Friday, November 21, 2008

Markets, Mortgages, & Bailouts – About Root Causes & Lessons Learned

We find ourselves at an inflection point, knowing now that things can no longer be as they were. Gravity has reappeared and brought us back to ground. We consume more than we produce. Many of our industries cannot compete in the face of cheaper foreign labor. We borrow money from foreigners and divvy it up among ourselves (see social security, cheap mortgage loans, unemployment insurance, subsidies, etc.) and then send cash back over our borders for stuff we can’t afford to make ourselves. The party seems to be coming to an abrupt end.

Mortgage loans going bad started the collapse of the house of cards. Democrats for years have been forcing banks to issue lots of loans to people who couldn’t afford them (see Community Reinvestment Act; Frank, Barney; Dodd, Chris; Friends of Angelo; community activist organizations). An exceptionally low interest rate set by government made too much money available for these risky loans. Then the loans were packaged into complex investment vehicles (see securitization, CMOs, CDOs, SIVs, etc., etc.) whose risks few people seem now to have ever understood, thus allowing the initial lenders to pass the toxins off to an ever-widening sphere of people. Credit rating companies performed their devious alchemy, making gold out of lead by proclaiming that baskets of these risky loans were actually credit worthy. Misbegotten agencies of the federal government with funny names, under the ruse of being publicly-traded companies (which simply allowed them to hire at high salaries Democrats between jobs [see, for example, Gorelick, Jamie; Raines, Franklin] and to donate money to Democrats [see, for example, Dodd, Chris (again); Obama, Barak]), bought lots of this toxic stuff on behalf of American taxpayers. Investors foreign and domestic hungry for yield amidst prolonged low interest rates themselves feasted on the toxins, and great financial companies full of people with degrees in finance from great schools even borrowed ever increasing amounts of money (see leverage) to buy risky loans for themselves, and then when they couldn’t get enough on their own bought other companies engorged with them (see Countrywide Financial; Washington Mutual). And finally, in what now looks tragic-comic in retrospect, financial firms even wrote and bought insurance contracts among themselves against the default of these toxic loans (see credit default swaps).

Those many Americans who lived prudently and responsibly within their means had little to no idea any of this was going on, and certainly had no notion of the extent of it, but nevertheless are now paying for it, one way or another. And where did all the money go? Well, some of it may have been paper money inside a bubble, but the wealth (see yachts, big; estates, country; jewelry, expensive; etc.) that all the clever financial engineers extracted from the game is real. They built Wall Street into the world capital of financial legerdemain, while the people now stuck with the tab were simply out teaching or healing or policing or building or growing or discovering or cleaning or whatever.

We will now see if enough of us have learned, or can learn, the real lesson of our relevant history -- that the misguided and all-too-visible heavy hand of government command and control is what put the “Great” in the Great Depression. The Troubled Asset Relief Program, passed some weeks ago with sudden urgency lest the economy immediately collapse (it was said), was an inauspicious start down the same path, giving one man, a Secretary of the Treasury, a $700 million discretionary slush fund to buy toxic assets from financial firms at prices that would have to be significantly above market value to have any beneficial economic effect, and thusly rescue the malefactors as well as our financial system. Fortunately that man, finally agreeing with his critics, has just now admitted that his original plan was a bad idea after all and that he has been doing something else instead. But he retains the slush fund and has now spent some of it, and is widely believed to have done some good with it. It is hard for ordinary mortals to fathom much of this, and everyday even experts on TV seem to disagree about everything.

John Michael Greco

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