MONEY TROUBLES (10-11-08)

Financial market meltdown, the global economy and government manipulation.


It's been a wild ride these last few months. It appears it all started several years ago, but it did not seem to show itself as a real concern until the supply of housing grew beyond that of demand. Many talking heads on the television have pointed out several problems that have contributed, but few have tied them all together. I'm going to attempt to do just that. Again, I stated the problem started in the housing market. Here is how and why. First, the government has pushed the false theme of "the American dream". The totally incorrect notion that every man, woman and child should live in a home that they themselves hold ownership of. Democrats have pointed to an increased percentage of Americans owning a home as a political plus. That, in it of itself, is fine. But when they push for the easing of laws and policies in an effort to allow those of lower income an increased access to lending institutions, they opened the market, and our economy as a hole, to an increased risk of total collapse. Now I could go on about how the lower class people who spend their resources on educating their children would do more for this country than blog 100% home ownership. After all, spending money to allow the next generation to break free from the lower class is substantially more important and much less risky. But this is not where this blog is going at this time. Back to government manipulation. The so called "American Dream" is fine for those looking for an investment vehicle that will, overtime, appreciate in value and provide a resource for retirement. It's now debatable whether it's a wise investment as compared to other investment choices, but for the most part, people have done pretty well over a period of decades in the housing game. The problem is, with the increasing percentage of Americans buying homes, the demand for housing artificially pushed up the value of these homes. This is what has been repeatedly referred to as the housing bubble. This led to the home builders, seeing great profit margins, responding to the demand by building a large numbers of homes. Now, if increased demand for houses increases their values, an increased supply will do the exact opposite. America now is experiencing the bursting of the largest bubble ever created. The combined pop of the housing and credit markets with the pyramids of complex debt products designed to finance them and spread the risk have cause an enormous bang heard and felt around the world. To catch you up. You have government telling lending institutions to loan money to people with poor credit to buy houses that were priced high and later fell when the housing price bubble finally popped. (Were just getting started here people.) Turns out the mortgage company that financed your home, doesn't actually hold your mortgage debt. They sell it up the food chain to larger institutions. Enter Freddie mac and Fannie mae. These two powerhouse mortgage companies bought home mortgages from smaller lending institutions, held some in their portfolio, then packaged others together and sold them to wall street and other world markets as housing securities. This tends to spread out the risk of one risky mortgage over a broad range of investors worldwide. This limits the amount of exposure if that mortgage were to fail. Sounds pretty wise until you do it a few million times and then hear that a large number of these mortgages have failed. Banks and other financial institutions had so many of these housing securities and had packaged so many of them together, know one really knew what they had or how much they were exposed to these foreclosures. To complicate things even further, you have an unregulated derivative market (aka hedges, swaps and futures) that are contracts where investors could essentially bet on the future price of these securities. These futures markets were seen as a way to smooth out the bumps in the system and lower the risk to buyers and sellers. A little history: Freddie and Fannie are companies that were originally government institutions designed and supported to remove the burden of the smaller lending institutions having to hold mortgage debt so they can continue doing more and more lending to support our "credit" based economy. The government then stepped back from Freddie and Fannie and allowed them to control their own affairs with insufficient regulation. Government did have some influence over the two and the Clinton administration pressured them to make more loans to these "people of questionable credit". They used this as a way to make them look good when the numbers of homes owned by the lower middle class were increased. They scored big political points when they stated more Americans were realizing the American dream. Now, back to the bubble and the lower class home buying. Several mortgage companies popped up left and right to finance housing sales to the lower class. Most regular banks and mainstream mortgage companies, that have to operate under certain governmental regulations, would not touch mortgages related to people of poor or questionable credit. The newer, smaller mortgage companies, not under government regulations, found they were still able to sell the mortgages up the food chain and to Freddie and Fannie in what is termed the sub prime mortgage market. They would create a loan system for the low credit, risky home buyer, sold at a larger interest rate to justify the risk to the market. But this higher interest rate only made it harder for the home buyer to make payment. So some lenders would have mortgages that started at a very low interest rate for a couple years and then reset to the higher rate. In those cases, either the home buyer did not understand that their payments would nearly double in a preset period of time or they were told that the value of their house would increase by then and they could be more easily refinanced to a loan with better terms or into another sub prime with another couple year low initial rate. All this went out the window when housing prices dropped. As prices dropped and interest rates reset, people found it harder or impossible to refinance a home worth less than the amount they owed. Now, many will talk about predatory lending practices and people getting hoodwinked by financiers. While they are somewhat responsible, the ignorance of people entering into these loans was equally at fault. "If you don't understand what your signing, don't sign it until someone, independent of the deal, has explained it to you." With several failed mortgages, the supply of homes in the market increased. This created even more downward pressure on the worth of houses. This hurt even more refinance schemes and pushed more people into foreclosure. This was the vicious cycle that caused a large amount of sub prime mortgages to fail. With the cost of these failures all moving up the food chain and eventually landing on Freddie and Fannie, they were headed toward complete and total collapse. It was later found that, according to internal memos, freddie and fannies own risk managers warned that taking these risky loans would leave them overexposed in a financial downturn or housing market collapse. They found senators Chris Dodd and Barney Frank (both socialist democrats) along with an army of freddie and fannie lobbyists fought of attempts by the bush administration and republican lawmakers to reform thier lending practices. Things got to the point where government had to step in and take over these institutions and spend billions of dollars to stabilize them. So now your federal government is left holding the bag for nearly 50% of all mortgages in this country. Freddie and Fannie were not the only companies hurt. Several other companies and banks, worldwide, held sub prime mortgages or purchased and held housing securities that were, or were thought to be, essentially worthless. With so many companies holding housing securities or the derivatives related to them, Banks and financial companies held tight to what money they had and stopped lending altogether. The governments refusal to help Lehman Brothers due to it's heavily leveraged derivative holdings, caused it to fail and, by doing so, caused money market madness. The credit markets, that global businesses use for long term funding of expansion projects or even short term loans to pay essential day to day expenses like payroll, just stopped doing business. This caused what was originally just a mortgage and finance system breakdown in the U.S. to become a major broad based, world wide, economic meltdown. This is where wall street meets main street and where domestic economic conditions meets world economic health. Now with world governments announcing a takeover of banks and the U.S. governments $700 billion dollars of additional measures designed to help financial markets, they had to explain to the public how and why their tax dollars were being spent. With all this talk from world government officials and the American presidential campaigns about wall street bailouts being so important to the entire economy as a whole, they convinced the American people that we were in for pretty tough times. Surprisingly the stock markets reacted to this negative talk. Everyone invested in our economy sold off everything. They lost confidence in both our economy and our governments control there of. Then world markets followed suit because their banks were in the same situation and they know that as the American economy gets a cold, the world economy gets the flu. With so much international money in the American economy and invested in American businesses, our stock market totally tanked. So here we are, trillions of dollars of wealth just vaporized from world stock markets. Banks, financial institutions and credit markets nearly shut down because banks don't trust each other enough to loan money back and fourth . World leaders are meeting to discuss a concerted approach to help free up credit markets with money by buying bank shares and housing securities, government loans to both big business and financial institutions and bank-to-bank loan guarantees. It appears the world governments have determined the cure for global economic conditions is best done through a partially nationalized the banking system. I'm no money market expert and surely there are several people more educated than I. But I do know nationalism is code for socialism and socialism only leads to weaker economic times. If, as they say, these measures are only to be taken as a temporary measure and that as conditions improve, government will sell off their holdings for modest profit, I say o.k. If it is later found that it is needed to be made a permanent way of keeping confidence in our banking system, I say it will do the exact opposite. Government money, infused into the system, on a short term basis to provide a helping hand or a step up through this crisis seems to be the only way to go. Government control of the banking systems, over the long term, with it's record of inefficiency and waste, would be the cause of our next global crisis. Taken to the extreme, government controls of banking could be used as a source of funding for government expenditures making banking a type of tax. I just can't imagine politicians and bureaucrats manipulating banking and finance in favor of the businesses and people that use them. It would be a huge drag on our economic growth and a new cash cow for special interest groups. Now, I'm almost always against government telling any business how they should operate. I've almost always been against government regulation believing the market would shake out the poorly managed. But this country does have regulations of business and more specifically the banking and financial businesses. Government caused this problem by allowing sub prime mortgage lending companies to operate unregulated and sell mortgages to people who have no business buying a home. If their going to sell risky loans, they should hold the risk. Government should have relaxed the regulations on what mortgages the huge institutions of Freddie and Fannie can buy. Their too big to allow them to fail without having larger effects on our overall economy. Everyone knew the price of housing was way out of skew and know one thought to correct appraisal methods to closer reflect reality. Supply and demand is a factor in house pricing, but it's not the only factor and obviously needs to be less of one in the future. Bottom line.... Government should only allow business enough rope to hang themselves, not choke off everyone around them.