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 investment banks, the bailout proposed by Treasury Secretary Henry Paulson addresses only half the problem. The financial meltdown will not end until we address the other half of the problem: homeowners facing foreclosure and bankruptcy.
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.
Foreclosed and vacant homes should be turned over to community land trusts and resold at a discount to families and individuals who have lost their homes. Placing the land in trust and leasing the land back to homeowners reduces the house price 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. They failed at all three. There should be stricter standards and improved oversight of the banking industry, so that lenders act in the best interest of borrowers.
The Congressional bailout plan primarily helps Wall Street investors. Since falling house prices are the root cause of this crisis, rescuing banks will not work if we do not also rescue homeowners.
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.
