Wednesday, October 10, 2012

Four Years After the Crisis

     It is hard to believe that it has been four years since the financial crisis, which was the impetus for an expansion of government, the likes of which we have never seen. The imposition of TARP (Troubled Asset Relief Program) on the market and financial system was the biggest mistake of the Bush administration. I cringe everytime I think about President Bush saying, "We have to abandon free market principles, in order to save the free market." I like President Bush and think our country owes him a debt of gratitude for his success in fighting the war on terror and keeping us safe. And, even with the crisis, his economic record would be highly enviable by any administration. The average unemployment rate during the Bush years was 4.9 percent and average GDP growth was 3.1 percent. The government still spent too much but his addition of 5 trillion to the debt in 8 years is dwarfed by President Obama's addition of 6 trillion in just four. If it wasn't for the spending and that pesky TARP program, his presidency would have been near perfect.
     I think that President Bush trusted the advice of his Treasury Secretary and the Chairman of the Federal Reserve, Hank Paulson and Ben Bernanke respectively. They made the President believe in their doomsday scenario of a complete collapse of the financial markets, unless he authorized hundreds of billions of dollars. The money, as the program name implies, was to be used to buy troubled assets, the mortgage-backed securities, so that the financial institutions could get them off their books. What actually happened was that the funds were given to the banks with little restrictions. Much of the money was used to buy treasuries, earning the banks interest on taxpayer money, a sweet deal. My question of the TARP believers has always been, "If the financial system was about to collapse, then how could the money have been repaid to the government so quickly (within 18 months)."
     To understand the orgins of the crisis, one needs to begin in the 1970s. President Carter signed into law the Community Reinvestment Act, which required mortgage lenders to make loans in economically depressed areas to people who didn't have any money. Under the Clinton Administration the program was expanded and the Justice Department threatened financial institutions with criminal investigations if they didn't participate. Eventually, mortgage lenders were required to make almost a quarter of their loans to people they knew would never repay the loans. Democrats in Congress allowed  Fannie Mae and Freddie Mac to lower the requirements for loans, no money down and no proof of employment. The rest of the mortgage industry had to comply or basically go out of business. Democrats in Congress also pushed to lower the requirements and standards for mortgage lenders' licenses. This created a perfect environment for unscrupulous lenders, which in turn lead to the further downward slide of the entire industry. With the greater demand for housing, values sky-rocketed and with the ability for people to borrow more than their house was worth, so did the mortgages.
     The banks were not going to lose money, so they packaged up the bad loans with some good ones and sold them on the open market in what is called mortgage-backed securities. Fannie Mae and Freddie Mac actually held seminars for mortgage lenders, teaching them the practice. These securities kept getting resold until there was no one left to sell them to and the gig was up. The government required these assetts to be valued with a process called, Mark to Market. Which meant the assetts had no intrinsic value, but were only worth what some one would pay for them that day on the market. Once the assetts started to be deemed worthless, it didn't take long for the house of cards to collapse.  
     The entire crisis was driven mostly by the liberal idea of fairness. In their estimation, it wasn't fair that some people owned homes and some didn't. So they used the power of government to be the great equalizer and provide a way for those who couldn't afford a home to get one. Many Republicans went along with them, in order to be politically correct and avoid being called anti-poor or anti-minority. When President Bush tried to reform Fannie Mae and Freddie Mac in the early and mid 2000s, Democrats excoriated him and called him a racist. People like Barney Frank, Chris Dodd and Maxine Waters said there was nothing wrong with Fannie and Freddie and that to suggest otherwise was racist.
     In conclusion, the financial crisis of 2008 is illustrative of what happens when government over-steps its bounds and meddles in the private sector. Had there been no government mandate for sub-prime loans, the market for them would not have existed. Mortgage lenders would have required proof of income, 20% down and a host of other standards which protected them, the borrower and ultimately the financial system as a whole.

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  1. I would like to thank you for your article on Four years after the crisis. I found it very informative and it gave me a new meaning of what really happened. I wish more people would be able to read this article and be better educated.

    1. Thomas Sowell has written book about this very subject: "The Housing Boom and Bust". Mr. Sowell is a brilliant economist and excellent educator.

    2. Thomas Sowell is one of my favorite economist/commentators. I have not read the book you mention but have read, "The Search For Cosmic Justice". Thanks for the note.

    3. mzha-Thanks for the kind words. I'm glad I could shed a little more light on the crisis for you.