09.29.08
Financial meltdown: what went wrong, and how will it affect us?
We are in the midst of the worst financial crisis since the Great Depression. The commercial and investment banking business was deregulated throughout the 1980s and 90s with the promise that it would lead to greater prosperity. Investors invented fancy new financial instruments to distribute and disguise the risk, and walked away with millions of dollars in profits. Consumers found it easier to get credit, and many spent well beyond their means. Some are now facing foreclosure or bankruptcy.
The biggest investment banks are failing because they have to book those losses. Even safe assets have lost billions of dollars in value. In less than two weeks we saw the five biggest bailouts in history: the world’s biggest insurer, with assets of nearly $1 trillion; two of the world’s biggest investment banks, with combined assets of $1.5 trillion; and the two giants of the mortgage industry, with assets of $1.8 trillion. The total bill so far is about $4.2 trillion- and there may be more coming.
The Federal Reserve and Treasury Department had to act because these failures threaten the stability of the global financial system. Each time another bank or financial institution is bailed out by the government, their financial obligations are absorbed by the U.S. Treasury. At the beginning of the Bush administration, total U.S. government debt was about $4.3 trillion. Two weeks ago it was about $9 trillion. After this it will be upwards of $13 trillion.
Guess who is going to end up paying that debt? Taxpayers will. In just two weeks, each American’s share of the national debt went from $30,000 to about $44,000. We owe much of it to the sovereign wealth funds of nations like China, Dubai, and Saudi Arabia, which lack democratic institutions and could change their mind about the safety of these investments any day. I’ll bet you could think of some better ways to spend your hard-earned money.
The financial innovation of investment banks had very little oversight by regulatory authorities. Most Americans didn’t receive a single dime of the profits, but they got stuck with the costs when they failed. This is corporate welfare at its very worst.
You have heard conservative politicians say that the economy is fundamentally sound and that everything will be fine. That’s nonsense. They want to offer more tax cuts for the wealthy and more deregulation as the remedy. It won’t work: that’s how we got into this mess in the first place.
Deregulation allowed commercial and investment banks to invent ever more complex financial instruments. The investors that bought and sold these products made a lot of money, but all that changed when the underlying assets (including homes) lost value. When confidence in the stability of the financial system was shaken, that deepened the crisis and caused the ensuing financial meltdown.
Many of us suffered the effects of foreclosures, bankruptcies, and deflated house prices. The long-term consequences will be higher interest rates and higher Federal income taxes. These effects will hit hardest at about the same time baby boomers are retiring in huge numbers, our children will be entering the work force, and we’ll be facing a crisis in funding for Medicare, Medicaid, and Social Security.
This may be a national problem, but there are local solutions. What state-level policies could we pursue that would mitigate the effects?
First, we need to do everything possible to keep people in their homes and restore confidence in the banking system. By focusing only on rescuing big banks, the “no strings attached” bailout package implemented by Treasury Secretary Henry Paulson addressed only part of the problem. The financial meltdown will not end until we address the source of the problem: homeowners who are facing foreclosure and bankruptcy. Rescuing banks will not work unless we also rescue homeowners.
Now that Fannie Mae and Freddie Mac are owned by the Federal government, they need to provide low-interest fixed-rate mortgages to creditworthy homeowners facing foreclosure or an interest rate reset on adjustable rate mortgages. This will reduce borrowing costs and risks, make homeownership more affordable, reduce the inventory of unsold homes, and stabilize house prices. This in turn will stabilize the value of the mortgage-backed securities the government is taking over.
Commercial banks are sitting on the cash reserves they’ve built up during this crisis, rather than lending them out. Part of these reserves are funds they’ve received from the Federal Troubled Assets Relief Program (TARP). That was not the purpose TARP funds were intended for. Banks should be required to lend TARP funds to financially distressed homeowners and businesses, or use them to purchase mortgage-backed securities from Freddie Mac and Fannie Mae. Reducing the risk of these securities will cause mortgage interest rates to fall.
Foreclosed and vacant homes should be turned over to community land trusts and resold at a discount to people who have lost their homes. Placing the land in trust and leasing the land back to homeowners reduces the house price and mortgage cost significantly and creates permanently affordable housing.
As for banking and the mortgage lending industry, we need to modify capital requirements- increasing them during economic booms to protect the financial system against incremental risk-taking, and lowering them during downturns to make credit more widely available when it is needed most.
Government’s role is to foster useful innovation, limit greed and speculation, and protect consumers. There should be stricter standards and improved oversight of the banking industry, so that lenders act in the best interest of borrowers and consumers.
My opponent Don Benton opposed the following bills to protect consumers from mortgage scams and predatory lenders:
- Senate Bill 6381 established stricter fiduciary duties for mortgage brokers and required them to act in the best interest of borrowers.
- Senate Bill 6452 required full disclosure of interest rates and yield spread premiums.
Rosy said,
September 22, 2008 at 9:44 am
Privatization of profits and socializing the cost of losses is
not acceptable ! Taxpayers deserve governmental
oversight of precious resources and public funds.
David Carrier understands this and will act in
the best interest of all of the people in his District.
M.Maggio said,
September 23, 2008 at 9:31 pm
We are at a crossroads in US economic history. Its a complicated subject with experts on both sides trying to push their own agendas. With a PhD in Economics David understands both sides and I know that whatever happens David will put the interests of working people first. He will be a strong and sensible voice for fiscal responsibility in Olympia at a time when its needed most!
John said,
September 24, 2008 at 7:26 pm
Nice post on the Bush crime family going away present Dr. Carrier.
If Warren Buffett is willing to dump 5 billion into Goldman Sachs for some preferred stock, it is very hard to understand why “we the people” have to fork over money to them with nothing but probably worthless paper received in return.
Or maybe that is why Buffett is buying because he knows a sucker deal when he sees one and wants in on the windfall being contemplated for the banks?
Lilith Saintcrow » Blog Archive » Why I Love My Country said,
October 2, 2008 at 10:27 am
[...] dealing with Wall Street is only half of the problem. The plan doesn’t take home foreclosures into account, and that’s going to affect a lot more people. I was just blogging about this the other day…
Administrator said,
October 5, 2008 at 8:50 pm
Predatory Lenders’ Partner in Crime: How the Bush Administration Stopped the States From Stepping In to Help Consumers
By Eliot Spitzer, Governor of New York
Washington Post, Thursday, February 14, 2008
For 140 years, the Federal Office of the Comptroller of the Currency (OCC) examined the books of national banks to make sure they were balanced, an important but uncontroversial function. But a few years ago, for the first time in its history, the OCC was used as a tool against consumers.
In 2003, during the height of the predatory lending crisis, the OCC invoked a clause from the 1863 National Bank Act to issue formal opinions preempting all state predatory lending laws, thereby rendering them inoperative. The OCC also promulgated new rules that prevented states from enforcing any of their own consumer protection laws against national banks. The federal government’s actions were so egregious and so unprecedented that all 50 state attorneys general, and all 50 state banking superintendents, actively fought the new rules.
But the unanimous opposition of the 50 states did not deter, or even slow, the Bush administration in its goal of protecting the banks. In fact, when my office opened an investigation of possible discrimination in mortgage lending by a number of banks, the OCC filed a federal lawsuit to stop the investigation.
Throughout our battles with the OCC and the banks, the mantra of the banks and their defenders was that efforts to curb predatory lending would deny access to credit to the very consumers the states were trying to protect. But the curbs we sought on predatory and unfair lending would have in no way jeopardized access to the legitimate credit market for appropriately priced loans. Instead, they would have stopped the scourge of predatory lending practices that have resulted in countless thousands of consumers losing their homes and put our economy in a precarious position.
When history tells the story of the subprime lending crisis and recounts its devastating effects on the lives of so many innocent homeowners, the Bush administration will not be judged favorably. The tale is still unfolding, but when the dust settles, it will be judged as a willing accomplice to the lenders who went to any lengths in their quest for profits. So willing, in fact, that it used the power of the federal government in an unprecedented assault on state legislatures, as well as on state attorneys general and anyone else on the side of consumers.
Administrator said,
October 5, 2008 at 9:02 pm
A BETTER BAILOUT
by: Joseph E. Stiglitz
The Nation, September 26, 2008
To be frank, the administration has a credibility and trust gap as big as that of Wall Street. If the crisis was as severe as they claim, why didn’t they propose a more credible plan? With lack of oversight and transparency the cause of the current problem, how could they make a proposal so short in both? If a quick consensus is required, why not include provisions to stop the source of bleeding, to aid the millions of Americans that are losing their homes? Why not spend as much on them as on Wall Street?
Do they still believe in trickle-down economics, when for the past eight years money has been trickling up to the wizards of Wall Street? Why not enact bankruptcy reform, to help Americans write down the value of the mortgage on their overvalued home? No one benefits from these costly foreclosures.
The administration is once again holding a gun at our head, saying, “My way or the highway.” We have been bamboozled before by this tactic. We should not let it happen to us again. There are alternatives. Warren Buffet showed the way, in providing equity to Goldman Sachs. The Scandinavian countries showed the way, almost two decades ago. By issuing preferred shares with warrants (options), one reduces the public’s downside risk and insures that they participate in some of the upside potential.
This approach is not only proven, it provides both incentives and wherewithal to resume lending. It furthermore avoids the hopeless task of trying to value millions of complex mortgages and even more complex products in which they are embedded, and it deals with the “lemons” problem – the government getting stuck with the worst or most overpriced assets.
Finally, we need to impose a special financial sector tax to pay for the bailouts conducted so far. We also need to create a reserve fund so that poor taxpayers won’t have to be called upon again to finance Wall Street’s foolishness.
Administrator said,
October 5, 2008 at 9:06 pm
Agency’s ’04 Rule Let Banks Pile Up New Debt
By Stephan Labaton
New York Times, October 2, 2008
On a bright spring afternoon, the five members of the Securities and Exchange Commission met in a basement hearing room to consider an urgent plea by the big investment banks. They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.
The five investment banks led the charge, including Goldman Sachs, which was headed by Henry M. Paulson Jr. Two years later, he left to become Treasury secretary. After 55 minutes of discussion, which can now be heard on the Web sites of the agency and The Times, the chairman, William H. Donaldson, a veteran Wall Street executive, called for a vote. It was unanimous. The decision, changing what was known as the net capital rule, was completed and published in The Federal Register a few months later.
With that, the five big independent investment firms were unleashed. In loosening the capital rules, which are supposed to provide a buffer in turbulent times, the agency also decided to rely on the firms’ own computer models for determining the riskiness of investments, essentially outsourcing the job of monitoring risk to the banks themselves. Over the following months and years, each of the firms would take advantage of the looser rules. At Bear Stearns, the leverage ratio — a measurement of how much the firm was borrowing compared to its total assets — rose sharply, to 33 to 1. In other words, for every dollar in equity, it had $33 of debt…
screekdude said,
October 6, 2008 at 12:29 am
Here are my views on your recent email, attached below:
I agree with most of the observations. This financial crisis has been brewing for a while. As early as 2006, there were people sounding the alarm that home prices were rising way out of proportion with the rise in family incomes. And speculators were buying homes just so that they could flip them. Sounded like the alarm that Greenspan sounded in his “irrational exuberance” speech, years before the Dot Com bust in 2000. But no one did anything to tighten credit at that time, when it could have been much cheaper, just as no one did anything to curb day trading and option trading in the late 1990s. Increase in products like derivatives (a very appropriate term borrowed from Calculus, which can very easily model the departure from the norm, and predict violent swings in prices) is a symptom of increase in speculation. When speculation rules price action, the normal market forces of supply and demand for ACTUAL GOODS AND SERVICES take a back seat. If I were to call the shots, any government economist who did not take action two years ago should be fired. I see the role of the government as the guardian of free market forces, which we preach all over the world. But we fail to practice it at home. Instead, we have crony capitalism, where the government looks the other way when the big donors repackage debt into complicated financial instruments and resell them for profit.
By the way, the same can be said about the other side of the equation. If capital is being squeezed by the debt crisis, which Democrats are quick to blame on crony capitalists, most of them Republicans, the supply of quality labor is being pinched by the pubic education system. Yes, the same system that supports democratic candidates for the most part. Trade unions belonging to teachers and other employees are quick to take the role of the victim when they see excesses on Wall Street. But I think this is just another smoke screen to hide the job it has not been doing for the last 40 years. I have not seen any politician who has ventured to turn this rock to see which worms crawl out – the rock is too big, the worms too many. My take on this is that they are afraid of losing the endorsement of large voting blocks the unions control. Since you claim to not take any help from big donors, I feel you are in a unique situation to make an impact here. The K-12 public education is at the bottom of the industrial world today, and soon it will be at the bottom of fast developing countries – in the bottom 25th percentile of the world population. Why do I say this? Because no matter what the state and national leaders have done, they have not been able to break the monopoly of the unions. Without free market forces in action in education, I don’t think you will see any tangible improvement. You are an economist, so I am sure you understand what happens when a monopoly takes hold of a system. I assert that no leading economy can afford to continue leading, with a system that is worse than what we used to call the 3rd world, just 10 years ago. States like Texas, Massachusetts, California, Arizona, have all woken up and started taking decisive action. The states of Oregon and Washington have not. And we are paying the price, with one of the highest unemployment rates, highest college remediation rates, and lowest college graduation rates in the nation. I don’t know about you, but I think this cannot continue if we were to do what is right for the local economy. Shortage of capital AND quality labor are about to create the perfect economic storm. Hold on for a very rough ride during the next few years.
chucksr said,
October 13, 2008 at 9:56 am
As of this date Don Benton has failed to have posted the Political Courage Test? Why?
Project Vote smart has this information on Senator Don Benton
Abortion
2008 Has received no points for issues on Abortion and has no history with any points He also received no points in previous years.
Labor
2008 Based on a point system, with points assigned for actions in support of or in opposition to Washington State Labor Council, AFL-CIO’s position, Senator Benton received a rating of 40.
Agriculture
2008 Based on a point system, with points assigned for actions in support of or in opposition to Washington Farm Bureau’s position, Senator Benton received a rating of 100.
Business
2008 Based on a point system, with points assigned for actions in support of or in opposition to Association of Washington Business’s position, Senator Benton received a rating of 91.
2008 Based on a point system, with points assigned for actions in support of or in opposition to Washington National Federation of Independent Business’s position, Senator Benton received a rating of 85.
2007 Based on a point system, with points assigned for actions in support of or in opposition to JobMakers’s position, Senator Benton received a rating of 45.
Civil Liberties and Civil Rights
2001-2002 Senator Benton supported the interests of the First American Education Project 65 percent in 2001-2002.
No record since 2002?
Conservative
2007 Based on a point system, with points assigned for actions in support of or in opposition to Washington Conservative Union’s position, Senator Benton received a rating of 73.
Education
2005 Senator Benton supported the interests of the Washington Education Association 55 percent in 2005.
Environmental Issues
2007-2008 Based on a point system, with points assigned for actions in support of or in opposition to Washington Conservation Voters’s position, Senator Benton received a rating of 46.
Family and Children Issues
2008 Based on a point system, with points assigned for actions in support of or in opposition to Washington Children’s Alliance’s position, Senator Benton received a rating of 67.
Government Reform
He has no score posted for 2006, 2007 or 2008.
Gun Issues
He has no score posted for 8 years
Women’s Issues
He has no score posted since 1998 (scored 33)
TOTAL = 534 OUT OF 1200= 44%
That is an “F” on any report card
Administrator said,
November 18, 2008 at 8:41 pm
Hank Paulson is finally listening:
Fighting the Financial Crisis, One Challenge at a Time
By HENRY M. PAULSON Jr., NYT, November 17, 2008
http://www.nytimes.com/2008/11/18/opinion/18paulson.html?th&emc=th
“More access to lower-cost mortgage lending is the No. 1 thing we can do to slow the decline in the housing market and reduce the number of foreclosures. Together with our bank capital program, the moves we have made to stabilize and strengthen Fannie Mae and Freddie Mac, and through them to increase the flow of mortgage credit, will promote mortgage lending. We are also working with the Department of Housing and Urban Development, the F.D.I.C. and others to reduce preventable foreclosures.”
Administrator said,
March 20, 2009 at 6:23 am
“Sold Out: How Wall Street and Washington Betrayed America,” a report released by Essential Information and the Consumer Education Foundation, details a dozen crucial deregulatory moves over the last decade — each a direct response to heavy lobbying from Wall Street and the broader financial sector, as the report details. (www.wallstreetwatch.org/soldoutreport.htm) Combined, these deregulatory moves helped pave the way for the current financial meltdown.
Here are the 12 DEREGULATORY STEPS TO FINANCIAL MELTDOWN:
http://www.commondreams.org/view/2009/03/07-3
Wall Street’s Best Investment – Part II
by Robert Weissman
http://www.commondreams.org/view/2009/03/07-3