Post by Ilithi Dragon on Dec 12, 2008 10:18:00 GMT -5
Well, I'm not sure how many of you are involved in or familiar with the financial industry, but I figure a lot of you are in the dark about the causes of the current economic BSOD, with reports on 'sub-prime loans', 'leveraging', etc. having about as much meaning as the technical jibberish in a computer BSOD. I'm not involved in the financial industry, but I've been doing some research of late, and I figured I'd share what I've dug up.
First, a few definitions.
Sub-prime mortgage: A sub-prime mortgage is a high-priced mortgage, it has a high interest rate, high monthly premiums (how much you have to pay back a month), etc.
Leveraging: Leveraging is using a small initial investment to control a much larger investment or some of money. In this case, with the mortgage industry, leveraging refers to banks lending an initial loan and then selling it to investors or other banks, so they can take out another loan, and another, and another, controlling more and more amounts of money with that initial loan.
CRA: The Community Reinvestment Act of 1977, enacted under President Jimmy Carter to force banks to stop discriminating against elligible minority borrowers, and often blamed for the collapse because 'the government forced banks to make bad loans'
Our economy is tanking right now not because of the CRA, or governments forcing banks to make bad loans, or anything like that - the CRA has actually had a small stabilizing effect on the collapse, because the banks involved in the CRA have very stringent requirements to thoroughly investigate the credit worthiness of all their borrowers applying for a loan, and have much greater motivation to make good loans because of the thoroughness of their investigation, and because most of their loans were made through local bank branches, which held onto the loans instead of selling them off, making them directly liable if they default.
The collapse of the housing market has to do with two main factors. The first is leveraging of loans, especially sub-prime loans, which are more likely to default. Mortgage brokers, which don't actually give loans, they just set them up between banks and borrowers, will broker mortgages, and sell them to banks (borrowers often also just go straight to the bank). The original lending bank then turns around and sells that loan to an investor or group of investors, or another bank/lending firm or group of banks/lending firms. This gives them the ability to lend another loan to another customer, which they can then sell to the same people, or someone else. The people buying the loans are making an investment, looking to get a return on their investment through the loan's interest rate, but often times, they don't hang onto the loan - they will often leverage the loan themselves, selling it off to someone else, so they can buy another loan (or make another investmentin something else). The company or investors THEY sell the loan to will often then turn around and sell it to someone ELSE, and so on.
This in and of itself isn't really a bad thing - leveraging, even in the housing market, isn't inherently bad, and can be a very useful tool. It's when it gets carried away that it becomes an issue. Most market analysts and financial experts who were predicting the collapse we are now experiencing years ago predicted that leveraging out by anything more than a factor of 6 is extremely dangerous and presents a severe risk of failure (i.e. if a bank can make 10 loans, they sell those loans off to be able to make more loans, then sell those new loans, etc. by a factor of 6). When the economy hit the fan, leverages by factors of 12 to 75 or more were common across the industry. The risk is that it only works so long as the money continues to flow - if the money stops flowing (a borrower defaults on a loan), all that massive debt the lender (and the people invested in that lender) accrued will come crashing down on top of it. This house of cards is not so unstable that it would collapse with the default of a single loan, but if enough loans default, it's like knocking out a card in the center of the bottom layer.
The other factor that led to the collapse of the housing market is an fundamental collapse of ethical behavior in the financial industry. A prime example: mortgage brokers have no incentive to make good loans (i.e. loans that people can actually pay back) - they get paid by the volume of loans they broker, not the quality of the loan, and once the loan is made, and they are just the broker of the loan, not the lender, so it's not their problem if the borrower defaults on the loan. Often times, the BANK doesn't care if it's a good loan or not, because they're going to sell the loan to another bank or lending firm, and won't have to deal with it should it default. That bank or lending firm then doesn't care if the loan is good, because THEY'RE probably going to sell the loan, and so on, and on, and on. THIS is where the bad loans come from, because most banks and mortgage brokers have little or no incentive to make good loans, and the high-cost (and thus high-return for lenders/investers), sub-prime mortgages were doled out like candy at Halloween to anyone who came knocking, regardless of whether or not they could actually afford to pay the loan back. The exceptions to this are the 'local banks', the smaller banks or larger banks with local branches in the community, which have a very large investment in the community and tend to hang onto loans more (thus giving incentive to make good loans), and who are also often run by people who actually live in the community, AND the CRA banks, who, through the regulation of the original Community Investment Act, were required by the government to thoroughly investigate potential borrowers for credit worthiness, and who also often held onto their loans more than any other lending organization (often because they would lend through local community branches).
On top of this, major and minor companies in the financial industry started short-selling each other, cheating and lying to get more money. Honesty and trustworthiness in the financial industry has essentially collapsed - banks won't even lend to each other, because nobody knows who can actually pay up. This whole situation was exacerbated and encouraged by a revision of the CRA act under the Bush administration, which effectively deregulated the entire housing market and much of the financial industry, allowing banks, investment groups, etc. to get away with a LOT more, and letting the over-leveraging and cheating run rampant to catastrophic extremes, which we're now facing. Added onto this is the bailout package, which is going to effectively saddle the American taxpayers with the bill for the rampant, blatantly unethical short-sighted 'immediate-gain, long-term-collapse' planning of the corporate executives and managers involved in the whole boondoggle, while they take the blank check and mosy off to an ultra-high-class resort in some tropic island nation where the U.S. courts and financial systems can't touch them.
The collapse of the lending industry wasn't just the only problem, it was also rampant over-lending by the lending industry (leveraging), rampant 'speculating' of the stock market which drove it to false highs (as demonstrated by the huge drop in the price of gas with the collapse, because 'speculators' would buy up oil, then speculate its price way up high to resell it, which they stopped doing with the market crash), and a lot of cheating, short-selling, etc. by various companies, groups and individuals, large and small.
It's effectively a fundamental collapse of ethical and moral behavior of the financial market and current administration/political party on a catastrophic scale, that's already cost us 2 TRILLION dollars, with another 6 TRILLION on the way.
And nothing against Republicans in general, or the traditional Republican ideals, as practiced by the great names in the Grand Old Party such as Lincoln, Teddy Roosevelt, Eisenhower, Goldwater, etc. (I'm a firm centrist independent myself, and vociferously despise the political party system as a whole), but any honest, open-minded examination of the people who have been running the GOP for the last 20-30 years will show that they have NOT been following the ideals of the party, as practiced by the great presidents (and presidential candidates like Goldwater), and have been going into an increasing collapse of ethical and moral behavior much like what has played out in the financial industry (and actually, it's more or less the same collapse, because if you closely examine the major players in the Republican party today, you'll find myriad connections and ties to the financial industry, both above and below the table).
Now don't get me wrong, I'm not laying the blame for the economic and ethical collapse of the U.S. financial industry on the Republican party, and there's plenty of blame to go around, but the people currently running the GOP, and the people they are connected to, hold a LOT of the blame for the mess we're in, either directly or indirectly, just like the last Great Depression (which was called The Republican Great Depression by many back then, and was caused by EXACTLY THE SAME PRACTICES of rampant speculation, over-lending, and deregulation that we've seen in the last 8 years, and that are causing the 'new' great depression we're going into now).
And that went into politics a little more than I intended, so I'll end with the reiteration of the fact that I have nothing against the Republican Party or Republicans in general, but that an honest evaluation of the situation shows that most of the people who've been robbing the cookie jar to be either top-level Republican Party members, or associated with them. Which is probably mostly because people in the financial 'country club' got into positions of power in the GOP, and started pulling their friends from the country club along with them.
First, a few definitions.
Sub-prime mortgage: A sub-prime mortgage is a high-priced mortgage, it has a high interest rate, high monthly premiums (how much you have to pay back a month), etc.
Leveraging: Leveraging is using a small initial investment to control a much larger investment or some of money. In this case, with the mortgage industry, leveraging refers to banks lending an initial loan and then selling it to investors or other banks, so they can take out another loan, and another, and another, controlling more and more amounts of money with that initial loan.
CRA: The Community Reinvestment Act of 1977, enacted under President Jimmy Carter to force banks to stop discriminating against elligible minority borrowers, and often blamed for the collapse because 'the government forced banks to make bad loans'
Our economy is tanking right now not because of the CRA, or governments forcing banks to make bad loans, or anything like that - the CRA has actually had a small stabilizing effect on the collapse, because the banks involved in the CRA have very stringent requirements to thoroughly investigate the credit worthiness of all their borrowers applying for a loan, and have much greater motivation to make good loans because of the thoroughness of their investigation, and because most of their loans were made through local bank branches, which held onto the loans instead of selling them off, making them directly liable if they default.
The collapse of the housing market has to do with two main factors. The first is leveraging of loans, especially sub-prime loans, which are more likely to default. Mortgage brokers, which don't actually give loans, they just set them up between banks and borrowers, will broker mortgages, and sell them to banks (borrowers often also just go straight to the bank). The original lending bank then turns around and sells that loan to an investor or group of investors, or another bank/lending firm or group of banks/lending firms. This gives them the ability to lend another loan to another customer, which they can then sell to the same people, or someone else. The people buying the loans are making an investment, looking to get a return on their investment through the loan's interest rate, but often times, they don't hang onto the loan - they will often leverage the loan themselves, selling it off to someone else, so they can buy another loan (or make another investmentin something else). The company or investors THEY sell the loan to will often then turn around and sell it to someone ELSE, and so on.
This in and of itself isn't really a bad thing - leveraging, even in the housing market, isn't inherently bad, and can be a very useful tool. It's when it gets carried away that it becomes an issue. Most market analysts and financial experts who were predicting the collapse we are now experiencing years ago predicted that leveraging out by anything more than a factor of 6 is extremely dangerous and presents a severe risk of failure (i.e. if a bank can make 10 loans, they sell those loans off to be able to make more loans, then sell those new loans, etc. by a factor of 6). When the economy hit the fan, leverages by factors of 12 to 75 or more were common across the industry. The risk is that it only works so long as the money continues to flow - if the money stops flowing (a borrower defaults on a loan), all that massive debt the lender (and the people invested in that lender) accrued will come crashing down on top of it. This house of cards is not so unstable that it would collapse with the default of a single loan, but if enough loans default, it's like knocking out a card in the center of the bottom layer.
The other factor that led to the collapse of the housing market is an fundamental collapse of ethical behavior in the financial industry. A prime example: mortgage brokers have no incentive to make good loans (i.e. loans that people can actually pay back) - they get paid by the volume of loans they broker, not the quality of the loan, and once the loan is made, and they are just the broker of the loan, not the lender, so it's not their problem if the borrower defaults on the loan. Often times, the BANK doesn't care if it's a good loan or not, because they're going to sell the loan to another bank or lending firm, and won't have to deal with it should it default. That bank or lending firm then doesn't care if the loan is good, because THEY'RE probably going to sell the loan, and so on, and on, and on. THIS is where the bad loans come from, because most banks and mortgage brokers have little or no incentive to make good loans, and the high-cost (and thus high-return for lenders/investers), sub-prime mortgages were doled out like candy at Halloween to anyone who came knocking, regardless of whether or not they could actually afford to pay the loan back. The exceptions to this are the 'local banks', the smaller banks or larger banks with local branches in the community, which have a very large investment in the community and tend to hang onto loans more (thus giving incentive to make good loans), and who are also often run by people who actually live in the community, AND the CRA banks, who, through the regulation of the original Community Investment Act, were required by the government to thoroughly investigate potential borrowers for credit worthiness, and who also often held onto their loans more than any other lending organization (often because they would lend through local community branches).
On top of this, major and minor companies in the financial industry started short-selling each other, cheating and lying to get more money. Honesty and trustworthiness in the financial industry has essentially collapsed - banks won't even lend to each other, because nobody knows who can actually pay up. This whole situation was exacerbated and encouraged by a revision of the CRA act under the Bush administration, which effectively deregulated the entire housing market and much of the financial industry, allowing banks, investment groups, etc. to get away with a LOT more, and letting the over-leveraging and cheating run rampant to catastrophic extremes, which we're now facing. Added onto this is the bailout package, which is going to effectively saddle the American taxpayers with the bill for the rampant, blatantly unethical short-sighted 'immediate-gain, long-term-collapse' planning of the corporate executives and managers involved in the whole boondoggle, while they take the blank check and mosy off to an ultra-high-class resort in some tropic island nation where the U.S. courts and financial systems can't touch them.
The collapse of the lending industry wasn't just the only problem, it was also rampant over-lending by the lending industry (leveraging), rampant 'speculating' of the stock market which drove it to false highs (as demonstrated by the huge drop in the price of gas with the collapse, because 'speculators' would buy up oil, then speculate its price way up high to resell it, which they stopped doing with the market crash), and a lot of cheating, short-selling, etc. by various companies, groups and individuals, large and small.
It's effectively a fundamental collapse of ethical and moral behavior of the financial market and current administration/political party on a catastrophic scale, that's already cost us 2 TRILLION dollars, with another 6 TRILLION on the way.
And nothing against Republicans in general, or the traditional Republican ideals, as practiced by the great names in the Grand Old Party such as Lincoln, Teddy Roosevelt, Eisenhower, Goldwater, etc. (I'm a firm centrist independent myself, and vociferously despise the political party system as a whole), but any honest, open-minded examination of the people who have been running the GOP for the last 20-30 years will show that they have NOT been following the ideals of the party, as practiced by the great presidents (and presidential candidates like Goldwater), and have been going into an increasing collapse of ethical and moral behavior much like what has played out in the financial industry (and actually, it's more or less the same collapse, because if you closely examine the major players in the Republican party today, you'll find myriad connections and ties to the financial industry, both above and below the table).
Now don't get me wrong, I'm not laying the blame for the economic and ethical collapse of the U.S. financial industry on the Republican party, and there's plenty of blame to go around, but the people currently running the GOP, and the people they are connected to, hold a LOT of the blame for the mess we're in, either directly or indirectly, just like the last Great Depression (which was called The Republican Great Depression by many back then, and was caused by EXACTLY THE SAME PRACTICES of rampant speculation, over-lending, and deregulation that we've seen in the last 8 years, and that are causing the 'new' great depression we're going into now).
And that went into politics a little more than I intended, so I'll end with the reiteration of the fact that I have nothing against the Republican Party or Republicans in general, but that an honest evaluation of the situation shows that most of the people who've been robbing the cookie jar to be either top-level Republican Party members, or associated with them. Which is probably mostly because people in the financial 'country club' got into positions of power in the GOP, and started pulling their friends from the country club along with them.
