Understanding The Financial Crisis, Part Two

With such a massive force befalling the American economy and financial system, I’m not sure, at this moment, that we can pick a starting point for the beginning of the events that have led us to where we are now, but I’m going to start with the time around the 9/11 attacks on the U.S. At that time, the American economy was already weakened by a slowdown. The attacks by Muslim extremists sent a major shockwave through the American economy. In an effort to combat the already slow economy, and then the aftermath of 9/11, the Federal Reserve, under Alan Greenspan, lowered interest rates. Credit of all types became relatively cheap, including credit for mortgage loans. Of course, by “cheap,” I’m meaning the cost of borrowing money; that is, interest charges, had come down substantially. Many American consumers became potential customers of the mortgage industry for a variety of reasons: many with existing mortgages sought to refinance those mortgages at lower rates, even being able to take out some “cash“ for part of their equity, others wanted to remodel existing homes in some way, others wanted to buy a home for the first time, while some existing property owners wanted to acquire additional properties for perhaps a vacation home, or to rent out for income, or to “flip.”

“Flipping property” is a form of real estate speculation; that is, buying property with the express hope that it will rise in value quickly so that it can then be sold for profit. I’d say the key terms here are “quickly” and “with little or no expense.” Further, the buyer doesn’t want to be a landlord, at least not for long. Now to differentiate here, every property buyer hopes that the property they buy will increase in value so that at some time in the future they can sell it either to “cash in,” or to upgrade their own residence. Further, there are people who buy “fix up” properties, who often actually serve a good purpose, as they take over homes in need of repair, make the renovations, and then sell the now more saleable property for a profit. In “flipping,” the buyer seldom wants the house for a residence, except perhaps very short term, since the key is being able to sell quickly and for a profit. Now “flipping” isn’t something new, but it became a potent force in the housing market in the last decade or so. Remember, too, these folks don’t care a “hoot” to whom they sell the property, as they sell it and wash their hands of it.

Home prices rose during the 1990s, after the recession of the early part of the decade. As the economic cycle slowed at the end of the 1990s and early 2000s, however, prices were a bit more stable, but with the super low interest rates of this decade, home prices took off, escalating faster than most Americans’ incomes; a dangerous situation.

I said it is tough to pick a place to start about this subject, and I chose the time “around” the 9/11 attacks, but I need to backtrack just a tad to the late 1990s. Remember in “Part One” about Fannie Mae and Freddie Mac helping to set the standards for mortgage loans? Well, besides those two “government sponsored” companies, there were many purely private companies that served the same role as Fannie and Freddie. Remember, too, Fannie and Freddie were PRIVATE companies, but with an “assumed” amount government backing; “assumed” by investors, that is.

To generalize here, the Great Depression brought about a major political realignment, with Democrats becoming the dominant party. One of the reasons for this was, Franklin Roosevelt chose to put himself and his administration on the side of non wealthy Americans. At a time when many Americans were either destitute, almost destitute, or fearful that they would soon be destitute, wealthy folks and their supporters were on the outs. With the Depression having occurred on the Republicans’ watch, and with Roosevelt and many Democratic followers having “hogged” so much of the political highway, it left little room for Republicans.*** This tendency by Democrats (and liberal Republicans) to support “the little guy” frequently helped many Americans to achieve that vague status of “middle class.” It also brought Democrats to advocate help for lower income folks, even long after the Depression had ended.

So why is this important? Politics is ALWAYS important! You don’t think people give millions and millions of dollars to political candidates just to have something to do, or because they feel charitable to politicians, do you? They want a point of view to prevail, or to actually get something more specific in return for their money.

In the late 1990s, the Clinton Administration made it clear that they wanted Fannie and Freddie to relax some of their high standards for lower income Americans. Simultaneously, in what was then a slowing housing market, investors in these companies wanted profits to remain on the upper end, and likewise wanted standards adjusted. The basic feelings were, these two could adjust their standards, but still keep lower income loans from being too risky. The problem was, the truly “private” mortgage part of the industry was on a path to wide open loans that would eventually lead to them feeling a person’s chest for a heartbeat, and then giving them a mortgage. With this part of the mortgage industry so wide open, Fannie and Freddie began to lose business to these companies.^^^

Loans to lower income, riskier borrowers are termed “subprime.” Understand, initially these loans were most often made to many folks with good credit and verifiable income, so it was assumed that the risks were also not that great. Some credibly reasoned, however, that as long as the economy was fairly sound, that few problems would ensue, but that if the economy entered into more than just a slight downturn, and unemployment escalated substantially, that defaults would also seriously escalate. Further, as private companies took more and more business from Fannie and Freddie, the two “standards setters” for mortgage loan approval, lost control of that all so important process, and in fact began to join in the growing business of buying mortgages made to VERY risky borrowers, that were truly subprime. The private companies, for example, allowed mortgages to be offered to potential home buyers for no down payments or interest only payments for a specific term. Further, many folks offered a mortgage had bad credit and in many cases didn’t even have verifiable income!!! They only had to state their income on the application, with no sources to verify that income. What this means is, you come to Randy and say, “Hey, how about loaning me $100,000?” And I say, “What’s your income?” You reply, “$75,000 a year.” I hand over 100 grand to you.

President George W. Bush announced that he wanted America to be the “ownership society,“ with more low income people and minorities becoming home owners. It was an admirable goal, and he signed a large tax credit of about two and a half billion dollars into law in 2002, which provided tax credits to home builders that built affordable single family dwellings in poorer neighborhoods over a five year period. Further, a bit later, he signed into law a measure that provided grants to help home buyers meet down payments and closing costs over a three or four year period. Further still, Bush made major increases to funds to help people, primarily minorities, build their own homes, through programs like Habitat for Humanity. All of these goals and programs were laudable and none of these things I’ve cited going back to the Clinton Administration individually brought about the crisis of today, rather they all helped to feed into the home building, home buying, home selling mentality that overtook common sense in the country. They also contributed to more risk exposure for Fannie Mae and Freddie Mac, which bought up the mortgages.

***Not all Democrats were taken with FDR, either out of conviction or out of jealousy (Jealousy? In politics? No! I can’t believe it!), with, for instance, the Democratic presidential nominee from 1928, Alfred Smith, of New York, being adamantly opposed to much of the New Deal. On the other hand, Fiorello LaGuardia, another New Yorker, and a Republican, supported much of FDR’s program.

^^^ Once a trend is established in business policy, no matter how irresponsible, even those NOT inclined to such behavior more or less have to follow or lose business, or even go out of business. If, for example, you make some product and pay your employees, let’s say, $12.00 an hour and offer a benefits package, too, but your competitor or competitors make the same product, even if of less quality, overseas and pay their employees $1.00 an hour and give them no benefits, you’re in a real pickle! There’s a good chance that either you move production overseas, or you draw up an ad for “Going Out Of Business Sale.”

Word History:
Buy-verb-The forms of this word are only found in the Germanic languages, and no connection has been made with other Indo European languages thus far. In Old Germanic, it was "bugjan" or "bugjanan," and it had the meaning of "obtaining something at a price." In Old English it was "bycgan," with the past tense being "bohte," seemingly pronounced "bow-ta" (vs. modern "bought"). Old Saxon, spoken by the Saxons who remained on the Continent (to differentiate between those who founded England), had "buggjan." Originally in English, it was pronounced much like "bidge" or "budge," depending upon the location in England; that is, by dialect. Interestingly, the pronunciation that ended up winning out and giving us today's way of saying it came from the southwestern part of England, and that "seems" not to have happened until the 1500s. All sources say how it is purely a Germanic word, and one mentions forms in other Germanic languages, but then gives no examples! Do you want to smack 'em, or should I? To my knowledge, standard German does not have a form of the word, but that doesn't mean a form of "buy" isn't used in German dialect, either "high" or "low." If I happen to find some examples, I'll post them.