Thursday, October 02, 2008

Who's to Blame

There has been a question rolling around in my head for the past week. It concerns the current economic crisis. To set the stage, let's go over the problems that led up to where we are in my opinion. It started with the banks loaning too much money to home-buyers who cannot afford to make the payments on the interest and the principle. This really kicked into high gear about 6 years ago. Since the terms for many of those loans were for zero interest for 5 years, many of those loans started to default about a year ago. (This is all just off the top of my head so feel free to correct if my misstatements make a difference to my argument below or sue me).

In other words, 6 years ago, many poor people (single mothers and african-americans among them) were able to buy homes for the first time.

Back when these loans were being written, the banks were repackaging the loans (bundling them up into groups) and selling that debt as investments to each other. These are shown as assets on the books of the holders of the repackaged debt (instruments or derivatives). When the holders defaulted, the assets became worth a fraction of their original worth and the banks began losing tons of money. Since they don't have enough assets, they can not make new loans.

With me so far?

Now here is my question: Who could have possibly stopped this from happening? President Bush? Congress? The Banks?

In a way, the answer is all of the above. Any of them literally could have stepped in and stopped allowing the loans to be made. But practically, none of them could have stopped it. President Kerry would have loved it if the mean-spirited GW Bush would have cut-off poor minorities from home ownership. Congress could have, but they have no political will. Had the banks done it, they would have been accused or red-lining and would have had to relent to pressure from everywhere.

I think that looking back in this case will help us to avoid this problem in the future. There will have to be national minimum requirements for obtaining loans. Notice I didn't say mortgages. There is a ton of other debt (credit cards) out there just waiting to cause the same or bigger problem. Just as banks have to have a certain level of assets backing the loans they make, consumers are going to have to have certain levels of income and or assets backing the loans they accept. Terms for those loans will also have to be more uniform. This will slow the economy in the short and mid-term, but will avoid a melt-down in the long term.

There will either be action on this, which will include hateful accusations against whoever tries to fix the problem, or we will be right back here in less than a decade. The era of creative and flexible financing is most probably over.



Jim The Knife said...

You hit the nail on the head, however, you didn't mention the "drop" in housing prices.

There are "some" assets. The banks aren't going to lose everything. Eventually the houses will sell and they'll recoup a lot of their investment. And when the housing market rises they'll recoup even more.

What they will lose is a ton of interest that the "greedy" banks have counted on in their balance sheets but never really existed.

On a side note, Falstaff said in a blog that he was concerned about how the current crisis was going to impact him. I don't see it and will talk to him about it.
The crisis will NOT impact me, nor you I suspect???

Special K said...

Housing prices? I didn't mention them because they are another effect of the problems I spelled out. When so many folks gave up their homes, the market was flooded with inventory. That would be enought to drop prices right there, but when the credit market cuts off money to buyers the prices fall even further.

I am glad the crisis won't impact you. A bad economy could hurt Falstaff's business. I'm a bit insulated as my main customer is in good shape financially, but there are limits to that insulation.