The Whole Mess, And What To Do About It

In my previous post, I opined about the current spending bill that Congress is kicking around as a solution to the current economic crisis…a bill that is less of an economic panacea and more of a huge series of political payoffs and pork barrel crap.

This then begs the question: If I have such a problem with Congress’s solution, what do I think should be done. In order to understand my answer, one must understand where the problem came from and why it is continuing to fester. In this post, I’ll briefly describe (by way of gross over-simplification) how the troubles began. In the next post, I’ll tell you my plan to deal with the problem. So, you’ll have to stay tuned.

This current economic crisis has been decades in the making, with wrongheaded policies from both political parties contributing to the impending mess. But the ball really got rolling when two things happened:

The banking industry was deregulated, allowing them to merge and grow into multinational corporations that were “too big to fail”. This deregulation was not a bad idea in itself; it certainly aroused some serious money-making in the financial sector, and should have made the banks even more solvent by allowing them to diversify into other areas like insurance and stock brokerage. It should not have been so bad, but it left the door open for the other shoe dropping…

…which was the new laws and regulations that Congress and its two ugly step-children Fannie Mae & Freddie Mac foisted upon the mortgage lending universe. The original idea seemed innocent enough; to allow more people of lesser means to partake of the American dream of home-ownership, a piece of real estate that was the ultimate investment in their future. These new rules, which even allowed alimony, child support, welfare and unemployment payments to be counted as income for loan consideration, were enforced under penalty of law. And this new artificially-created market of people who could now “afford” their dream home, combined with years of low interest rates, sent the housing market to the moon; with home values climbing at historic rates. This new equity, in turn, allowed home-owners to borrow still more against their steadily appreciating real estate assets.

Now these blazing hot mortgages were then sold off to other banks (some discount mortgage brokers sold 100% of their loans immediately after they were finalized) and bundled into mortgage-backed securities (MBS’s), literally these bundles of debt markers were sold as assets much like bonds, and held as assets by these “too big to fail” banks. Everyone was fat and happy until the unthinkable happened. Some of the common folks who had been allowed to borrow against their real estate (sometimes for even more than the house was worth at the time) got behind on their mortgages…especially those who had taken out adjustable rate mortgages (ARM’s) who after the salad days of the low interest in the beginning, got hit with the balloon of interest at the end that they had not budgeted for. Then some more people got behind, more got foreclosed upon.

So then the banks were left with a lot of mortgages that were either in arrears or in foreclosure, only able to recover a fraction of the value of the loan by seizing the collateral. This was bad enough, but it also affected the value of the MBS’s that stood upon the integrity of the mortgage debt. When the mortgage market began to falter, and house prices started to slip, the MBS assets the banks held began to crumble as well. This affected their cash on hand to pay their own debts to other banks, and like a windmill when the props are kicked out from under it, the whole thing began to sway precariously in the breeze.

Check back later tonight for the rest of the story…my solution to this mess. Perhaps my wife, being the banker in the family, will make an appearance to set me straight where I went awry.

Nolanbuck