How They Took Us To The Cleaners
The Federal Government is getting ready to assume control of Fannie Mae and Freddie Mac, and this tsunami sized financial techtonic event seems to be passing with little political notice.
How did we get here? How did it come to this? Most Americans don't seem to understand the role that Fannie and Freddie play in enabling money intended to be loaned for houses to get to people who want to borrow money to buy houses. It is one of the financial foundations of the global economy.
Because Americans are undereducated in matters of Finance and Economics, it was(in hindsight) relatively easy for someone to game the system. It is difficult to be certain how many in congress actually understood the implications of what they were voting for back in December of 2000 when they deregulated the futures market, but they basically allowed the following game to be set up and played.
The riskiest borrowers could be steered into sub-prime loans, often with zero understanding of what they were getting into. These risky loans could then be bundles into a tranche, and sold on the futures market. The fact that the riskiest borrowers were getting sub-prime loans was an essential part of the game--because then it was safe for hedge funds to buy PUT contracts on them--essentially betting that the underlying leveraged securities would default on the loan and be worth less in the future than they were at the time the contract was written. Goldman Sachs made a pretty bundle on these put contracts. Doesn't an ex CEO from Goldman Sachs have a prominent role in the current administration? It is important to remember that a similar game is played on the futures market with respect to Petroleum and other commodities such as corn and wheat. The speculators themselves now drive the price.
Anyway, that is the game that was played: a new variation on 'shoot the fish in the barrel'. It was an insiders game, of course.
The public at large is woefully ignorant of these facts, and the players involved. Most of the trail of this whodunit leads to the feet of Phil Gramm and the cronies he represented. But congress voted the legislation in, and, to date, hasn't done much to repair the breech. Maybe their own complicity is the reason why Dems have so far, refused to make much political hay from this. But they are wrong to do so. If they were asleep at the switch, they should admit it, educate themselves, and propose reasonable solutions(close the loophole). Most of these problems could be cured with sunshine and ventilation.
John McCain of course, continues to rely on Phil Gramm for cousel, and you can bet Gramm would be prominent in McCain's administration. That is definitely a case of putting the Fox in charge of egg production. Sarah Palin was out on the stump yesterday mouthing homilies about shrinking the size of Freddie and Fannie, and making them smarter and more effective. It is obvious that she understand little if nothing about Freddie, Fannie, and international finance.
But Obama, in his comments from the stump, has not reassured me that he 'gets it', either. Maybe he is afraid of sounding too much the nerdlinger professor. Someone HAS to educate the Public. A good place to begin is this article from Mother Jones:
<a href="http://www.motherjones.com/news/feature/2008/07/foreclosure-phil.html" >Foreclosure Phil</a>
How did we get here? How did it come to this? Most Americans don't seem to understand the role that Fannie and Freddie play in enabling money intended to be loaned for houses to get to people who want to borrow money to buy houses. It is one of the financial foundations of the global economy.
Because Americans are undereducated in matters of Finance and Economics, it was(in hindsight) relatively easy for someone to game the system. It is difficult to be certain how many in congress actually understood the implications of what they were voting for back in December of 2000 when they deregulated the futures market, but they basically allowed the following game to be set up and played.
The riskiest borrowers could be steered into sub-prime loans, often with zero understanding of what they were getting into. These risky loans could then be bundles into a tranche, and sold on the futures market. The fact that the riskiest borrowers were getting sub-prime loans was an essential part of the game--because then it was safe for hedge funds to buy PUT contracts on them--essentially betting that the underlying leveraged securities would default on the loan and be worth less in the future than they were at the time the contract was written. Goldman Sachs made a pretty bundle on these put contracts. Doesn't an ex CEO from Goldman Sachs have a prominent role in the current administration? It is important to remember that a similar game is played on the futures market with respect to Petroleum and other commodities such as corn and wheat. The speculators themselves now drive the price.
Anyway, that is the game that was played: a new variation on 'shoot the fish in the barrel'. It was an insiders game, of course.
The public at large is woefully ignorant of these facts, and the players involved. Most of the trail of this whodunit leads to the feet of Phil Gramm and the cronies he represented. But congress voted the legislation in, and, to date, hasn't done much to repair the breech. Maybe their own complicity is the reason why Dems have so far, refused to make much political hay from this. But they are wrong to do so. If they were asleep at the switch, they should admit it, educate themselves, and propose reasonable solutions(close the loophole). Most of these problems could be cured with sunshine and ventilation.
John McCain of course, continues to rely on Phil Gramm for cousel, and you can bet Gramm would be prominent in McCain's administration. That is definitely a case of putting the Fox in charge of egg production. Sarah Palin was out on the stump yesterday mouthing homilies about shrinking the size of Freddie and Fannie, and making them smarter and more effective. It is obvious that she understand little if nothing about Freddie, Fannie, and international finance.
But Obama, in his comments from the stump, has not reassured me that he 'gets it', either. Maybe he is afraid of sounding too much the nerdlinger professor. Someone HAS to educate the Public. A good place to begin is this article from Mother Jones:
<a href="http://www.motherjones.com/news/feature/2008/07/foreclosure-phil.html" >Foreclosure Phil</a>
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Link broken in main post, for some reason:
Foreclosure Phil
September 7, 2008 10:03 AM | Reply | Permalink
That's just how TPM's Wonderful Blogging Software "works." Unlike the commenting system, where you must type in your HTML tags (and get it right the first time, with no preview or edit, in a window too small to even see an entire URL in an "a href" tag), when you write a blog, you cannot type in your HTML tags. Instead you must use the little "italic" and "link" (etc.) widgets at the bottom of the screen.
Why this is so, only the gods and Josh Marshall know.
September 8, 2008 6:17 AM | Reply | Permalink
Knowledgeable and informative. Naturally, almost no one will read or recommend it. You must get tired of hanging around a place like this.
September 7, 2008 1:06 PM | Reply | Permalink
Sometimes, yeah. But I am deluded into thinking that the way that the viral marketing of memes works is that if I can get an idea into the hands of one person who gets it into the hand of 2, and one of those gets it into the hands of someone who can get it out to 100, then I am satisfied to be a sower going forth sowing seeds. I fully expect some to land on rocky soil, some to land on the path and get squished, some to get eaten by birds. But if just one of those seeds grows up and fruits, it may shed a thousand more...
September 7, 2008 3:39 PM | Reply | Permalink
I completely agree with you regarding getting memes out there and the potential for the exponential when it comes to moving things "up" to where they're noticed and picked up.
Thanks for never giving up!!
September 7, 2008 5:04 PM | Reply | Permalink
Though I recommend the blog, I strongly condemn the promotion of memes. We have too many memes already, and the nation is at serious risk of meme overload, which experts predict would lead to mass insomnia, sexual frustration, and a disco revival. Memes seemed like a good idea 20 years ago, but like invasive species, they've taken over the entire political landscape. We are literally drowning in memes. They must be stopped.
September 7, 2008 6:52 PM | Reply | Permalink
Well, Dawkins and Hofstadter didn't invent memes, they merely came up with a name and a 'genetic' metaphor for ideas that 'seem to have a life of their own'. We have always been drowning in memes. It takes discriminative wisdom to separate the good ideas from the bad ideas, and to innoculate yourself against bad ideas.
September 7, 2008 7:17 PM | Reply | Permalink
Exactly. According the U.S. 2000 census, only 0.8% of the population has discriminative wisdom. That's why the meme epidemic will cause a devastating disco revival. Most nations experience disco no more than once a millennium. Two disco decades in half a century could well destroy us, as it did the Byzantine Empire in the 1453.
Stop spreading memes!
September 7, 2008 8:06 PM | Reply | Permalink
I'm expecting your anti-meme meme will have little success...
September 7, 2008 8:35 PM | Reply | Permalink
Sorry, I don't respond to meme trolls
September 7, 2008 8:37 PM | Reply | Permalink
"discriminative wisdom"
C4logic, you are a buddhist? Vunderbar!
September 7, 2008 8:58 PM | Reply | Permalink
natch...I follow the middle way of dynamic equilibrium ;-)
September 7, 2008 9:19 PM | Reply | Permalink
I follow the falling petals and the pains of pebbles in my shoes.
;)
September 7, 2008 9:41 PM | Reply | Permalink
Well, I spent the days of my youth driving freight trains over the Allegheny mountains--dynamic equilibrium kept me on the long shiny rails...old ways die the hardest.
September 7, 2008 10:55 PM | Reply | Permalink
Well, I am recommending it...this is exactly the kind of post I hope to find when I log in to TPM.
Question, what role does/did Glass-Steagal play in all this?
September 7, 2008 3:53 PM | Reply | Permalink
Here is a little bit more...
When Bill Clinton signed the Gramm-Leach-Bliley Act, it repealed the Glass-Steagall Act of 1933. This allowed commercial and investment banks to consolidate. Some economists have asserted the repeal of the Glass-Steagall Act contributed to the 2007 subprime mortgage financial crisis--that is a little too simplistic, but it certainly set the stage for the depredations that took place. The new act enabled commercial lenders such as Citigroup, (largest U.S. bank)to underwrite and trade financial instruments such as mortgage-backed securities and collateralized debt obligations and create structured investment vehicles, or SIVs, that bought those securities. Citigroup played a major role in pushing for the repeal. It was then called Citicorp--they merged with Travelers Insurance the year before through loopholes in Glass-Steagall that allowed temporary exemptions. With lobbying led by Roger Levy, the "finance, insurance and real estate industries together were the largest campaign contributors and biggest spenders on lobbying of all business sectors in 1999, the year before Gramm-Leach-Bliley. They gave more than $200 million for lobbying in 1998, according to the Center for Responsive Politics...
September 7, 2008 4:33 PM | Reply | Permalink
Thanks for that. With all respect to Bill Clinton, he had a hand in this mischief. I was a big fan of Rubin in the nineties, but only slowly came to realize that Rubinomics was penny-wise, pound-foolish. I, for one, was definitely behind the power curve on the long term effects of repealing (in effect) Glass-Steagall.
September 7, 2008 4:40 PM | Reply | Permalink
I think quite a few legislators were led down the primrose path on this on. This came at the very end of his administration, to my knowledge he has never been publicly interviewed and answered questions as to what he thought it would accomplish, who was lobbying for it and why. The same goes for the other players, as well. But the legislation came at a moment when the country was distracted by the debacle of election 2000, in December, and apparently nobody realized the act had been inserted at the last minute into omnibus legislation. The consequences of this to the futures market has been devastating to financial stability as we have seen not only with sub prime mortgages, but with ordinary commodities like grain, and oil. The future was forecast for us with the artificial California energy crisis of 2000/2001 that was the first example of how deregulated commodities markets could be manipulated. The games that Enron played then are the games played with mortgage backed securities and oil and barley, now. It'a all the same game.
September 7, 2008 4:50 PM | Reply | Permalink
Right. It is a metaphysical question now as to what extent "true" supply/demand has effect on price setting in commodity trading.
off topic but as long as we have that rarest of TPM threads, a policy one: what do you make of the year to year drop in corporate receipts in the national budget? Are the PIC's eating this up? I came across this delightful passage:
"For a glimpse into this quiet and lucrative world, head up to the 13th floor of 1105 N. Market St.. Through smoked‑glass windows, a visitor can view the high‑rise headquarters surrounding Wilmington's prestigious Rodney Square: DuPont and Hercules, Wilmington Trust and MBNA. But turn back, and look inside this slender office tower. Tucked within the building's stark, upper floors, is another, hidden corporate center. Here, more than 700 corporate headquarters make up a vast and quiet business district of their own. The lobby computer lists their names: Shell and Seagram and Sumitomo, Colgate‑Palmolive and Columbia Hospitals and Comcast, British Airways and Ikea, Pepsico and Nabisco, General Electric and the Hard Rock Cafe. How do 700 corporate headquarters squeeze into five narrow floors? How do 500 fit on the 13th floor alone? "Frankly, it's none of your business," said Sonja Allen, part of the staff that runs this corporate center for Wilmington Trust Corp. . . . "Some of my clients are saving over $1 million a month, and all they've done is bought the Delaware address," said Nancy Descano, holding company chief of CSC Networks outside Wilmington."
http://www.cbpp.org/4-9-02sfp.htm#_ednref13
Those charts tell quite a story. In boom or bust, corporate receipts as a percentage of GDP keep dropping. Yet the GOP wants to cut taxes on the one sector that is stable, household incomes. I am not a genius, but I can add and this means they are setting up permanent deficits that must eventually bankrupt the government.
Well that solves the problem the New Deal presented them....
September 7, 2008 5:34 PM | Reply | Permalink
Thanks for bring this issue up. This is what, as a nation, we should be talking about instead of whether Sarah Palin can run the Pentagon cause she knows how to field dress a moose.
You are right. The numbers don't add up. But the publicly traded corporations will want to argue, as Reagan did, that they do not pay taxes, their customers do, and they need to be responsible to their stockholders, and competitive in a global economy. My own view--for what it is worth--is that's a lot of hooey, as are Bermuda, Cayman tax havens. My view is, you take services from the government, you throw down. I would like to see an economic model that shows what corporations get in terms of value from city, state and federal governments in terms of services that they leverage to conduct their business. They could not draw a glass of water, drive across town, fly into or out of an airport, use the phone or a fax machine without the infrastructure provided by government. Where would they get their workers without public eduction? From immigrants--oh I see. That's cheap. No. Really. They need to pay their fair share. You take out, you put in, simple as that.
September 7, 2008 5:46 PM | Reply | Permalink
Delaware...first state in the nation in corporate welfare. NOW I remember why wanted Obama to choose a different running mate.
September 7, 2008 8:47 PM | Reply | Permalink
Yes, before Bermuda, there was Delaware...
September 7, 2008 9:40 PM | Reply | Permalink
Don't you?
I mean, it must be so painful for you.
September 8, 2008 6:18 AM | Reply | Permalink
Here is a link to a site that appeals to the policy wonks among us:
http://cboblog.cbo.gov/
Fannie Mae, etc. is in there...
September 7, 2008 4:06 PM | Reply | Permalink
Thank you for the admonishment and the link, c4logic.
Excellent post.
September 7, 2008 4:14 PM | Reply | Permalink
This was Phil Gramms doing
September 7, 2008 4:30 PM | Reply | Permalink
And now Phil Graam is McCain's economic advisor and McCain doesn't really understand how the american economy works....
September 7, 2008 5:12 PM | Reply | Permalink
Nice way to connect the dots. You also lay blame where it is properly to be found - a succession of politicians on both the left and right. I also wonder at the last four decades of seepage into the powers of policy by the tendrils of corporate America. We have witnessed a dramatic reversal of all the FDR-era controls put in place to avoid this kind of corruption and instability in the system.
I know it may seem that Barack doesn't get this sort of stuff, I find that hard to believe. I am sure he understands that our only way out of most of our financial problems is to turn back the enormous gains made by corporates and rich individuals over the last 30 years. I just think he doesn't believe that is an argument that can be made via a corporate dominated media. He needs to come in under the radar on certain things.
I expect a lot of Bootstrap Speeches from President Obama over the course of 2009 warning us of what is to come and what our role to play will be. The rest will be mostly policy things that aren't of much interest to the public at large, but will address everything you speak of.
Fixing this stuff will be the work of multiple generations, just like it took three generations to screw it up.
September 7, 2008 5:13 PM | Reply | Permalink
I agree with your assurance that Obama does get this stuff, his level of information osmosis is pretty impressive. But whatever his own degree of awareness and understanding, I have not heard him delve into and decompose the problem and suggest a solution--which would be to close the Enron loophole and reinstate the regulation of commodities market.
I see the futures market as analogous to a nuclear pile. If left unmonitored, there is a chance that the chain reactions will run away into a melt down. We saw this with energy markets in CA in 2000. We saw it with sub-prime mortgages leveraged to the max. We saw it again this summer with Oil. Every nuclear engineer knows that you need something like carbon rods to insert into the nuclear pile to regulate the chain reaction and keep it sustainable. But Republicans do not seem to understand this, philosophically. They do not believe in regulation. They do not believe in 'government'. A free market is a chaotic market, and cycles of boom bust are not what ordinary people want. That may be what Goldman Sachs wants, cause they profit on the way up, and they profit on the way down. But it is hell on the little guy.
Obama needs to find a way to connect these problems to the situation that confronts the public, without oversimplifying, or sounding too nerdy. The Republicans, of course have found the answer in a simple slogan: 'Drill, baby, drill.'
As if...
September 7, 2008 5:32 PM | Reply | Permalink
Again, I think Obama will keep his message to the people focused on the big themes while his team lays waste to the existing structures that keep Washington broken behind the scenes. He'll need to use both the carrot for voters to stay involved and hold their reps accountable. While at the same time using the stick of the bully pulpit to make legislators do things not in their own best interests if he is to fix anything.
This one is kind of nebulous in the details, but can still be addressed as part of our more aspirational goals as a country. We The People can still be the power an Obama administration needs to get things done without expecting every American to care about the nitty-gritty policy stuff. Make American lives better and they support whatever it takes to get the job done, whether they truly understand or not.
I agree, however, that restoring the controls over the financial markets and restoring progressive taxation is the only way we will establish enough stability to accomplish everything in the democratic platform.
It will also take democrats, republicans and independents to get it done. Nothing like a little added challenge - combining three passionate groups of individuals who have been convinced to fight each other at every turn over a period of 40 years.
Kind of puts into perspective how good Obama has been to get this far. I think he has what it takes to get us the rest of the way.
September 7, 2008 7:59 PM | Reply | Permalink
I don't disagree with this, but I think the important message for the consumer who wants to buy a house is that the Guardians and Protectors let them go down a very dark alley and get talked into something that was not only bad for them, but bad for all the taxpayers, and bad for the global economy.
No down payment? No problem. No job? No problem. Don't make enough money? No problem. House worth less than you're borrowing? No problem. No documentation. No problem.
You can argue Caveat Emptor, but in this case people's natural desire for a once in a lifetime opportunity, or the chance to get rich quick in real estate, or own more house than they can afford, or simply own their own home, to begin with; all of these longings were exploited by venal predators for a sure thing, can't loose scheme that utimately caused the implosion of an entire matrix of inter-related industries: Contractors, remodellers, building supply, closing agents, banks, brokers, underwriters, financial instrument makers. It broke the system--and some people profited handsomely by it. And many naive homeowners lost their homes and their equity, and many investors lost all the value of their shares, and the taxpayers are left holding the bag for trillions of dollars of international monetary liability.
It was the Republican watch. They did not prevent it from happening. What good is all their crowing about security if the party of fiscal restraint cannot keep the whole system from melting down???
That is what the little guy needs to understand. That is why we need to government to serve in the role of Guardian and Protector. It was the only reason the good citizens of Dodge hired Marshall Dillon.
That is the lesson for the little guy.
September 7, 2008 8:58 PM | Reply | Permalink
I agree that the government dropped the ball, as it has dropped the ball on just about every fiscal decision over the last forty years, under democrats and republicans alike.
No one noticed who was at fault then and they won't notice now.
Obama's challenge is to motivate people to become more engaged and informed while at the same time regulating industry to the extent that is needed to avoid the type of shit we saw in the mortgage industry, but which is also mirrored in the Dot.com Boom under Clinton that left a lot of the little guys ruined.
Again, this has been a multi-generational problem that won't be solved with a series of Public Service Announcements by the Obama administration, as well as the guy speaks.
September 8, 2008 7:58 AM | Reply | Permalink
Yes, the problem is institutional in nature. But Congress should take a lesson from James Madison, and be clock builders. Anyone who is in the business of providing loans should share in the risk. You have to have a stake in the outcome. That is the root of the problem. As long as you can take a professional fee for brokering the transaction, and then unload the mortgage to someone else, who assumes you have done due diligence on the level of risk associated with the loan--the temptation to write as many loans as possible, with no due diligence, is to great a temptation. This is the situation that needs to be addressed.
As for multi-generational solutions--I am one of those who does not see very many generations left for civilization on this planet. I see inevitable population collapse, global pandemic, and ecological catastrophe at every turn. I do not see homo sapiens making the correct decisions to avoid this outcome. I see cat 5 tornados and cat 5 hurricanes coming with such frequency that the surface of the earth will not tolerate fixed structures. I expect my great grandchildren, if they survive at all, will be hunting buffalo on the Great Plains while riding painted ponies...
September 8, 2008 8:06 AM | Reply | Permalink
I guess I am a little more optimistic.
I think Obama's success this year is a realization by the American people that something needs to be done and now. When I say multi-generational solutions I mean solutions that are long-range in nature not that we have to wait multiple generations to get started. I believe the next two generations are sufficiently focused and progressive to make great strides.
I think what begins with a landslide for Obama can turn into the tipping point we need to address all the problems you discuss. It will also take a revolution in Congress on the left and right. No one side can do this alone. The job is way too big.
I am also a big fan of your solutions for these scum bags making billions off our most vulnerable citizens. Don't confuse patience with complaisance. It is my fondest wish that life gets very hard for some previously very powerful people in this country. But we will also need to rebuild those existing institutions in a way that makes them work for us as we implement our long-range plans through pragmatic and practical short-term tactics.
Evolution and not revolutions is what will save us from ourselves. We don't have enough time to rebuild everything from scratch. Otherwise, you are right, the human race won't be long for this world as the dominant species.
September 8, 2008 9:14 AM | Reply | Permalink
I wish I COULD be more optimistic, long haul. But I am the kind of guy who smells the flowers, and looks around for the funeral.
I WISH Obama would win. But let's face it. There are a LOT of authoritarian followers out there. Look at these people who are WILD for Palin. What do they know about her. Nothing really. She's a mom and she hunts and she thumps the Bible. But somewhere they got the idea that she kicks ass--for them. That is all then need to know. Someone with the SYMBOL OF AUTHORITY told them--she belong to you--she is your warrior. And she is elevated to Goddes like status.
It is TRULY frightening. But that is what we are up against.
I would like to see the bastids that brought all this ruin working on the chain gang--but I just don't see it happening. On a personal level, I think the best we can do is to tirelessly attempt to educate ourselves, slowly scrub away the years of misinformation and disinformation, and develop the skills to obstruct their attempts to condition us. Lets admit it, we are all victims of an Information War. Mine started in Kindergarten, when they told me Columbus 'discovered' America. In 2004, after Kerry lost, I figured 4 more years of Bush would have the rabble dragging him out of the White House in the glare of torchlights, with pitchforks. And now a good many of my fellow Americans want to elevate the Hockey Mom From Wasilla. With all the complicated, wicked problems we face--America has a Death Wish. Face it.
September 8, 2008 9:52 AM | Reply | Permalink
"cause they profit on the way up, and they profit on the way down. But it is hell on the little guy."
Right: it's all in the c-delta. They live off movement.
September 7, 2008 5:47 PM | Reply | Permalink
There's no story to capture the public interest, at least not yet. You need bad guys like Jeff Skilling and Ken Lay. You need ordinary folks who got screwed. (Taking on an ill-advised loan and losing your house doesn't count. It's seen as voluntary. You need people who are perceived to have been deceived or to have fallen victim to forces beyond their control.)
If the economy slips further into recession, people may really start looking for someone to blame. But despite the possible positive repercussions, let's hope that doesn't happen.
September 7, 2008 7:06 PM | Reply | Permalink
The Russian and the Chinese National Banks have been dumping their Fannie and Freddie bonds on the market. If Freddie and Fannie cannot raise money--the whole real estate industry and all of its dependents stops cold. The flow of financial transactions through this system is the energy that drives the engine of the housing market. If people do not understand that yet, they soon will. If there is no market for your house, then it is worthless.
There is no single individual who is responsible--but deregulation is the idea at the heart of the whole debacle.
September 7, 2008 7:22 PM | Reply | Permalink
I don't disagree with you, just trying to explain why this hasn't caught the public's attention. I wholeheartedly support trying to draw more attention to it.
September 7, 2008 7:57 PM | Reply | Permalink
Yes, I understand that we agree. Don't misunderstand me. The public does not grasp the fix we are in, or what it means for the future. But lets face it, it isn't a sexy story. The suject of finance, mortgages, tranches, leveraged derivatives give most people an intense desire to leave the room.
A mother of 5 field dressing a moose while taking revenge on her sister's x-husband by abusing her authority is sexy. Nobody has any problem understanding it. Drill, baby, drill, as wrong minded and as simple minded as it sounds--is easy for trogolodytes to understand.
But the story of how the financial mavens cooked up a scheme to drive the riskiest borrowers into loans that were sure to default so they could sell put contracts on them--well it has the character of a riddle wrapped inside a mystery stuffed into an enigma. They tried real hard to cover their tracks. They counter on the public disinterest and ignorance to get away with it.
The same financial industry does the same thing to poor people by selling them used cars for negotiated monthly payments they know will break them--and after a few months they repossess the cars and sell them all over again to new, poor folks. The predators never stop. They work overtime. They stay up late at night hatching new schemes. The naive need protection from these schemes. They are dangerous to the dynamic equilibrium of the whole system. Just remember the story of Pinocchio at the mercy of the Cat and the Fox.
A fool and their money never get together in the first place...
September 7, 2008 9:12 PM | Reply | Permalink
Happened to my sister.
It's a nice analogy but not completely apt. The car dealers make money even in the case of default. In this case, the lenders themselves carried no risk because they sold the loans, but Fannie and Freddie got stuck with the bill, hence the bailout. F&F et al would not have bought the subprime loans had they properly anticipated the real estate market collapse and thus would not have facilitated the practice. So I see this as more of a bubble problem than a predation problem. The legislation should be designed to keep the market from becoming too leveraged rather than to protect individuals from predatory lending practices.
September 7, 2008 10:11 PM | Reply | Permalink
Good point, in a defaulted property everything is gone, and frequently the property becomes a blight on the community--yeah, I was thinking more about the heartlessness and social irresponsibility of the predators more than the final outcome. But you're right, the metaphor is strained.
September 7, 2008 10:58 PM | Reply | Permalink
I forgot to mention that I think both situations you described need to be addressed: predatory practices as well as dangerously over-leveraged derivatives. In this case, the two went hand in hand.
September 7, 2008 11:01 PM | Reply | Permalink
Other than preventing deception, it would be very difficult to craft a law to protect against lending to people with poor credit. How would someone's credit risk be assessed? And how would you allow for a lender to offer a loan to someone who has poor credit on paper but because of extenuating circumstances is considered trustworthy. And frankly, what business of the government is it to stop a lawful transaction that is freely entered into by two parties?
The solutions to the problem that I've seen have to do with extending accreditation, along with all the regulatory requirements that come with it, to additional financial institutions. The point of such proposals is to moderate the boom-bust cycles by preventing large financial corporates from becoming over-leveraged.
September 7, 2008 11:29 PM | Reply | Permalink
You don't try to keep individuals from entering into consensual transactions; rather, you try to rationally limit the desire of the lenders to make those loans.
I don't really think that mortgage securitization is bad in itself, but it got out of control.
Seems to me the most broken link in the chain was the bogus ratings system. There simply was no such thing as independent ratings--too many conflicts of interest and too much plain laziness.
[Just one example of skewing the market--investment ratings used to use the same standard across the board. Now they are rated within categories. So although muni bonds have tremendously low default rates compared to other investments, in order to get top investment ratings municipalities often have to buy insurance, from other Wall Street companies who have incestuous relationships with the ratings companies.]
To me the problem isn't lender's being able to fix their risks, it's that they were overpaid for the assets they sold. The assets should have been rated as much riskier, which would have lowered the prices lenders could get, which would have discouraged lenders from pursuing the riskier business.
September 8, 2008 7:51 AM | Reply | Permalink
Agreed. All must be forced to share the risk is the best way to avoid a recurrance of this debacle.
September 8, 2008 8:09 AM | Reply | Permalink
I agree that this was the problem, but the prices (and risk assessments) are set by the market. It's very difficult for the government to control prices without fucking things up.
What the government can do and has done successfully with banks is to accredit Fannie & Freddie and other institutions and require that they have the assets to cover their loans.
September 8, 2008 9:14 AM | Reply | Permalink
I don't think the gov't should control prices, but they can look at regulating the relationships and basis of fees and such to try to insure independent judgment by ratings agencies.
September 8, 2008 9:25 AM | Reply | Permalink
I agree that Gov't should stay out of pricing that should be dictated by supply demand ratios. However, they could say that they will not underwrite the loan unless due diligence is certified and the risk is contained with in specified boundaries relative to the borrowers likelihood of repayment or default. When Banks used to hold mortgages, this was SOP.
September 8, 2008 9:42 AM | Reply | Permalink
I think the dividing razor is the fact that Fannie and Freddie offer Government backed securities. Two parties entering into a financial transaction by mutual consent is fine--but if Uncle Sam has to underwrite the deal, the taxpayers should have the right to stipulate the conditions that must be fulfilled before the transaction can proceed. Part of the problem was underdocumentation, or fake documentation.
It should be a no brainer that before Uncle Sam underwrites your loan, you have to provide evidence that you are employed. That your employment is no capricious. A downpayment should be required. The source of that downpayment should be verified to avoid money laundering schemes. The house needs to be carefully appraised. the Ratio of loan to equity needs to be fairly low. These are the kinds of loans Uncle Sam should underwrite. If you want to engage in other kinds of risky borrowing: like no job, no down payment, borrow more than appraised value and so forth--then these transactions should NEVER be permited to be securitized by Fannie or Freddie and Uncle Sam should never, ever, ever be on the hook for them.
Uncle Sam HAD to take over Freddie and Fanny because they were ultimately reponsible to make good on the securities--but then they never paid close enough attention to the liabilities Freddie and Fannie were piling onto them. When you think about it--that is INSANELY irresonsible. But from Fannie and Freddies point of view, 2 publicly traded entites, if you could get away with it, you would be a fool not to play the game at the vivid edge--since as a business entity--YOU ultimately shared NO risk.
September 8, 2008 7:58 AM | Reply | Permalink
Uncle Sam wasn't officially on the hook for the bad loans. Wiki says:: Some MBS issuers, such as Fannie Mae, Freddie Mac, and Ginnie Mae, guarantee against homeowner default risk. In the case of Ginnie Mae, this guarantee is backed with the full faith and credit of the US Federal government. This is not the case with Fannie Mae or Freddie Mac, but these two entities have lines of credit with the US Federal government; however, these lines of credit are extremely small when compared with the average amount of money circulated through Fannie Mae or Freddie Mac in one day's business. They've been bailed out not because the government was required to do so but because the country cannot afford to have them fail.
So let's make the de facto support official. Let's require F&F and others to open their books and limit their liability. Some stipulation for mortgage loans, like a minimum deposit, might be acceptable. I just think that the government needs to stay out of trying to manage pricing and risk assessment though the blunt instrument of legislation and focus instead on leverage.
September 8, 2008 9:27 AM | Reply | Permalink
Good point. Uncle Sam was not required by law to make good the loans. But a lot of investors assumed they were--and in the end we have this de facto vs de jure situation.
September 8, 2008 9:40 AM | Reply | Permalink
News doesn't cover it because maybe they are trying to be "responsible" and keep consumer confidence up or they just don't want to show the charts that show just how much unsecured debt is out there. The problem with the subprime securities is that some banks don't really know how exposed they are or even have a clear chain of custody. There is this crazy uncertainty in their quantitative models. No one really knows what their CDO's are worth.
The media knows most of the story, but can you imagine them having Wolf Blitzer or Katie Couric or Shepard Smith start talking about the ABX index?
September 7, 2008 10:07 PM | Reply | Permalink
You could be right. The psychological factor of optimism born of blissful ignorance is probably the only thing preventing a complete economic collapse.
September 7, 2008 11:04 PM | Reply | Permalink
We better all brush up on our Mandarin Chinese.
When the Chinese start buying up stuff at fire-sale prices because there is no market here, we all may wind up working for them.
Or renting from them.
Congrats on reaching Numero Uno!
September 7, 2008 11:21 PM | Reply | Permalink
News is driven by ratings. With a few exceptions, the media focuses on what interests its audience. Media companies that fail to do that don't survive. Frankly, people just don't want to hear about financial regulation because it's boring to them.
Look at TPM. 99% of the posts (from the management and the readers) are about the horse race b/c that's what fascinates us. It's not that Josh or any of we reader/bloggers have an agenda that involves ignoring financial regulation; it's just that, for better or for worse, we're not focused on it.
In short, why would you expect the media to cover stories that their audiences are interested in?
September 7, 2008 11:40 PM | Reply | Permalink
If it bleeds it leads. The financial meltdown and Uncle Sam stepping in to provide corporate handouts is great drama, and something the public should be mighty pissed off about.
One reason the MSM avoids these topics I think relates to WHO OWNS WHAT, and the incestuous relations between these corporations.
who owns what
Given the relationship between the publicly traded corporations that own much of the media, and the brokers that analyze their equities and the bankers that loan them operating funds--you think the board of GE is going to piss off the board of Citibank?
September 8, 2008 8:14 AM | Reply | Permalink
Don't worry. Sarah Palin may have only one Bachelor of Arts degree, but it's from six different colleges! I'm sure she understands the economics of Fannie Mae and Freddie Mac just perfectly. And she would've "just said no" to that silly ol' deregulation of the futures market. Anyway, there's no need to worry your poor little servant's heart sick about Fannie and Freddie. You can always sell your home...on eBay!
And as for Senator Keating, er..I mean McCain, well...you know he was a POW, right?
....
We're doomed.
September 7, 2008 7:54 PM | Reply | Permalink
And McCain spent his days in the Hanoi Hilton redecorating and remodelling each of his ten houses over and over again. That makes him something of an expert on the housing industry. What McCain went through wrestling fire demons transformed him from McCain the Grey into McCain the White Wizard...
September 7, 2008 9:18 PM | Reply | Permalink
Who can explain this to the public?
Have you read Obama's speech from March on financial re-regulation? Does it do anyhting for you?
http://www.nytimes.com/2008/03/27/us/politics/27text-obama.html?pagewanted=all
Do you see a way of crystallizing this for those who have no idea how these institutions work.
As to the current crisis:
Who made the money, again?
How did the ratings agencies fail to accurately asses the risk of these instruments or did the get a payoff for creating a false sense of risklessness that made the puts all the more lucrative?
September 7, 2008 11:34 PM | Reply | Permalink
I read the speech you cited and I agree it is a stem winder. He has some reasonable ideas--pretty tame--but he talks like a college professor. That may be fine when you are adressing Cooper Union. the big problem with the public understanding finance is the jargon involved: derivatives, leverage, commodification, hedge, securitize. It isn't that the concepts themselves are so difficult to understand--it's that the jargon used tends to obfuscate the issues.
As to the ratings agencies failing to accurately asses the risk of these instruments--the first problem was fraud in the appraisal of these properties, and the documentation for the borrower. The first watchdogs did not do their job. Then the value of the underlying properties went into free fall. That was when the problem first surfaces in the French Banking community as they could no longer determine the value of the security because the underlying properties were impossible to appraise.
The business with the put contracts was a unique opportunity created by the new anti-regulatory climate, and the wild west practices of the mortgage brokers. The guys on the front end were instructed to steer certain types of borrowers to sub-prime loans destined to reset their rates. The Players who made out counted on the Fed inevitably raising interest rates--and they KNEW that a lot of borrowers would be unable to pay the new monthly payments--they knew the houses would forclose. They knew the market would collapse. All of this was essential if their put contracts were to be realized. To them, it was night following day. Not every financial institution--obviously--played this game. Many were bamboozled and lost, big time, Bear Stearns, among them. But some were smart, Goldman Sachs, among them. To my knowledge, Goldman was the main beneficiary. I am sure there are others, but have not uncovered them yet. Here is some more information:
How Goldman Sachs Made Money
Tip of the Iceberg
GS Makes Out
The Guy from Liar's Poker
September 8, 2008 9:37 AM | Reply | Permalink
Thanks for the links. Seems like Goldman did not make anywhere as much as the other big houses lost. That has me puzzled. The folks holding the hard assets normally would be considered winners, but if they cannot sell, they have a problem.
It sounds like there is a fair amount of consensus about what happened. What is always puzzling is how many people engaged in wishful thinking rather than keen analysis. People should have to go to jail for the ratings agencies debacle. Second best, why would any of the firms who got burned ever trust the ratings agencies again. Why aren't they out of business. (again, there is the possibility that this was just collusion.
As to the public messaging, it is important to be able to talk about complex subjects simply and straightforwardly. It's more important to be able to talk about it in a way that is as complex as the problem demands. If all you can do is talk simply then you wind up with George Bush economic policy management rather than Bill Clinton economic policy management. That's the whole crux of the pickle we are in now: * years of political responses to serious policy issues.
Obama's speech was,I think , intended to show his sophistication to a sophisticated audience. It got good reviews from some very smart people.
The task at hand is different. How do you make this a campaign issue. I think it is fair to say the Republicans put the fox in charge of the hen house and that why we have so few eggs right now.
What's the metaphor for the responsible adult supervision we need?
September 8, 2008 10:19 AM | Reply | Permalink
The problem is so big, the transactions so numerous, that research is problematic. Some prosecutions for violations of the law have begun, but this is hard work.
One message I would hammer if I were running for office is what it does to the public interest when an industry subject to regulation supplies the regulator to the agency writing the regulations. I would hammer that issue over and over.
September 8, 2008 11:18 AM | Reply | Permalink
Hey, C4,
Are you serious about driving trains over the Alleghenies? Sounds like you got to live a childhood fantasy of mine.
September 8, 2008 12:32 AM | Reply | Permalink
Yup. I was also President of the Brotherhood of Locomotive Engineers Union Local. But I haven't set foot on an engine in 23 years.
September 8, 2008 8:16 AM | Reply | Permalink
Asian markets are up this morning almost 4%. If they escape a global recession that means the demand for oil will remain high and the pinch on American consumers continues. All of that exurban housing stock is rapidly becoming worthless, expensive to heat, expensive to get to and impossible to finance.
How bad will this be by the end of October? We may all learn how to field dress deer unless Obama becomes the next FDR.
September 8, 2008 1:01 AM | Reply | Permalink
Not nearly enough deer to go around, I'm afraid.
Squirrel, maybe. And skunk, perhaps. And even at that, I have my doubts.
Which means that a lot of us will simply get dead.
September 8, 2008 6:19 AM | Reply | Permalink
Uncle Sam stepping in has, for the moment, reassured foreign investors, who bought a LOT of bonds. But Uncle Sam only recently discovered the state of their accounting, and who knows what other shoes will drop? This situation is unprecedented--it may end up costing the taxpayer nothing, it may cost hundreds of billions. Adding hundreds of billions to the trillion we've spent thus far, how big is the national debt supposed to grow? They've spent all the collectible tax revenues for the next century, and McCain-Palin want to cut taxes and cut government services. How can half the country not see this as DIRE? I mean, H.L. Mencken aside--is there a bottom to the depth of the stupidity of the supporters of McCain-Palin?
September 8, 2008 8:42 AM | Reply | Permalink
While discussing Phil Gramm it's ought to ,but isn't, always be an occasion to recall that his wife (Wendy?)was intrically involved in the collapse of Enron. It's more or less known that she was a director of Enron. Much less known that while she was head of the agency regulating trading in commondity futures (CFTC?)it changed the rules in a way that facilitated Enron's activities-and collapse.
I'm writing in a generalized fashion since while I don't recall the precise details (as I'm sure others here do),for me the interesting point is that her involvement ought to be an integral part of any mention of either Enron or her husband.
And it isn't.
September 8, 2008 6:40 AM | Reply | Permalink
You are right. The deregulation the Gramm's sought had Enron as it's first beneficiary--and you see where that led them. Wendy may be the ultimate center of the whole storm. Phil Gramm left the Senate in 2002 embroiled in scandal, and Wendy was named in Enron lawsuits. She has not served on another board. Remember, she was on the AUDIT committee.
She held several positions in the Reagan Administration, including heading the Commodity Futures Trading Commission from 1988 to 1993. After a lobbying campaign from Enron, the CFTC exempted it from regulation in trading of energy derivatives. Subsequently, Gramm resigned from the CFTC and took a seat on the Enron Board of Directors and served on its Audit Committee. I read somewhere that she was the author of the legislation, back in 2000--but I could not find the reference I originally read. Here are some additional links.
Enron and the Gramms
Clean Air Trust Report On Wendy Gramm
Salon Article on Wendy Gramm
September 8, 2008 8:35 AM | Reply | Permalink
As one who survived the last great disco pandemic of the 70s, I certainly don't want to relive those horrors. Oh the humanity!
September 8, 2008 11:31 AM | Reply | Permalink