Thursday, April 22, 2010


Not to change the subject, but it looks like banking regulation is the hot topic in the news these days. At the heart of this issue is all the damage caused by mortgage backed derivatives trading, which reminds me that this is the very same subject which kicked off our long, bizarre relationship.

You will recall the RNC was running a campaign ad which sought to connect the burgeoning mortgage crisis to the Community Reinvestment Act. The theory was that the poor little innocent banks had been forced by government to write questionable loans to people in depressed neighborhoods who ultimately couldn't afford the payments.

Now although the CRA was originally intended to stop an obvious practice of discrimination, like many other government programs it really did get out of hand.

Banks had routinely "red lined" certain neighborhoods. Some applicants who lived in those neighborhoods would have their loans denied, while other applicants with the same credit rating would have them approved, simply because they lived outside the red line. In its original form, the CRA was intended to stop this practice. Well, so far so good. But like many other government programs, the CRA transformed into a vehicle for the kind of social engineering you are always railing against.

Many in government believed the responsibility of home ownership in certain economically depressed areas would result in all sorts of community improvements, based on the fairly practical idea that people who own the homes they live in are far more likely than renters to take an avid interest in the stability of the surrounding community.

What went wrong? Well, when the housing bubble popped, some of the highest rates of foreclosure occurred in those previously red lined neighborhoods. So therefore you can make a good case that the excesses of the CRA made a fairly handsome contribution to the crisis. BUT... (There's always a but, isn't there?)

To argue that the CRA was the mother of the mortgage crisis is not only silly, but goes against common sense. The red lined areas in which the CRA was active constitute only a tiny fraction of the mortgage landscape. Sure, the CRA exacerbated the problem in those areas, but the overwhelming number of foreclosures have occurred, and are still occurring, outside of them. The real problem, as I noted then, had absolutely nothing to do with government.

For years, real estate values all over the country skyrocketed. Lenders and buyers both cashed in on this phenomenon. Banks could write questionable loans with the assurance that even in the event of foreclose, properties could be quickly unloaded in a seller's market. For their part, private individuals could buy expensive properties and sink thousands into interest only payments, all based on the certainty that equity would accrue through appreciation, rather than the more traditional accrual by a combination of interest and equity payments in the standard fixed term mortgage.

But as we all know now, like the subject of Levitra commercials, real estate values can't keep going up forever. Sooner or later supply outstrips demand, the market exhales and all the dominoes start falling. I think perhaps the only blame you can lay at government's feet consists of the virtually unlimited subsidies provided by the mortgage interest and capital gains deductions from taxable income. However those deductions were around long before the mortgage crisis was a gleam in Uncle Sam's eye.

What really gave the mortgage crisis wings was the derivatives market. Deregulation of the financial industry allowed loan originators to bundle mortgage loans into investments which were as portable as common stocks. And man what a ride that was! Everyone, and I mean everyone (that includes you and me Steve), cashed in. Mortgage backed derivatives seeped into every nook, cranny, hinge and joint of the financial universe: from the assembly line worker who has five bucks deducted from his meager paycheck for a 401K, to the little old lady who has her little all wrapped up in what she thought was a rock solid mutual fund.

Lehman Brothers Holdings was the first big player to get kicked off the roulette table and the aftershock was impressive. The Dow dropped over a thousand points in one day, eventually losing half its value (7000 points!) in 18 months. And after Lehman's, who would be next? Well, we'll never know for sure because George Bush and Congress rushed to the rescue with the Troubled Asset Relief Program. And all of a sudden we started hearing about the awful sin of government bailouts.

Now Steve, its all well and good to stand up there on a soap box and rant about TARP. And easy, too. All you have to do is throw out your chest and claim financial markets should have been allowed to sort this thing out on their own.

Really? How, do you think, would they have done this? I'll tell you how - and isn't the idyllic picture of strong, well managed institutions emerging from the crisis even stronger, while weak, poorly managed institutions drop off like chaff. Unlike competitors in other industries which survive by building better mousetraps and selling them for less, financial institutions are all deeply interconnected. Its really not even rational to believe that if a Morgan-Stanley, with almost a trillion dollars in assets had gone belly up, big banks (which themselves have investments in Morgan-Stanly) would not also have gone belly up as well.

Now I suppose that wouldn't be a problem for me if it was your bank or your investment firm which went belly up, as opposed to mine. Then, I could just stick my thumbs in my ears, wiggle my fingers, and say nyah nyah nyah nyah nyah while I waited for my bank to call and let me know they too were going white side up due to the 30% of now worthless capitalization they had in your investment firm.

My guess is without TARP, like mountain climbers roped together, more banks and institutions would have fallen into the abyss and in short order we would be facing a situation which would make the Great Depression of the 30's look like an Enya Concert. But I digress...

Before Congress today is some legislation designed to introduce a little more transparency into the financial industry as well as put in place a proactive set of measures to be taken when a bank or other financial institution begins to lose traction. And wouldn't you know it, Mitch McConnell is lying about the whole thing. He's telling everyone who will listen that this legislation is bad because it institutionalizes government bailouts. That is false, and now many of his fellow Republicans aren't buying it.

Bob Corker, the Republican from Tennessee who helped negotiate the 50 billion dollar resolution fund (to be funded by the financial institutions themselves) noted in a speech on the floor of the Senate:

"But this fund that’s been set up is anything but a bailout. It’s been set up to, in essence, provide upfront funding by the industry so that when these companies are seized, there’s money available to make payroll and to wind it down while the pieces are being sold off. "

Now this is hardly a bailout. But why, if it walks, talks, bobs its head and waddles like a duck are several Republicans like Mitch McConnell calling it a yellow belly sapsucker? Well, because Mitch and a few of his buddies are in bed with the same companies which will be affected by the transparency provisions and other sensible regulations. So, they're raising the boogy man of bailouts to kill the bill - even though saner heads in their own party know it isn't true!

Now Steve, I don't know whether to laugh, cry, or just set fire to myself when I see a supposedly honorable, elected Senator putting out bald faced lies like this. And maybe the most disturbing thing about this is how anyone with a $200.00 net book can actually go and read the bill.

Now if you rely on Faux News for information, I doubt if you will be very well informed on this issue. But in any case, what are your thoughts?


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