Banking Crisis

[Tony Alicea]

"I Tell You!"

Today I went to the bank to cash a check and there was a sign on the
teller's window: "Teller doesn't carry more than $20 in cash"!

When it was my turn, the teller said "Remember the toaster we gave you
when you first opened your account with us? Could you bring it back
please? We can surely use it now."

Then I went to the ATM outside ('cause I wanted more than $20) and it
printed me an IOU instead of giving me cash!

I TELL YOU! This situation is B-A-D!!

Ha ha!

PS: It's so serious that it has made socialists out of die hard capitalists!

PPS: A friend of mine at the Treasury wanted to know if I wished that my
personal debt was also included in the bail-out agreement. (I think she
likes me!)

[Pat Farrell]

Originally posted by Tony Alicea:
PS: It's so serious that it has made socialists out of die hard capitalists!

Its worse than that, its made socialists out of Republicans.

[Mark Spritzler]

Originally posted by Pat Farrell:


Its worse than that, its made socialists out of Republicans.

Actually even worse than that. Republicans decided that they needed more government involvement.

Mark

[Ulf Dittmer]

Well, Bush Jr. never was a small government Republican, so it's not too surprising.

[frank davis]

Originally posted by Mark Spritzler:


Actually even worse than that. Republicans decided that they needed more government involvement.

Mark

Maybe those Repubs should first ask how much of the current crisis is due to government involvement, policies, or regulations in the first place. Govt established institutions Fannie Mae and Freddie Mac surely influenced the mortgage market to a very large extent. Once banks figured they could originate trash loans and re-sell them to suckers in secondary markets things were bound to go downhill. The secondary markets had little checks and balances.

Also, don't forget the govt policy to encourage home ownership that started some years before the bubble started(pre-Bush even). Federal regulators encouraged banks to make loans that were more risky than was customary to increase home ownership. When Feds announce such policies and encouragements in such a heavily regulated industry its not insane to assume there could be some type of federal backing if push comes to shove. And that's how its played out it seems.

[Marc Peabody]

hehe

Originally posted by Tony Alicea:
PS: It's so serious that it has made socialists out of die hard capitalists!

The proposed bailout is more Capitalist than Socialist, saving the companies that have to handle foreclosures, not the homeowners that are going into foreclosure.

[Pat Farrell]

Originally posted by Marc Peabody:
The proposed bailout is more Capitalist than Socialist, saving ....

Perhaps this is true, but how do you know that? Its just three pages long, and most of it talks about how there can be no oversight or review of any decisions made.

The phrase I keep hearing is socializing the risk, and having Capitalistic rewards. With is pretty good if you can make it happen and you are on the Capitalistic side.

[frank davis]

The federal Community Reinvestment Act (CRA) encouraged banks to make sub-prime loans to encourage home ownership. If they did not make loans or if any type of pattern in loan rejections could be fabricated based on low-income communities being presumebly "red-lined" then they got sued. The only safe course was to make the loans and then count on Fannie Mae, Freddie Mac, and Bear Sterns, etc, to take them off their hands before the loans defaulted.

The banks found they could increase loan approvals rates by allowing people to qualify for variable interest loans, low down payments, etc. So, with everybody practically eligible for a home loan now, the dependable law of supply and demand kicked in :everyone bought houses and prices skyrocketed.
In this case , it was a bubble, and bubbles always pop.

A more entertaining version of this story is on video:
http://uk.youtube.com/watch?v=H5tZc8oH--o

[Frank Silbermann]

Originally posted by herb slocomb:
The federal Community Reinvestment Act (CRA) encouraged banks to make sub-prime loans to encourage home ownership. If they did not make loans or if any type of pattern in loan rejections could be fabricated based on low-income communities being presumebly "red-lined" then they got sued. The only safe course was to make the loans and then count on Fannie Mae, Freddie Mac, and Bear Sterns, etc, to take them off their hands before the loans defaulted.

The banks found they could increase loan approvals rates by allowing people to qualify for variable interest loans, low down payments, etc. So, with everybody practically eligible for a home loan now, the dependable law of supply and demand kicked in :everyone bought houses and prices skyrocketed.
In this case , it was a bubble, and bubbles always pop.

A more entertaining version of this story is on video:
http://uk.youtube.com/watch?v=H5tZc8oH--o

It was reasonable for the government to tell banks not to redline minority communities without regard to the income and capital of the loan applicant.

In a stable market, it might even have been reasonable for the government to ask the banks to make loans available for people with sufficient income but without substantial down-payments at _slightly_ higher interest rates (to compensate for the added of bank loss risked in cases of forclosure should they lose their jobs and their home). But this was bad policy once the bubble started; when house prices aren't stable you need a substantial downpayment not merely to reduce the bank's loss in case the borrower lost his job, but to deter the borrower from walking away from the loan when housing prices tumble.

As for variable rate loans, it was reasonable for banks to issue loans with rates that vary in parallel with the prime rate, because banks would not have to charge as much if they didn't have to bear the risk of inflation. What was indefensible was the creation of loans with "teaser" rates -- low interest and interest-only for the first three years, with high interest rates (and principal) thereafter EVEN WITHOUT any changes in the fed's prime rate. What is the purpose of teasing a borrower? It was nothing more than to provide an opportunity for mortgage brokers to swindle simple-minded applicants by neglecting to tell them what that their real payment would be three times as high! Rates that they knew the borrowers couldn't pay even if there was NO CHANGE WHATSOEVER in their financial situation and tried really hard to pay it -- just so the bank could steal their down-payment! Do people really deserve to have their entire net worth confiscated just because they're too naive to know that they need their own lawyer to read a contract before they sign it?

And where the borrowers had no down-payment, these brokers were swindling the people to whom they sold the loans. If the banks wanted the brokers to do that, then the banks were swindling the people to whom _they_ sold the loans.

The sad thing, however, is that a financial crash of some kind _was_ unavoidable. Had the banks and mortgage brokers operated ethically, foreign investors would have realized five years ago that there simply were no good investment opportunities for all the dollars they were accumulating by selling us services and manufactured goods, and that they would either have to spend that money buying American goods and services in return or see that money rapidly lose value as the dollar declined.

Postponing the crash only made it deeper.

[frank davis]

Originally posted by Frank Silbermann:
...

In a stable market, it might even have been reasonable for the government to ask the banks to make loans available for people with sufficient income but without substantial down-payments at _slightly_ higher interest rates (to compensate for the added of bank loss risked in cases of forclosure should they lose their jobs and their home)...

I thought banks usually acted that way, adjusting the interest rate for those risk factors?

I'm trying to find out what are the most significant factors that triggered potentially the most massive financial crisis in US history. My assumption is that human nature, e.g. greed , is relatively fixed and constant over long periods of time, so institutional forces are where I am focused now in my search. So in regards to your "stable prices" reference, I want know what unusual forces triggered the massively unstable home prices.

But this was bad policy once the bubble started; when house prices aren't stable you need a substantial downpayment not merely to reduce the bank's loss in case the borrower lost his job, but to deter the borrower from walking away from the loan when housing prices tumble.

The key question is still what caused the bubble? Without knowing that, we are acting blindly in trying to find a cure. I'm still doing my Google research on this but here's where I'm at now:

1.) Credit standards were loosened in 1999 by Fannie Mae:
http://articles.latimes.com/1999/oct/01/business/fi-17403
2.) Home prices shot up like a rocket after 1999:
http://www.nytimes.com/imagepages/2006/08/26/weekinreview/27leon_graph2.html


When Fannie Mae, the largest player in the secondary mortgage market, loosens standards and buys mortgages from the other banks, then I think it has a huge ripple effect on the whole mortgage market on all levels.

As for variable rate loans, it was reasonable for banks to issue loans with rates that vary in parallel with the prime rate, because banks would not have to charge as much if they didn't have to bear the risk of inflation. What was indefensible was the creation of loans with "teaser" rates -- low interest and interest-only for the first three years, with high interest rates (and principal) thereafter EVEN WITHOUT any changes in the fed's prime rate. What is the purpose of teasing a borrower? It was nothing more than to provide an opportunity for mortgage brokers to swindle simple-minded applicants by neglecting to tell them what that their real payment would be three times as high!

I'm trying to understand why banks didn't swindle these poor simple-minded folks in the prior 70+ years?

I suspect something changed in the regulations, e.g. the loosening of regulations under the Clinton administration as in previously cited URL .

The sad thing, however, is that a financial crash of some kind _was_ unavoidable.

I'm still trying to understand this, but couldn't we have kept the same regulations on the banks that we had before the Clinton administration lobbied to loosen them?

As lending standards fell lower and lower, Fannie Mae continued to buy until the very end, facilitating the mess in an evil spiral.

This question is pivotal, the next President is being chosen now on the basis of his or his part's connection with this scandal.

Even the NYT admits Bush in 2003 proposed new regulatory oversight for Fannie Mae, described as "the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago.
http://query.nytimes.com/gst/fullpage.html?res=9E06E3D6123BF932A2575AC0A9659C8B63

McCain also tried to warn of problems with Fannie Mae 2 years ago:
link to govtrack.us

On the other hand, Obama , the "community organizer" was intimately connected with ACORN, a group without precedent in ongoing voter fraud and involvement in threatening banks with lawsuits and sit ins. (Google ACORN & fraud for starters, then Google Obama & ACORN, then see
http://www.cbsnews.com/stories/2008/06/02/opinion/main4145761.shtml).

[ UD: edited link to preserve layout ]
[ October 15, 2008: Message edited by: Ulf Dittmer ]

[Frank Silbermann]

Me, earlier: In a stable market, it might even have been reasonable for the government to ask the banks to make loans available for people with sufficient income but without substantial down-payments at _slightly_ higher interest rates (to compensate for the added of bank loss risked in cases of forclosure should they lose their jobs and their home)...

herb slocomb:
I thought banks usually acted that way, adjusting the interest rate for those risk factors?

Yes, but within reason. If the rates you requires would leave them unable to make the payments, you don't give them the loan.

herb slocomb:
I want know what unusual forces triggered the massively unstable home prices. The key question is still what caused the bubble? Without knowing that, we are acting blindly in trying to find a cure.

We have had bubbles before, ever since the Dutch Tulip Bulb craze. What makes it worse is when people are allowed to speculate using borrowed money. After 1932 we tried to restrict the purchase of stocks using borrowed money; we didn't have such rules for housing.

herb slocomb:
I'm trying to understand why banks didn't swindle these poor simple-minded folks in the prior 70+ years? I suspect something changed in the regulations, e.g. the loosening of regulations under the Clinton administration as in (the earlier) cited URL. ... I'm still trying to understand this, but couldn't we have kept the same regulations on the banks that we had before the Clinton administration lobbied to loosen them?

Had we kept those regulations, some of the losses might have been prevented, but I don't think that was the driving factor. There were other, more important changes to the economy.

Increased computerization allowed banking to become far more complex. Before computerization, it simply would not have been possible to create the derivatives-based house-of-cards that hid risk from purchasers of debt. Without the derivatives market, mortgage brokers and banks could not have sold the mortgages the wrote so easily. It's one thing to lend money to a deadbeat if you're the one who's going to get stiffed; but if someone else seems willing to take the risk, then you have less personal incentive to withhold the loan from likely defaulters. In other words, the increased ability to sell debt created perverse incentives.

I think a bigger driver was America's international trade (im)balance of payments. Foreigners were left with huge heaps of dollars that they did not want to spend of American goods and services. Nor did it make sense to invest those dollars in American industry, because Amercan industry was selling less and less to ourselves and others. The logical outcome would be for the dollar fall relative to other currencies until Americans stopped importing more goods than we exported. Then American workers would become as poor as foreign third-world workers, and third-world industrialization would have to slow. Nobody wanted that to happen on their watch; governments were judged by how well they prevented (i.e. postponed) the day of reckoning. So foreign investor put their dollars into American real estate (the only thing America had that foreigners still wanted to buy) and into loans (better, I guess, to have more dollars you don't want to spend on American goods and services rather than fewer). This caused an unnatural rise in the prices of real estate, and this process acquired a momentum of its own -- as people began buying real estate (thereby bidding up the price) on the expectation that its value would increase -- a self-fulfilling prophecy. The rising prices added to the false perception that risky loans were safe, on the assumption that one could always find someone to buy the property for more money. People thought America's real estate was becoming more valuable because of immigration's increase to the buyer pool -- but a large portion of that buyer pool was fraudulent -- simpletons who gauged their ability to pay by the initial "teaser" rate, who couldn't afford to pay off their loans under any circumstances.

Housing prices had to fall eventually, simply because there was a limit even to the prices that buyers could _pretend_ to be able to pay, and because there was still plenty of land on which builders could increase the housing supply.

But your desire to get down to the ultimate question of "What changed?" is a wise way of looking at it. (We should apply that kind of thinking to crime policies as well.) In summary, I believe it was the perverse incentives created by the now-feasible-to-create derivatives market, and the initial distortion in housing prices caused, ultimately, by our negative balance of payments.

Unfortunately, I don't believe there is _any_ solution that does not involve having Americans become substantially poorer. Ultimately, people who cannot accumulate 20% of the cost of a house simply cannot absorb the risk of owning one. As other countries use more oil, we will not be able to afford as much. As other governments stop robbing their own businessmen (e.g. no longer demand huge bribes for permits, no longer greedily confiscate private wealth), people will no longer need to pay a premium for the products of American industries -- which therefore will no longer be able to pay a premium to American workers. And as the most culturally attuned Americans cease to reproduce themselves -- to be replaced by people who, shall we say, don't know how to make money -- the effect will be like the 1960s' middle-class flight to the suburbs which impoverished the inner-cities. Except this time, instead of leaving the inner-cities for elsewhere their heritage of literacy and know-how will be leaving the entire world.

It's kind of a perfect storm. We are sinking, and whoever is at the helm will be blamed. If he turns left and crashes into an iceberg, he'll be blamed for turning left. If he turns right and crashes into a different iceberg, he'll be blamed for turning right. If he steers straight ahead, he'll be blamed for crashing into _that_ iceberg. And if he lays down the anchor, he'll be blamed when all the icebergs converge upon us.
[ October 02, 2008: Message edited by: Frank Silbermann ]

[frank davis]

Originally posted by Frank Silbermann:


But your desire to get down to the ultimate question of "What changed?" is a wise way of looking at it. (We should apply that kind of thinking to crime policies as well.) In summary, I believe it was the perverse incentives created by the now-feasible-to-create derivatives market, and the initial distortion in housing prices caused, ultimately, by our negative balance of payments.


[ October 02, 2008: Message edited by: Frank Silbermann ]

It all comes down to the huge increases in the number of risky loans or "sub-primes" in recent years; take away that one fact and there is no crisis. I agree with the factors and incentives you mention as playing a part in that increase in bad loans. Still, I suspect the laws, regulations, policies, and customs in effect in prior years that prevented the huge increase in sub-prime loans in the past may have worked to a satisfactory degree in the present had they not been dismantled.

Loan standards were dismantled - It seems common sense to me, but why would an applicant's income to pay a loan be considered an "outdated" criteria?
http://www.nypost.com/seven/02052008/postopinion/opedcolumnists/the_real_scandal_243911.htm?page=0
http://articles.latimes.com/1999/oct/01/business/fi-17403


I understand the incentives you mentioned and also the govt's role:
http://online.wsj.com/article/SB122212948811465427.html?mod=googlenews_wsj
but still, when you get right down to it, no matter the storm of incentives swirling around the banks, the tried and true criteria of income to loan ratio would have stopped most of this mess.

[Martha Simmons]

HS: The key question is still what caused the bubble? Without knowing that, we are acting blindly in trying to find a cure. I'm still doing my Google research on this but here's where I'm at now:
Hi Herb,

If you are seriously interested in this topic, why not to read books? Not a perfect source either, but at least it seems more systematic. I liked Confessions of a Subprime Lender and The Trillion Dollar Meltdown � they complement each other nicely, since one is written from a front-end perspective � brokers and lenders, how they worked and what motivated them, and another more from a back-end perspective � financial institutions that bought subprime morgages.

I really don't want to sound patronizing (which I guess I do nonetheless), but your links seem mostly to point to a rather marginal factor that contributed to this perfect mess.
[ October 14, 2008: Message edited by: Martha Simmons ]

[Martha Simmons]

Just one argument against "let's blame minorities" line of thoughts: "house bubble" isn't USA-only event, the same process of insanely raising prices happened in lots of other countries: Great Britain and Spain are mentioned often, but heck, even Russia. When I was in Russia early this year, I was shocked to see offers of credit everywhere, even written on paper and glued to the walls � I swear it's that bad. And nobody cares about minorities' access to credit in Russia.

[Ulf Dittmer]

I think Japan and Germany are the only developed economies that have not seen housing prices rise (prices fell, actually) significantly over the last 10-15 years.

[Peter Rooke]

Looks like they are designing a new credit instrument UTC-TAX, for new under the counter deals using (our) TAX revenues as collateral. These can be used to replace all the old �toxic� deals make on older credit instruments. These should be able to achieve a high credit rating as they are using government money.

"Then you do make a profit for yourself," Yossarian declared. "Of course I do. But it all goes to the syndicate. And everybody has a share. Don't you understand? It's exactly what happens with those plum tomatoes I sell to Colonel Cathcart." "Buy," Yossarian corrected him. "You don't sell plum tomatoes to Colonel Cathcart and Colonel Korn. You buy plum tomatoes from them." "No, sell," Milo corrected Yossarian. "I distribute my plum tomatoes in markets all over Pianosa under an assumed name so that Colonel Cathcart and Colonel Korn can buy them up from me under their assumed names at four cents apiece and sell them back to me the next day at five cents apiece. They make a profit of one cent apiece, I make a profit of three and a half cents apiece, and everybody comes out ahead." [Catch-22, Heller]

[frank davis]

Originally posted by Martha Simmons:
Just one argument against "let's blame minorities" line of thoughts: "house bubble" isn't USA-only event, the same process of insanely raising prices happened in lots of other countries: Great Britain and Spain are mentioned often, but heck, even Russia. When I was in Russia early this year, I was shocked to see offers of credit everywhere, even written on paper and glued to the walls � I swear it's that bad. And nobody cares about minorities' access to credit in Russia.

Martha Simmons,

I never before heard of your "let's blame minorities" line of thought; perhaps you have jumped to a conclusion based on the Federal Reserve Bank of Boston's lax lending guidelines they posted online. Seriously, until you presented it now, I've seen no one else advance this theory.

Another factor to consider is that credit markets are global in nature and affect each other. Demand and supply of credit can cross borders. In the case of Russia however, its probably simply catching up in terms of utilizing credit. When I was there 8 years ago, there was zero utiliziation of credit. Most average stores did not accept any type of credit card. So, starting from a baseline of zero, there was a huge untapped market for credit to be utilized. As Russia struggles haphazardly with the free market, it is expected that they begin to exploit this previoulsy vastly underutilized aspect of capitlaism. Vast markets tend to attract vast efforts to utlizie them.

What we do know is that home lending standards decreased preceding the US crisis & I offer some factors in the equation (US Dept of HUD & politics at FNMA & Fed Reserve affecting sub prime market lending standards). Surely not the whole story, I admit, but the decision to allow lower lending standards within the regulated environment of banking had a documented & explicit statement of political intent from an administration in power at the time the process began. I cannot see how that is irrelevant, at the very least.

[ October 15, 2008: Message edited by: herb slocomb ]
[ October 15, 2008: Message edited by: herb slocomb ]

[frank davis]

Originally posted by Martha Simmons:

Hi Herb,

If you are seriously interested in this topic, why not to read books? Not a perfect source either, but at least it seems more systematic. I liked Confessions of a Subprime Lender and The Trillion Dollar Meltdown � they complement each other nicely, since one is written from a front-end perspective � brokers and lenders, how they worked and what motivated them, and another more from a back-end perspective � financial institutions that bought subprime morgages.

I really don't want to sound patronizing (which I guess I do nonetheless), but your links seem mostly to point to a rather marginal factor that contributed to this perfect mess.

[ October 14, 2008: Message edited by: Martha Simmons ] [/b]

Hi Martha,

Don't worry about you being patronizing; I'm ready and willing to hear from you what you think precipitated the crisis. I thought generally lending standards would have to go down first to account for the huge rise in much riskier mortgages that were not allowed under prior standards. I still don't understand how your theory disputes that. It was kind of you to mention book reading, but I regret that you couldn't recall a single fact from those books to offer to us to help us understand why why we deserve to be patronized.

[marc weber]

Originally posted by herb slocomb:
... until you presented it now, I've seen no one else advance this theory...

[Mike Simmons]

Seems pretty clear to me - Herb is rejecting the characterization that Martha gave for his theory.

[Martha Simmons]

Herb: I never before heard of your "let's blame minorities" line of thought; perhaps you have jumped to a conclusion based on the Federal Reserve Bank of Boston's lax lending guidelines they posted online. Seriously, until you presented it now, I've seen no one else advance this theory.

Hm. Perhaps I did jump to a conclusion after reading this:

Posted by Herb:

The federal Community Reinvestment Act (CRA) encouraged banks to make sub-prime loans to encourage home ownership. If they did not make loans or if any type of pattern in loan rejections could be fabricated based on low-income communities being presumebly "red-lined" then they got sued. The only safe course was to make the loans and then count on Fannie Mae, Freddie Mac, and Bear Sterns, etc, to take them off their hands before the loans defaulted.

Linked by Herb:

The nation�s largest provider of mortgage funds, moving to�increase homeownership among minorities and low-income residents, unveiled�a program Thursday to loosen lending standards for people with��slightly impaired��credit.

Also linked by Herb:

PERHAPS the greatest scandal of the mortgage crisis is that it is a direct result of an intentional loosening of underwriting standards - done in the name of ending discrimination, despite warnings that it could lead to wide-scale defaults ... From the current hand-wringing, you'd think that the banks came up with the idea of looser underwriting standards on their own, with regulators just asleep on the job. In fact, it was the regulators who relaxed these standards - at the behest of community groups and "progressive" political forces.

In the 1980s, groups such as the activists at ACORN began pushing charges of "redlining" - claims that banks discriminated against minorities in mortgage lending.

What I learn from the books I mentioned was actually pretty nicely summarized by Frank:

Increased computerization allowed banking to become far more complex. Before computerization, it simply would not have been possible to create the derivatives-based house-of-cards that hid risk from purchasers of debt. Without the derivatives market, mortgage brokers and banks could not have sold the mortgages the wrote so easily. It's one thing to lend money to a deadbeat if you're the one who's going to get stiffed; but if someone else seems willing to take the risk, then you have less personal incentive to withhold the loan from likely defaulters. In other words, the increased ability to sell debt created perverse incentives.

Typically, in past the same institution that give you a loan hold it; now lenders simply sold mortgages upstream to other investors. Riskier loans yield higher percents, so why not give them to anybody who could walk in? And if lending guidelines stood in your way, the worse for them. So why lenders gave these crazy loans � because they sold them right away and got profit.

Now why investors bought these risky loans � well, they did not. They bought derivatives, like CDO � which is a cool concept, if to think about it, and I guess would work just fine in a healthy market -- too bad the market wasn't healthy anymore. Which brings us to the next question:

Frank: But your desire to get down to the ultimate question of "What changed?" is a wise way of looking at it.

That's the question that John R. Talbott pursued in his �Sell Now! The End of the Housing Bubble� book. Based on Robert Shiller's data on housing prices, (to which graph you linked here) he concluded that prices were flat for the most of the century, until they started to accelerate in 1997. Then he decided to account for �the tax shield� (deduction of mortgage interest from your taxable income) and concluded that in fact, real home prices started to rise since 1981. What change in 1981 is that inflation went down and this brought him to his ultimate conclusions, that the ultimate reason of the house bubble is that the lending formula that banks around the world use, which is based on borrowers income in the first year of borrowing, is flawed and is not adequate for the low inflation years.

The answer for both conundrums is one and the same: The qualifying formula banks use to determine the amount of money they will lend to eventual home purchasers has an implied error in it. Qualifying formulas are heavily weighted toward first-year ratios that take almost no account of future income growth due to general inflation. Therefore, banks underlend to homebuyers during periods of high inflation and overlend during periods of low inflation. The explains an explosion in housing prices worldwide over the last ten years as inflation has eased, nominal rates have declined, and lending has mushroomed.

Personally, I am not terribly convinced by his arguments and searching for
a second opinion...
[ October 15, 2008: Message edited by: Martha Simmons ]

[Martha Simmons]

Herb: In the case of Russia however, its probably simply catching up in terms of utilizing credit. When I was there 8 years ago, there was zero utiliziation of credit. Most average stores did not accept any type of credit card. So, starting from a baseline of zero, there was a huge untapped market for credit to be utilized. As Russia struggles haphazardly with the free market, it is expected that they begin to exploit this previoulsy vastly underutilized aspect of capitlaism.

In fact, credit wasn't something unheard of in Russia. When Russia was the Soviet Union, there was credit available, to buy an apartment, for example, � that's how my parents paid for their, 30 years with very low payments � and other big purchases (no credit cards though). It was actually an advent of capitalism with its inflation and instability that killed the credit. I was so shocked by the credit bacchanalia I observed this year because I guess in my mind credit is closely tied to a stable economic system, where you can safely assume your life's savings won't turn into pumpkins overnight, any night, and I just don't see what is so stable about Russia-2008.

[frank davis]

Originally posted by Martha Simmons:
...Therefore, banks underlend to homebuyers during periods of high inflation and overlend during periods of low inflation. The explains an explosion in housing prices worldwide over the last ten years as inflation has eased, nominal rates have declined, and lending has mushroomed...


Personally, I am not terribly convinced by his arguments and searching for
a second opinion...

I think a lot of valid points can be made about market bubbles in general, and also regarding the relation with lowered interest rates which undeniably increased demand for housing by making them more affordable with financing. I don't want to give the impression that I can't appreciate those other factors; I can. But, there is a factor that is given less "air time" in the media and that is the govt's active role in creating the mess. What gets airtime is "greed" and how market deregulation is to blame.

I think the severity of this crisis and the govt's role in it doesn't make it a simple case of market failure. I think you mentioned a key fact in that banks used to hold on to their loans in the past. They therefore had huge incentive not to make too many risky loans or sub-primes. I think sub-primes, about 46% which are in default, are about half the cause of the currrent crisis. You also point out that banks were willing to make the riskier loans because they could re-sell them. That's the key point where we agree.

Fannie Mae was the largest purchaser of sub-primes. Did not Fannie Mae also sell sub-primes to others and those loans become "derivatives"? Fannie Mae had several roles here in implementing the explicit policy directive of the Dept of HUD at the start of the bubble around 1999. One, it told banks to lower lending standards. Two, it bought the sub-primes created under the lowered standards fueling the growth of their creation throughout the industry. Three, from I understand, they also sold sub-primes to others who may have bundled them or created derivatives. The third level was seen to have some type of implied government guarantee and because of that guarantee normal standards of financial prudence were weakened.

My prior citations in prior posts were not meant to be exhaustive, merely as examples of a govt policy being implemented. The policy found expression in other channels as well. Eventually , lowered lending standards spread and became the norm. But I think I overemphasized this aspect, the market for those sub-prime loans created by Fannie Mae was equally as important. Without Fannie buying the sub-primes their creation would have been severely curtailed. Without sub-primes, the current crisis would not exist.

[Martha Simmons]

Herb: I don't want to give the impression that I can't appreciate those other factors; I can. But, there is a factor that is given less "air time" in the media and that is the govt's active role in creating the mess. What gets airtime is "greed" and how market deregulation is to blame.

That's why arguing on the Internet can be so unsatisfying: as soon as we clear misunderstandings, there isn't much left to argue about.

"the goverment's active role" -- the Federal Reserve and Alan Greenspan personally are seem to get their well-deserved share of beating... But basically I agree, all parties found something to be happy about in the state of affairs in the late housing market: the banks, the government and the home buyers. And to complain about "greed" is as productive as to complain about the force of gravity.

[Pat Farrell]

Originally posted by Martha Simmons:
all parties found something to be happy about in the state of affairs in the late housing market: the banks, the government and the home buyers. And to complain about "greed" is as productive as to complain about the force of gravity.

You left out a huge number of folks who were happy. The carpenters, and electricians, the guys who ran the lumber yard. The farmers who sold their land to developers, the developers, they guys who pave roads. Real estate companies, real estate agents. And local politicians, who could accept campaign funds from all of the above so they would vote to rezone the farm to quarter acre lots.

Reasonable people will include GM, Ford and Dodge, who sold SUVs to folks who bought houses 50 miles from their jobs, along with gas companies and Saidi princes.

[frank davis]

Originally posted by Martha Simmons:

But basically I agree, all parties found something to be happy about in the state of affairs in the late housing market: the banks, the government and the home buyers. And to complain about "greed" is as productive as to complain about the force of gravity.

Even several years before the market peaked in South Florida, the average family earning average wages could not afford the average home despite "creative" financing. So the demand shifted to rentals and their rates went up also. So a large proportion of people were using more than half their income to pay housing costs, leaving little or none for savings for retirement, for their children's education, or when economy goes bad.

Realtors and speculators (some Realtors speculated) did well. Another fact I saw somewhere was that a large proportion of these sub-prime were for second homes and from that it was deduced that a significant proportion were investor/speculator owned. At one point in the South Florida condo market, which peaked before the general housing market, about 80% of the condos were investor owned and they never lived or planned to live in their purchases.

So the bailout "relief" to the homeowner is often not what we envision; e.g. not a situation where a family is being forced into the street because of foreclosure, but more commonly a foreign or out of State speculator who bought homes in South Florida to make a quick buck and when values fell he simply stopped making payments which he wrote off as deduction on his taxes.
The bailout is probably helping those who need the least help more often than not. Still, the billions it is costing will be paid for by us eventually in higher taxes or some other form. There is no free lunch.

[Pat Farrell]

Originally posted by herb slocomb:
not a situation where a family is being forced into the street because of foreclosure

There have been very few, if any, cases where folks were in houses that they could afford, and were making payments on, that forced them out onto the streets.

There are lots of cases where folks put nothing down, signed mortgage agreements that they didn't understand, and contained insane esclation clauss. They were tossed out of their houses. But what did they lose?
They were renting houses, they had nothing when they got into it, and ended up with no equity. Surprize!