Thursday, October 02, 2008

Here’s how I see what caused this mess and why I don’t support it the bailout
....Guys, I could spend days formatting and properly explaining what happened, there are some gaps in my analysis, but I believe I captured the essence of what's going to affect all of us. Here are the facts and causes as I see it.
  1. The repealing of the Glass-Steagall Act
    What is it: A law passed by Congress in 1933 that prohibited commercial banks from collaborating with full-service brokerage firms or participating in investment banking activities"
    What did it do: It protected bank depositors from the additional risks associated with security transactions. The act was repealed in 1999 and the distinction between commercial banks and brokerage firms has blurred
    Why is this important: If the trading of mortgage backed securities was limited to brokerage firms, it would not affect commercial banks as significantly
  2. Community Re-Investment Act of 1977
    Requires banks to lend in Low-Income neighborhoods where they take deposits
  3. Affordable Housing Goals Set by Fannie and Freddie Mac - banks began to feel pressured to loan more and more money in low income neighborhoods and to people whom they would not otherwise lend money to. Not doing so meant tougher regulation and shakedowns from various government entities including but not limited to the senate banking committee
  4. Political Correctness - Loosening of credit and increasing homeownership was the thing to do. If you didn’t loan a certain percent in certain neighborhoods you would get shaken down by local (I hate to say it) community organizers and be labeled as racist on the local news.
  5. Fannie Mae and Freddie Mac - sometime in the 90’s, they began purchasing more and more high risk mortgages, the more they bought the more they were at risk of failure due to massive defaults. (it only takes about an incremental 2% of all homeowners to begin defaulting to cause a crisis like this)
  6. Democrats - I can't begin to write all this down, but Chris Dodd and Barney Frank have thier hands all over this

How this all ties together

  • Every Mortgage purchased by Fannie and Freddie increased a bank’s liquidity. The bank’s credit limit would be tied in a mortgage, therefore not allowing it to make other loans (car’s, HELOC’s, etc)
  • Fannie Mae and Freddie Mac would bundle individual mortgages they purchased into securities (Bonds and funds). Fannie and Freddie were not required to disclose the "mix" of mortgages in these securities. For example: Security X had 100 mortgages and 50% of them were high risk sub-prime.
  • Fannie and Freddie would guarantee the securities against default and sell them to investors (commercial banks and brokerage firms). These now combined banks/brokerage firms are the same entities making bad loans. (Under Glass-Steagall they had to be separate)
  • Fannie and Freddie also bought mortgages from banks and other lenders and hold them in their own portfolios. This market for mortgages (i.e. mortgage backed securities) allowed the lenders to make more loans by freeing up obligations / credit (fancy word used for it in the news is "increase liquidity")
  • Remember the rules of banks, they are required by law to maintain a certain level of liquidity. I.e. if you have a $100 in deposits, you can only lend X% of that. Well, if you sold the loan, buy it back in the form of a security and hold it in your brokerage firm (which you happen to own) then you are free to make more loans against that $100 (more bad loans by the way). But they all end u in the same place.


  • Big Mess. Some say caused by lack of regulation others say caused by too much regulation. I am on the too much regulation camp. Free markets dictate that many of the bad loans made would not have been made if not for affordable housing goals!
  • Personal Experience: I've had 4 mortgages in my life: 1997, 2003, 2006 and 2007 (4 different houses). I remember my first mortgage (don't we all) at 25. I was well qualified for my 72K condo in westlake OH. But remember having to provide all by a blood sample to get the mortgage, this was before I signed any loan papers. Fast forward to 2007 and I was simply asked if I am willing to document my income!

So what does the bailout do

  • Here is where it gets ironic, the 700 Billion Dollars congress will authorize the treasury to spend will be used to buy back all these bad mortgages sitting with banks and mortgage companies and brokerage firms (Market creation)As the gov’t buys them, they will free up the banks liquidity to make more loans and lines of credit. Which is what got us into this mess to begin with
  • Why I don’t support it:
    They say "credit will tighten" or "dry up". Who cares! This is absolutely true. But guess who it dries up for… it dries up for people who are not freaking qualified to begin with. Those with good credit can still get loans, the rate may go higher and it may be more difficult. The word difficult I use losely. This means it may take more than 15 mins to get a loan, heaven forbid it may take a day or two and an actual loan officer (live person) may have to review the application and you may actually have to document and prove your income.
  • There are free market solutions out there, I'll get into those on a separate post
  • Context: 700 Billion is enough cash to give every US citizen from 0 to 100 years old, rich poor, whatever (as long as you have a SSN) approximately $2,300. (I’ll hit that in a separate post)

I am sure many of you are glued to tv's watching this, but this is what I see. I will post on the solutions later. The bailout is a bad thing and a stupid thing, the GOP was smart not to back it and Mccain should grow a pair and withdraw support and leave OBAMA to push it. If it were so important the Dems can pass it without a single GOP vote. But they won't do that, they want to hang around the GOP's neck if it fails and take credit in the unlikely event that it actually works!

If Obama, the Lord Messiah and most merciful one (as Rush likes to call him) is such a uniter all he has to do is rally his own party and pass it and save the country. But the little political weasel man child won't do it because he knows it won't work!

Hopefully this is helpful


Janell said...

I think you really hit it with the repeal of Glass-Steagall. I think even FDR would be mortified to see how his "New Deals" got twisted into creating such a nanny state. When he was in charge, poor people were starving to death. His 'alphabet soup' policies (WPA, TVA, CCC, etc.) were only supposed to be for temporary assistance. Now, "assistance" has become "entitlements" , including home ownership. The bailout looks to me like it will continue to snowball us into more gov't regualtions translated "socialism."
Good analysis, Joe.

Jamie Dawn said...

I do not support the bailout "rescue" bills that have been proposed. I've called and emailed my senators and representative to make my voice heard.
All of mine are Democrats here in AR. My house representative voted for the first bill, and both my senators voted yes last night on the new version.
I called my house reps office today to ask him to reverse his vote this time around, but I doubt he will.
I am very disappointed that McCain did not make a stand against the proposed bills and vow to come up with a clean bill that uses other options with no extras added. He could have worked quickly to come up with a plan that was short and focused and given Americans a website to go to to read it.
We the people would have stood with him and flooded the phone lines and emails of our Congressional leaders.

Jim said...

I'm glad someone bailed AIG out, half of my retirement is there.
I vote for Warren Buffet to become the KING OF THE UNITED STATES!
He was on Charlie Rose last night and I agree with everything he said.
Essentially we are dead ducks if that bill doesn't pass. And he is saying it isn't near perfect but we don't have time to do anything else.
People are starting to layoff here in Houston cause they can't make payroll, the feds will shut down again because their budget ended September 30, and the refinery companies are going to boycott until Congress rescues them!
(just teasing on the last)
Tomorrow will tell.
I'm betting on Sarah Palin tonight, she should finish it up in the seventh round.
And I am not (I try not to be) political on the blogs.

cdroses said...

Very well said.
I thank God every day I had told George, "No. I am not getting into a balloon mortgage." I would rather rent for the rest of my life.
I don't own a credit card, and really want to keep it that way.

Joe B said...

Thanks Janell
Jamie Dawn, I also got on the horn to my congressman and senator's. Unfortunately, Senator Hussein is one of my senators and the other is Dick Durbin (eggh)
Jim, I agree that credit is important to run everyday business, make a payroll, etc.
The best way to do that is create a market for these bad loans. What I disagree with is the manner in which it is being solved, there are no less than atleast 50 different ways to handle this. Everyone knows it.
Even if the bill passes, which it probabl will, having people out there to experience tight credit is probably a good thing. Maybe some people will now manage their financial lives differently. Glad you kept your AIG retirement. Clarifying question, did you retire from AIG or is your retirement holdings at AIG (big difference). If your holdings where there, you would have been fine (unless it was AIG stock).
CD, Agreed! However, I use my AMEX all the time. I am fortunate enough to be able to pay it off every month or if I let it ride I can pay it off anytime I want. I run as much of my everyday life through that card. I get points and redeem home depot giftcards with those points. I used to have tons of credit card debt in my 20's.

Ralph said...

I'm just guessing but you seem to be a little worked up about the bail out. Okay, that's a joke. But then so is the bail out. All it will do is make low income and easy money more readily available - the very thing that created the problem in the first place. A look who gets to pay the bill - us taxpayers.