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"A Play for Power"
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The Wall Street meltdown: who's to blame?
The blame game ... it's a fascinating sport. I'm an expert ... ask my wife. But I come by it naturally. When I was growing up, every time the tool slipped from my Dad's hand and he skinned a knuckle or took a chunk out of a finger ... he looked to see if I was around. If I was anywhere close by, you can bet the reason for it was because I was "in his light."
This week, the blame game is centered on the Wall Street meltdown. Some folks blame greedy bankers, some blame the government. Others blame deregulation. With the American presidential election a little over a month away, some are just happy to have something else to blame on poor old George W. Bush and the Republicans. (Meanwhile, I hear the Obama/Biden campaign and the liberal media are desperately searching for a way to pin it all on Sarah Palin so they can send her back to Alaska.) Regardless, Wall Street now looks more like airport road in Baghdad than an elite thoroughfare through America's financial district.
The situation is serious. The meltdown raises doubt about the nation's entire financial system. Young folks worry that they might not ever be able to buy a home of their own; old folks like me have seen a large chunk of their retirement savings disappear.
While many take a partisan view, as one writer reported, "No one cog in the federal government's machine of financial regulation let down the country by failing to prevent the latest shakeout on Wall Street. The entire system did." A spokeswoman for a consumer-oriented research group on lending echoed those sentiments. She explained it this way: "The job of regulators is that when the party's in full swing, make sure the party-goers drink responsibly. Instead, they let everyone drink as much as they wanted and then handed them the car keys."
On September 15, the bar ran dry and the party on Wall Street ended. Lehman Brothers filed for bankruptcy protection. Merrill Lynch sold itself to the Bank of America for $50 billion. After propping-up the sale of faltering investment bank Bear Stearns to J.P. Morgan Chase, the government moved to take over mortgage giants Fannie Mae and Freddie Mac.
Some said such troubles were reminiscent of the Great Depression of 1929, as then - like now - a number of banks failed because of their links to securities trading. The Glass-Steagall Act enacted in 1933, and later the 1956 Bank Holding Company Act, were put into place to specifically prevent the financial system from ever going down that road again. They mandated the separation of banks, insurance companies and securities firms. However, by the 1970s, a faltering U.S. economy under President Jimmy Carter brought about a huge change in America's thinking. California governor Ronald Reagan won the White House by voicing his faith in free markets while expressing disdain for big government.
If disgust with the Carter presidency started the movement, in 1999, another democrat gave it a shove. President Bill Clinton signed a Bill called the Financial Services Modernization Act that virtually eliminated the post-depression reforms and removed the firewall separating banks, securities firms and insurers.
Under Clinton, and later under George W. Bush and a Congress swooning over political correctness, the government went about promoting home ownership to minorities and other borrowers with weak credit. In 1995 and again in 2005, the Community Reinvestment Act was strengthened to force banks operating in low and moderate-income neighborhoods to meet the credit needs of the communities they served. Under the provisions of the Bill, the record of each institution in meeting the credit needs of its community was evaluated and taken into account whenever they applied to expand their facility or open new branch banks.
Now as you can imagine, lending to borrowers with weak credit went against the grain of professional bankers. But what the heck? Interest rates were low; money was plentiful. The market for mortgage-backed bonds was booming. The opportunity to package and sell mortgages at a profit would more than offset the risk. As a result, about thirty-eight percent of the mortgage bonds held by banks and investment houses were backed by sub prime loans. Today they are at the root of Wall Street's financial crisis.
Why? A generation ago, banks, credit unions and S&Ls held all the mortgages they made until maturity. Thus, lenders had an ownership stake in the creditworthiness of their borrowers. But in recent years, mortgages of all types were bundled together to create mortgage-backed securities, or mortgage bonds, that were sold to the highest bidder. Loans to the least credit-worthy borrowers carried the highest risk, but since they also paid the highest returns, banks and other institutional investors bought a boatload. The process helped more people buy homes and created a booming mortgage-bond market led by investment banks.
So far, so good, eh? It's too bad that in the process, no one looked out for the creditworthiness of the borrowers. Loans were made with little or no down payment to the least credit-worthy borrowers. To keep the monthly payments as low as possible, many chose variable rate or "interest only" mortgages. When the rates went up, many were unable to pay and those loans went into default.
Foreclosures flooded the market and real estate values plummeted. Financial institutions that held mortgage-backed bonds were stuck. If the securities they held were worth anything at all, they were worth much less than their face value. That created a real solvency crisis for the banks and investment houses. For example, my wife owns a number of shares in a publicly held single-family residential mortgage lender that operates in all 50 states. Their portfolio is comprised of high quality AA-AAA rated assets principally in the jumbo and super-jumbo segment of the adjustable rate mortgage market. A recent run on their cash nearly put them out of business. Shares my wife paid $25.80 for a couple of years back are now worth 44-cents.
From 2004 to 2007, at least three oversight agencies had issued warnings about risky loans but with Congress and the White House looked the other way. No one in authority was willing to close the bar and call a halt to the soiree. Nicolas Bollen, a professor in finance at Vanderbilt University put it this way: "It was another example of an asset bubble that appears periodically. An economy will disregard risk, and when people see another investor making money by investing in an asset, others will throw caution to the wind. In such an environment, no one wants to kill the goose that laid the golden egg."
So now that the housing bubble has burst, who are we to blame? The democrats? The republicans? Pandering Washington politicians in pursuit of votes? Too much or too little government involvement? The abject failure of government regulators? Greedy investors and Wall Street bankers? Those that in pursuit of the American dream took advantage of the easy money? I say all share in the blame.
And in the debate of whether we should put another trillion dollars or so on the American Credit Card, I say we have no choice. For while passing this debt on to generations yet unborn is practically unthinkable, the damage to our economy from doing nothing would be far worse. Swallowing the bitter pill now may be the only chance they have not to have to grow up in a banana republic.