Keynesian Economics gave us the Subprime Mortgage Crisis, but the Government blames S&P

Posted by PITHOCRATES - August 20th, 2011

We call it the Subprime Mortgage Crisis, not the Mortgage-Backed Securities Crisis 

When responsible for a problem you can accept blame.  Or you can blame the messenger.  Or better yet, you can attack the messenger (see Criticism of Standard & Poor’s over U.S. credit rating compounds its troubles in Washington by Jim Puzzanghera, Los Angeles Times, posted 8/18/2011 on WGNtv).

The backlash against Standard & Poor’s for downgrading the U.S. credit rating adds to the company’s problems in the nation’s capital, where it faces investigations for its role in fueling the financial crisis with faulty assessments of mortgage-backed securities.

S&P and the other credit-rating firms are widely believed to have enabled the near market meltdown by giving AAA ratings to many securities backed by risky subprime mortgages.

So the credit-rating firms enabled the subprime mortgage crisis.  Interesting.  Because the bad subprime mortgages already existed by the time those mortgage-backed securities came to them for review.  And it was those preexisting mortgages that people defaulted on and caused the near market meltdown.  So I don’t think you can blame this all on S&P.  And remember, we call it the subprime mortgage crisis.  Not the mortgage-backed securities crisis.  Ergo, the cause was the subprime mortgages.  And S&P didn’t write those mortgages.

Subprime Mortgages:  Creative Financing to Qualify the Unqualified

Once upon a time you saved up 20% for the down payment on a new house.  Then you went to a savings and loan to get a mortgage.  Or a bank.  In those days, people saved their money.  They deposited it into their savings accounts and earned 3% interest.  The banks and savings and loans then loaned it at 6%.  And the bankers were on the golf course by 3 PM.  Hence the joke about the 3-6-3 industry.  It wasn’t very sexy.  But it was reliable.  Few defaulted.  Because a new home owner had a lot to lose from day 1 thanks to that 20% down payment.

But there was a problem with this.  Home ownership was restricted to only those people who could afford to buy houses.  Those who could put down a 20% down payment.  And who had a job with sufficient income to qualify for a mortgage.  Well, you can see the problem with this.  What about the poor people who couldn’t come up with the 20% down payment nor had a job with sufficient income to qualify for a mortgage?

After World War II home ownership became a national goal.  Home ownership equaled economic growth.  It became the American dream (no longer was it the liberty that the Founding Fathers gave us).  As the years went by some saw that the poor were being left out.  Included in that long list of those who could not qualify for a mortgage were a lot of blacks.  Activists claimed that banks were redlining.  Disapproving a larger percentage of black applicants than white.  There were protests.  Investigations.  Banks had to figure out a way to qualify the unqualified and fast.  To prove that they weren’t being racist.

And the subprime mortgage was born.   Adjustable Interest Rate (ARM).  No documentation.  Zero down.  Interest only.  All kinds of creative financing to qualify the unqualified for mortgages.  And it was a hit.  Poor people liked them.  But banks were still reluctant to issue many of them.  Because they were far more risky than a conventional mortgage.  And it was dangerous to have too many of them on their books.  But then federal government solved that problem.

Fannie and Freddie enabled the Mortgage Lenders to Approve Risky Mortgages

Enter Fannie Mae and Freddie MacGovernment Sponsored Enterprises.  They would buy (or guarantee) those risky mortgages from the banks.  The banks breathed a huge sigh of relief.  Then started selling the crap out of subprime mortgages.  Because they were exposed to no risk thanks to Fannie and Freddie.  And the housing market took off.  The government urged Fannie and Freddie to lower their standards and buy even more risky mortgages.  To keep the housing boom alive.  And they did.  Not only were home owners snatching them up.  But speculators, too.  And the term ‘house flipping‘ entered the American lexicon.

Fannie and Freddie then repackaged the subprime mortgages they bought and resold them.  Into so-called ‘safe’ investments.  Thanks to being tied to a mortgage, historically one of the safest investments in America.  Well, they were when people were putting 20% down, at least.  So these mortgage back securities were created.  Reviewed by the credit-rating agencies.  And sold to investors, mutual funds, pension funds, 401(k)s, etc.  Who bought them with abandon.  Because they were rated AAA.  Long after those risky mortgages were written.

They were time bombs just waiting to go off.  Not because of the credit rating agencies.  But because of Fannie and Freddie.  Who enabled the mortgage lenders to approve risky mortgages with no risk to themselves.  And a long standing government policy to put as many people as possible into homes.  Because economic growth all came from home ownership.  And then it happened.  There was a housing bubble thanks to easy monetary policy.  The economy was heating up.  Worried about inflation, the Fed tapped the brakes.  Raised interest rates.  And all of those ARMs reset at higher rates.  People couldn’t afford the new higher monthly payments.  The higher interest rates left the speculators with lots of houses.  That they bought with no money down.  That no one was buying.  And, well, the rest you know.

The Greatest Threat to American Fiscal Solvency is the Government’s growing Health Care Tab 

So S&P didn’t cause the subprime mortgage crisis.  Whether they gave those securities AAA ratings or not those subprime mortgage holders were going to default anyway.  The origins of the subprime mortgage crisis reach a lot further back than S&P.  But their credibility did take a hit.  So they’re trying to be a little more cautious these days.  And if anyone paid attention during the debt ceiling debates, they know the country’s long-term finances are in some serious trouble.

Jeffrey Miron wrote a paper about the health of the U.S. states.  He starts in the introduction by going over the state of affairs in the federal government (see The Fiscal Health of U.S. States by Jeffrey Miron posted 8/15/2011 on Mercatus Center).

As the worldwide financial crisis has eased, economic policy debates have shifted from the short-term issue of stabilization to the log-term issue of fiscal imbalance.  Current projections suggests that the U.S. federal government faces an exploding ratio of debt to GDP, driven in large part by spending on health insurance1.  If this trend continues, the United States will soon find itself unable to roll over its debt and be force to default, generating a fiscal crisis.

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1  U.S. Congressional Budget Office, “CBO’s 2011 Long-Term Budget Outlook” (Washington, DC: CBO, June 2011)

Perhaps this is why S&P downgraded U.S. debt.  Because that debt ceiling deal did nothing to address the greatest threat to American fiscal solvency.  The government’s growing health care tab.  The nation indeed may be seeing some difficult times.  As will the states.

This paper offers five conclusions. First, state government finances are not on a stable path; if spending patterns continue to follow those of recent decades, the ratio of state debt to output will increase without bound. Second, the key driver of increasing state and local expenditures is health-care costs, especially Medicaid and subsidies for health-insurance exchanges under the Patient Protection and Affordable Care Act of 2009. Third, states have large implicit debts for unfunded pension liabilities, making their net debt positions substantially worse than official debt statistics indicate. Fourth, if spending trends continue and tax revenues remain near their historical levels relative to output, most states will reach dangerous ratios of debt to GDP within 20 to 30 years. Fifth, states differ in their degrees of fiscal imbalance, but the overriding fact is that all states face fiscal meltdown in the foreseeable future.

Not a pretty picture.  This whole European Socialism model is pushing both the states and the country to default.  Like it is currently pushing European nations toward default in the Eurozone.  Whose financial crisis is worst than America’s.  So far.

Keynesian Economics stimulated the Housing Market into the Granddaddy of all Housing Bubbles 

Social engineering.  Tax and spend liberalism.  Keynesian economics.   These are what gave us the subprime mortgage crisis.  Putting people into houses who couldn’t afford them.  And keeping interest rates artificially low to stimulate the housing market into the granddaddy of all housing bubbles.  The subprime mortgage crisis.  And more of the same will only push us further down the Eurozone road.  Sadly, a road often taken throughout history.  As once great nations fell, littering this road.  The Road to Serfdom.

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LESSONS LEARNED #35: “Not only is ignorance bliss, but it’s a godsend to Big Government.” -Old Pithy

Posted by PITHOCRATES - October 14th, 2010

If Jefferson Could Talk from the Grave He’d Be Hoarse from Shouting by Now

Politicians.  They’re all the same.  Well, most of them.  They enter politics for one thing.  For a career.  And what do people want from a career?  Great success.  Great prestige.  Great wealth.  Great power.  And a little revenge.  The pencil-neck, computer-nerd geek takes great pleasure in seeing a jock from his high school days emptying his trash while boarding his private jet. “Those wedgies and swirlies were a bitch but look at us now.”  It’s true.  The best revenge is living well.

But some people lack any talent or ability.  Some of them will never amount to anything.  They’ll never know the joy of looking down on people better than them with sweet condescension.  So these people go into politics.  Where people with no talent or ability can live well.  It’s a simple formula.  Sell your soul.  Whore yourself out.  Shake down businesses with taxation and regulation (and get even with all those people who have far more talent and ability than you ever had).  Collect tribute.  Consolidate power.  Hold those you serve in contempt.

Lord Acton wrote in 1887, “Power tends to corrupt, and absolute power corrupts absolutely.”  A century earlier, Thomas Jefferson fought tirelessly to prevent great money and federal power from conjoining.  The Old World capitals consolidated money and power.  And this concentrated the money and power into fewer and fewer hands.  Kings ruled by whim.  And oppressed their hapless subjects.  It’s a story as old as time.  And is still true today.  To the great chagrin of Jefferson.

Go West, Young Man

The transcontinental railroad was making poor progress during the Civil War.  Because it was starved for capital.  No one would invest.  Few doubted that they could build it.  Even if they could, few doubted it would ever make money.  The West was mostly raw, unsettled land.  There was nothing to transport.  Nothing to earn revenue.  It was a huge investment with a huge risk.  Investors are smart when it comes to money.  And they saw the transcontinental railroad as a one-way road that their money would go down and never return.  They needed something.  Big Government.

When it comes to throwing money away on a losing investment there is but one place to go.  Uncle Sam.  With the power to tax, the federal government has huge piles of money to play with.  So here’s what happened to build that railroad.  Union Pacific (UP) created a shell company called Crédit Mobilier (CM) to finance and build the railroad.  These companies were one and the same.  Without getting too complicated, UP sold their ‘worthless’ stock to CM at par.  Now, CM being a finance and construction company, a train never had to run over the road they were building to make a profit.  Union Pacific, on the other hand, needed trains running on that new track.  They were a transportation company.  They earned a profit from transporting goods on their trains.  This meant it could take years before UP could even hope to earn a profit on the new transcontinental railroad.  CM, on the other hand, could start earning a profit with the first invoice they submitted for construction.  And they did.

CM had strong revenues.  They submitted grossly inflated construction invoices to UP.  UP added a small construction management fee and submitted them to the government.  The government paid UP.  UP paid CM.  With revenues far exceeding their costs, CM made obscene profits.  CM stock took off into the stratosphere.  Some of which was sold to Congressmen at a deep discount who in turn realized obscene capital gains if they sold their stock.  Or collected obscene dividends if they held onto their stock.  In return for this sweetheart deal, they approved all cost overruns.  Killed any legislation unfavorable to UP/CM.  Provided lucrative incentives to build track on the worst ground in the most indirect path (to maximize the railroad’s mineral rights).  Provided little to no oversight on the construction of the road (some track was built on ice, with cheap steel and flimsy wooden trestles wherever possible).  When east met west the different railroads kept on building, parallel to each other to keep billing Uncle Sam.  All paid by the public treasury.  By the taxpayer.  The little guy.  Being raped and pillaged by their own representatives.

Affordable Housing for Those Who Vote Democrat

Politicians buy votes.  Pad the federal payroll.  Steal from the treasury.  Break the law.  Violate our trust.  You know, politician stuff.  Because of the inconvenience of elections, they can’t be too blatant about their rape and pillage.  So they do things that are in the best interest of the public.  Or so they say.  Like affordable housing.  You see, the Left buys the votes of the poor and minorities by throwing bones to them.  And there are a lot of minorities in the inner cities of the bluest of blue cities.  So they threw big bones to them.  Houses.

Despite their War on Poverty, the Left just can’t help these people.  The truth is, of course, that they don’t want to help them.  If they’re poor and dependent on the government, the Left can count on their vote.  If they escape poverty and don’t need Big Government to provide for them, these people are of no use to the Left.  Ergo, they never escape poverty.

Of course, the problem of remaining in abject poverty is that you can’t qualify for a mortgage.  Banks are funny that way.  They only loan money to people who can pay them back.  So they declined a lot of mortgages to these poor inner city minorities.  Well, this was just too good for Big Government to pass up.  A large group of minorities (i.e., a large Democrat voting bloc) being denied mortgages?  Why, that’s racism.  So they drafted a lot of legislation and unleashed their justice department with extreme prejudice.  The message?  Approve these loans.  Or face the consequences (revoking a bank’s charter, a federal lawsuit, a public demonstration headed by Jesse Jackson, Charlie Rangel, et al, etc.).  So they found creative ways to approve loans.  And they got a little help from Uncle Sam.

The Subprime Mortgage Crisis is a Lot Like the Crédit Mobilier Scandal

By a little I mean a lot.  Uncle Sam screwed the mortgage bankers by making them approve extremely risky loans.  So, to help the mortgage bankers, Uncle Sam screwed the American people.  They guaranteed those highly risky mortgages, thus transferring the risk from them to us, the taxpayer.  And to further mitigate the bankers’ risks, they purchased a lot of those highly risky mortgages to remove them from the banks’ balance sheets.  It’s called the secondary mortgage market.  And the primary players are none other than Fannie Mae and Freddie Mac, ground zero of the subprime mortgage crisis.

Once upon a time, a mortgage was one of the safest investments.  People saved up to pay a 20% down payment.  With their life savings invested, people paid their mortgage payment and they paid them on time.  And if you could afford a 20% down payment, mortgage bankers had a lot of confidence that you would be able to service your mortgage.  But in the day of 5%, 3% and 0% down, a person doesn’t have a whole lot to lose.  This makes the first few years of these mortgages especially risky.  The introduction of ‘no documentation’ mortgages meant people could lie about their income (or include overtime earnings).  Add to that the Adjustable Rate Mortgage (ARM) and the interest-only mortgage and you just made these especially risky mortgages even more risky.  Sure, these will get almost anyone into a home, but they get in by the skin of their teeth.  But if they lose their overtime due to a weakened economy, if their interest rate on their ARM resets at a higher rate or a balloon payment is due on their interest-only loan, guess what?  That stream of mortgage payments could very well stop.

Now that would be a BIG problem.  Because of what Freddie and Fannie did with those mortgages they bought.  They sliced them up and built creative investment vehicles.  Derivatives.  Mortgage backed securities called collateralized debt obligations.  Wall Street repackaged all these risky mortgages into highly profitable investments.  Everybody bought them.  Pension funds.  Trust funds.  In America.  And throughout the world.  Big gains with a low risk.  Or so it would seem.  You see, they never eliminated the risk.  They only transferred it to someone else.  And once people couldn’t pay their mortgage payments anymore, the house of cards came crashing down.  We call it the subprime mortgage crisis of 2008.  It caused a worldwide recession.  And cost the American taxpayer dearly.  Even those not born yet.

Yes We Can…Screw the American Taxpayer

The subprime mortgage crisis of 2008 is a government creation.  Their quest of affordable housing to buy votes put more and more people into houses they couldn’t afford.  They created legislation akin to extortion of the banking industry.  They used the Justice Department to apply the muscle for that extortion.  They had their friends in the media and the activists for racial equality to further pressure the banking industry.  Their lack of oversight of Fannie and Freddie (thank you Barney Frank and Chris Dodd) let them make extremely risky loans.  And their policies of buying extremely risky mortgages ultimately transferred all risk to the taxpayer.  Why?  Because like all good government scandals, the seekers of favors rewarded our representatives well for their complicity with sweetheart mortgage deals, vacation junkets, fat contributions to their campaign war chests, etc.  In other words, politics as usual.  But on a grand scale.

Why do they do it?  Because they can.  They count on you being ignorant of history.  And accepting every lie they tell you.  Because they hold you in contempt.  They look down on you with sweet condescension.  These pencil-neck geeks who could never amount to anything on their own merit or ability.  But some sold souls later and they have finally gotten even with those who were better than them.  And here they are.  Still living well.  Even during the worst recession since the Great Depression.

www.PITHOCRATES.com

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