. “The greatest tragedy would be to accept the refrain that no one could have seen this coming and thus nothing could have been done. If we accept this notion, it will happen again.

Their devastation numbers (very modest, I’m sure);

  • There are more than 26 million Americans who are out of work, cannot find full-time work, or have given up looking for work.
  • About four million families have lost their homes to foreclosure and another four and a half million have slipped into the foreclosure process or are seriously behind on their mortgage payments.
  • Nearly $11 trillion in household wealth has vanished, with retirement accounts and life savings swept away.
  • Businesses, large and small, have felt the sting of a deep recession.

“Yet there was pervasive permissiveness; little meaningful action was taken to quell the threats in a timely manner. The prime example is the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards. The Federal Reserve was the one entity empowered to do so and it did not.”

Flashback to 2008 – “Democrat Barney Frank, then ranking member and now chairman of the House Financial Services Committee, said, “I want to roll the dice a little bit more in this situation towards subsidized housing“? Isn’t the fact that the ranking Democrat in charge of oversight of Fannie Mae was in a sexual relationship with a high-ranking Fannie Mae executive a glaring conflict of interest? Isn’t it worth noting that Democratic Rep. Maxine Waters insisted, “we do not have a crisis at Freddie Mac, and in particular at Fannie Mae, under the outstanding leadership of Mr. Frank Raines”? Shouldn’t the American people know that Democratic Rep. Gregory Meeks insist that “there’s been nothing that was indicated that’s wrong with Fannie Mae?”

 Here’s the summary of the summary – FCIC Final Report Conclusions

  • We conclude this financial crisis was avoidable.
  • We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis.
  • We conclude the government was ill prepared for the crisis, and its inconsistent response added to the uncertainty and panic in the financial markets.
  • We conclude there was a systemic breakdown in accountability and ethics.
  • We conclude collapsing mortgage-lending standards and the mortgage securitization pipeline lit and spread the flame of contagion and crisis.
  • We conclude over-the-counter derivatives contributed significantly to this crisis.
  • We conclude the failures of credit rating agencies were essential cogs in the wheel of financial destruction.
  • We conclude a combination of excessive borrowing, risky investments, and lack of transparency put the financial system on a collision course with crisis.
  • We conclude widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets.

Besides the fact the foxes watching the henhouse all along, they ordered a commission of hounds to establish convoluted blame with a notable party politics slant. Carefully determining predatory buyers and lenders were as much at fault as Freddie Mac and Fannie Mae. They set up critical interviews that only select commissioners were notified to ask questions.  As a result of the meltdown we have been subjected to an over-reaching and recovery inhibiting Dodd-Frank Act regulation before the commission even took a serious look at the cause and effects that government created. This was predicted in an article by Thomas Sowell.

Need more of Thomas Sowell’s brilliance? Here he chronicles the financial debacle in five parts – The Politics of the Housing Boom“. The most critical information that came out of the financial commission – because I view it as the most unbiased – came from a dissent opinion by Commissioner Peter J. Wallison, The major cause of the economic bust is concluded as thus;

What Caused the Financial Crisis?
George Santayana is often quoted for the aphorism that “Those who cannot remember the past are condemned to repeat it.” Looking back on the financial crisis, we can see why the study of history is often so contentious and why revisionist histories are so easy to construct. There are always many factors that could have caused an historical event; the difficult task is to discern which, among a welter of possible causes, were the significant ones—the ones without which history would have been different. Using this standard, I believe that the sine qua non of the financial crisis was U.S. government housing policy, which led to the creation of 27 million subprime and other risky loans—half of all mortgages in the United States—which were ready to default as soon as the massive 1997-2007 housing bubble began to deflate. If the U.S. government had not chosen this policy path—fostering the growth of a bubble of unprecedented size and an equally unprecedented number of weak and high risk residential mortgages—the great financial crisis of 2008 would never have occurred.

Initiated by Congress in 1992 and pressed by HUD in both the Clinton and George W. Bush Administrations, the U.S. government’s housing policy sought to increase home ownership in the United States through an intensive effort to reduce mortgage underwriting standards. In pursuit of this policy, HUD used (i) the affordable housing requirements imposed by Congress in 1992 on the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, (ii) its control over the policies of the Federal Housing Administration (FHA), and (iii) a “Best Practices Initiative” for subprime lenders and mortgage banks, to encourage greater subprime and other high risk lending. HUD’s key role in the growth of subprime and other high risk mortgage lending is covered in detail in Part III.

Ultimately, all these entities, as well as insured banks covered by the CRA, were compelled to compete for mortgage borrowers who were at or below the median income in the areas in which they lived. This competition caused underwriting standards to decline, increased the numbers of weak and high risk loans far beyond what the market would produce without government influence, and contributed importantly to the growth of the 1997-2007 housing bubble.

When the bubble began to deflate in mid-2007, the low quality and high risk loans engendered by government policies failed in unprecedented numbers. The effect of these defaults was exacerbated by the fact that few if any investors—including housing market analysts—understood at the time that Fannie Mae and Freddie Mac had been acquiring large numbers of subprime and other high risk loans in order to meet HUD’s affordable housing goals.

Alarmed by the unexpected delinquencies and defaults that began to appear in mid-2007, investors fled the multi-trillion dollar market for mortgage-backed securities (MBS), dropping MBS values—and especially those MBS backed by subprime and other risky loans—to fractions of their former prices. Mark-to-market accounting then required financial institutions to write down the value of their assets—reducing their capital positions and causing great investor and creditor unease. The mechanism by which the defaults and delinquencies on subprime and other high risk mortgages were transmitted to the financial system as a whole is covered in detail in Part II.

In this environment, the government’s rescue of Bear Stearns in March of 2008 temporarily calmed investor fears but created a significant moral hazard; investors and other market participants reasonably believed after the rescue of Bear that all large financial institutions would also be rescued if they encountered financial difficulties. However, when Lehman Brothers—an investment bank even larger than Bear—was allowed to fail, market participants were shocked; suddenly, they were forced to consider the financial health of their counterparties, many of which appeared weakened by losses and the capital writedowns required by mark-to-market accounting. This caused a halt to lending and a hoarding of cash—a virtually unprecedented period of market paralysis and panic that we know as the financial crisis of 2008.”

Wallison goes on to say;

“No financial system, in my view, could have survived the failure of large numbers of high risk mortgages once the bubble began to deflate, and no market could have avoided a panic when it became clear that the number of defaults and delinquencies among these mortgages far exceeded anything that even the most sophisticated market participants expected. This conclusion has significant policy implications. If in fact the financial crisis was caused by government housing policies, then the Dodd-Frank Act was legislative overreach and unnecessary. The appropriate policy choice was to reduce or eliminate the government’s involvement in the residential mortgage markets, not to impose significant new regulation on the financial system.”

Image: renjith krishnan / FreeDigitalPhotos.net

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