Monday, January 26, 2009
Bruce Bartlett on the economy
Bruce Bartlett Has an excellent article about the various schools of economic thought regarding stimulating the economy. From what I know of the House Bill. it would satisfy none of them.
Saturday, January 24, 2009
More on the financial crisis
Michael Lewis, the author of Liar's Poker,has written a long but informative and entertaining article about the subprime mortgage debacle.
Wednesday, January 21, 2009
Tuesday, January 6, 2009
The financial crisis: a perfect financial storm?
Tens if not hundreds of thousands of words have been written about the current financial crisis and the accompanying recession. Much of this analysis has been first rate, but this article will provide an overview of how we came to this pass.
As many before me have said there is plenty of blame to go around.
The current mess was brought about by a combination of government and private sector mistakes. The federal government significantly contributed to this mess in three ways: the Community Reinvestment Act, lax oversight of Fannie Mae and Freddie Mac, and a loose monetary policy.
The CRA was passed during the Carter administration. Its goal was to make affordable housing available to low income borrowers. Unfortunately, the phrase "affordable housing" is a pernicious misnomer. In reality, people were often encouraged to purchase houses that they could not afford, leading to defaults and foreclosures.
Mortgage lenders frequently went along with this scheme, some more eagerly than others, because they could lay off many of these risky loans on somebody else. That is where Fannie and Freddie come in. These government-sponsored enterprises do not originate mortgages. Rather, they purchase mortgages in the aftermarket. Fannie and Freddie hold approximately half of all of the mortgages outstanding in this country. I haven't seen a breakdown, but I would bet that a disproportionate number of mortgages held by Fannie and Freddie are dogs. When the auditors sounded the alarm about what was happening at Fannie and Freddie in 2004, they were savaged by Democrats in Congress, including Maxine Waters and Barney Frank. Real estate prices were still rising, and no one wanted to face the truth.
One reason real estate prices kept rising was that the Federal Reserve pursued a very loose monetary policy, driving short-term interest rates down to historic lows. But eventually the housing boom ended (booms always do), and the house of cards came crashing down.
Interestingly, the mortgage lenders were not those hardest hit. In addition to laying off mortgages on Fannie and Freddie, lenders had also packaged them into derivative securities called Collateralized Debt Obligations. These were snapped up by investment houses that frequently used leverage (borrowed money) to purchase them. When the investments finally had to be marked down, these companies did not have the requisite financial reserves to avoid defaulting on the loans.
The first major company to go was Bear Stearns, followed by Merrill Lynch and Lehman Brothers. American International Group, a huge international insurance company, also found itself in trouble, because it had sold contracts guaranteeing the repayment of the CDOs (called credit default swaps). None of these companies was in the business of making mortgage loans. Their spectacular miscalculations are incomprehensible Three large retail lenders, Countrywide, IndiMac Bank, and Washington Mutual also became insolvent, along with a number of smaller lenders.
We have all learned the hard way that laying off risky loans to other companies doesn't protect you if the entire financial system becomes overburdened and crashes. Our elected officials -- Democrat and Republican alike -- still do not want to face the music. Their frantic efforts to prop up bad loans and insolvent companies may well prolong the problem by preventing the unwinding that has to occur. This same thing happened in Japan during the 1990s, and Japan has still not fully recovered.
The market will eventually self correct, if it is allowed to do so. The process will be painful, but it is necessary to get valuations back to rational levels.
As many before me have said there is plenty of blame to go around.
The current mess was brought about by a combination of government and private sector mistakes. The federal government significantly contributed to this mess in three ways: the Community Reinvestment Act, lax oversight of Fannie Mae and Freddie Mac, and a loose monetary policy.
The CRA was passed during the Carter administration. Its goal was to make affordable housing available to low income borrowers. Unfortunately, the phrase "affordable housing" is a pernicious misnomer. In reality, people were often encouraged to purchase houses that they could not afford, leading to defaults and foreclosures.
Mortgage lenders frequently went along with this scheme, some more eagerly than others, because they could lay off many of these risky loans on somebody else. That is where Fannie and Freddie come in. These government-sponsored enterprises do not originate mortgages. Rather, they purchase mortgages in the aftermarket. Fannie and Freddie hold approximately half of all of the mortgages outstanding in this country. I haven't seen a breakdown, but I would bet that a disproportionate number of mortgages held by Fannie and Freddie are dogs. When the auditors sounded the alarm about what was happening at Fannie and Freddie in 2004, they were savaged by Democrats in Congress, including Maxine Waters and Barney Frank. Real estate prices were still rising, and no one wanted to face the truth.
One reason real estate prices kept rising was that the Federal Reserve pursued a very loose monetary policy, driving short-term interest rates down to historic lows. But eventually the housing boom ended (booms always do), and the house of cards came crashing down.
Interestingly, the mortgage lenders were not those hardest hit. In addition to laying off mortgages on Fannie and Freddie, lenders had also packaged them into derivative securities called Collateralized Debt Obligations. These were snapped up by investment houses that frequently used leverage (borrowed money) to purchase them. When the investments finally had to be marked down, these companies did not have the requisite financial reserves to avoid defaulting on the loans.
The first major company to go was Bear Stearns, followed by Merrill Lynch and Lehman Brothers. American International Group, a huge international insurance company, also found itself in trouble, because it had sold contracts guaranteeing the repayment of the CDOs (called credit default swaps). None of these companies was in the business of making mortgage loans. Their spectacular miscalculations are incomprehensible Three large retail lenders, Countrywide, IndiMac Bank, and Washington Mutual also became insolvent, along with a number of smaller lenders.
We have all learned the hard way that laying off risky loans to other companies doesn't protect you if the entire financial system becomes overburdened and crashes. Our elected officials -- Democrat and Republican alike -- still do not want to face the music. Their frantic efforts to prop up bad loans and insolvent companies may well prolong the problem by preventing the unwinding that has to occur. This same thing happened in Japan during the 1990s, and Japan has still not fully recovered.
The market will eventually self correct, if it is allowed to do so. The process will be painful, but it is necessary to get valuations back to rational levels.
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