This Is Not Your Grandpa's Depression (Yet)

September 22, 2008

I don't know about you, but the wild roller coaster ride in the financial markets last week left me more than a little bit concerned about just where this country is headed. In one week, the entire landscape of Wall Street was transformed forever, as mega-titans of the investment business with household names like Merrill Lynch and Lehman Brothers disappeared and the world's largest insurance company, AIG, went into receivership under supervision of the US government. This came just a couple of weeks after the two federally-guaranteed private mortgage banks, Fannie Mae and Freddie Mac, were taken over by our government to prevent collapse of the mortgage market.

The numbers involved exceed a trillion dollars (that's a "1" with twelve zeroes behind it)--so large as to defy comprehension. The ordinary person is left to wonder what happened, what it all means, and who to trust. The impact of all this turmoil will not be known for months or even years. But we do know that thousands of investors have been hurt, thousands of homeowners who have underwater mortgages don't know where they stand, and thousands of jobs have been lost.

In the meantime, you and I are left wondering how all this will shake out. The current administration has stepped in with a massive financial tourniquet in the form of costly bailouts and takeovers to stop the hemorrhage and stabilize the financial markets. But how in the world did this come about in the first place? The simple answer seems to be that unchecked human greed had its inevitable consequences…

How so? In simple terms, relaxed lending standards made it too easy to make shaky loans. Lenders made loans without looking closely at the ability of the borrower to repay the loan. In the pre-Reagan days, most home loans stayed home with local thrift institutions, who held them to maturity and took the risk locally. The bonanza for mortgage companies came when they could sell the loans off, take their fees and let Uncle Sam take the risk. But after the loan standards were relaxed, too many people bought houses larger than they could afford. Thinking the housing boom would last forever, they used gimmick loans that distorted their ability to repay. The lender then sold the loan upstream to Fannie Mae or Freddie Mac, which put the mortgage into a pool of other similar loans and used the mortgages as collateral for securities that they sold to investors with a federal guarantee. It was all hunky-dory as long as the homeowner kept paying on his mortgage. But--when people began to lose their jobs and defaulted on their mortgages, it sent a deep shudder throughout the system. Each bad mortgage tainted the pool of mortgages that had been the underlying security for the bonds held by investors around the world, and, as more defaults occurred, investor confidence began to erode, leading to panic.

Some say that is simply "the market" at work and that it will all work out in the end. Tell that to the widow who bought stock in Bear Stearns that is now worthless. What has happened is that the steady drumbeat of Republican demands for de-regulation of the financial industries over the past thirty years finally resulted in removal of the regulatory protection you and I thought was there. The originator of the shaky loan did not have to hold the loan until maturity; he took his origination fee and sold the loan off to someone else who then assumed the risk, which was then guaranteed by the federal government. Such a deal! Now the chickens have come home to roost. We, the People, now get to pay for those relaxed rules that lobbyists in Washington got changed (many who now work for the Bush administration or the institutions they regulate).

There are layers of complexity in this whole mess that defy understanding. We have been left holding the bag, but we don't know what's in it. Anybody who has investments in the stock market has to be concerned, because almost every mutual fund has some investment in mortgage instruments. People living on fixed income pensions will be affected as costs rise. Nobody knows how well the bailouts will work. The bottom line is uncertainty.

There are times when government is the only solution to the problem. It is clear this is one of those times. It will take some time to fix this mess, well beyond the term of the Current Occupant in Washington, D.C. Do we really want to trust the management of this country to somebody who has been a prime mover in the legislative changes that led to the current financial debacle, and whose party has devoted the last three decades to dismantling the regulatory system that is supposed to protect us?

Charlie Crow