Free Market + Liberal Entitlement=Disaster

CT

To us at PCT it has become imperative that the people of the United States know the truth about the Subprime Bust and what "REALLY" got us here. Opie and myself both agree that the economy is to sophisticated and intricate to be demolished by one group, one bad decision, or one person. This was more about an intermingling of two philosophies that are polar opposites and the effect was devastating to our economy. All of the information we drew from seems to point to that conclusion, minus all of the nuances of macroeconomics.

The Basics of the Bust:

In the mid-90's mortgage lenders relaxed strict credit standards thereby allowing people who would not normally qualify for home loans to be able to obtain them. Interest rates on these loans were greatly increased to compensate for the greater risk involved. Mortgage companies contributed more risk to the market by further lowering underwriting standards to increase the availability of the sub prime loans. Here are some numbers via the Heritage Foundation showing the percentage changes form late 90's-2006 due to the availability of subprime loans.

As a consequence, the availability of risky loans soared from the late 1990s through 2006. In 2001, newly originated subprime, Alt-A, and home equity lines (seconds) totaled $330 billion and amounted to 15 percent of all residential mortgages. Just three years later, in 2004, these mortgages accounted for almost $1.1 trillion in new loans, equal to 37 percent of the total. Their volume peaked in 2006 when they reached $1.4 trillion and 48 percent of the total. Over a similar period, the volume of mortgage-backed securities (MBS) collateralized by subprime mortgages increased from $18.5 billion in 1995 to $507.9 billion in 2005. [1]

Here is how Wall Street fits in to this scenario, enter a little "financial engineering." Large banks like Goldman Sachs or Lehman Brothers would buy hundreds of millions of dollars of these low quality loans from a mortgage underwriter and then bundle them together. They were organized by risk level into "tranches". This worked out well because analysts and rating agencies believed that by bundling up these loans you lowered your risks by depending on thousands of people paying the interest and principal rather than a single entity. The danger of everyone defaulting was minimal and since housing value was on the rise and interest rates were lowering. Even if someone defaulted on their loan you could re-structure the debt and still make a profit. This worked out great for everyone until there were a large number of defaults on the subprime loans which sent everything into a tail spin.

This is the mechanics of the bubble and the bust but this is the how and why, It started with the Community Reinvestment Act of 1977. Here is the definition provided by the Federal Reserve Board.

The Community Reinvestment Act is intended to encourage depository institutions to help meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods, consistent with safe and sound operations. It was enacted by the Congress in 1977 (12 U.S.C. 2901) and is implemented by Regulation BB (12 CFR 228). The regulation was substantially revised in May 1995, and was most recently amended in August 2005.
[2]

Now, we jump ahead to 1999 and the Financial Services Modernization Act of 1999, it is defined as this,

Allowing firms to transform themselves into financial holding companies that can engage in a wide range of financial services will give rise to more competition, and consumers will benefit from lower prices, onestop financial services, and innovation leading to more products. U.S. firms will be better able to compete globally. [3]

The FSMA was created to allow banks that loan to you and I to become financial holding companies as well. They could deal in insurance, security underwriting, portfolio investments, etc. But in order to get this legislation passed through Senator Phil Gramm had to accept CRA amendments to the FSMA in order to get it passed through the Clinton White House.

There are two things about the CRA amendments and its accountability measures that draw my suspicions to it contributing to the subprime bust.

Information collected for CRA ratings does create a database for class-action lawyers to use in suing banks servicing low-income areas.
[3]

An unsatisfactory CRA rating does prevent a bank from merging or being acquired. [3]

If banks did not fulfill their obligations to the CRA amendments they could be lined up for a class action lawsuit from any number of "community activist groups". Also if they did not have a history of lending to low income consumers then they would not be allowed to reap the financial potential provided by the FSMA. I believe they saw an opportunity through the FSMA and its CRA amendments to really open up the market for subprime loans through some disastrously creative "financial engineering". This kept groups like ACORN at bay, allowed them to meet regulatory guidelines, and make a healthy profit in the meantime.

The CRA also imposes a larger cost on society by misallocating capital. In the absence of government intervention, credit markets efficiently allocate funds on the basis of risk and return. High-risk borrowers are charged higher interest rates to compensate lenders for the increased likelihood of nonpayment. Borrowers with a low probability of default borrow on more advantageous terms. To remain competitive, banks have devised sophisticated models for rating borrowers and allocating funds. That does not mean that low-income or high-risk borrowers are excluded from credit markets. Banks are willing to extend credit to any group if such loans,on average, are profitable. [3]

As noted above the credit markets could have regulated themselves through the profitability of the loans they were issuing. None of this was necessary, the FSMA and CRA should never have been coupled, it created a market with high octane potential for calamity. Simply this venue was used as a tool by the financial market. They were motivated by, ironically, regulatory fears and simple greed to reap a profit with some less than lustrous effects. I have asked this question before, "How do you regulate an attempt a deregulation?"

Now onto President Bush and the 2003-04 Congress's complicity. Welcome to the American Dream Downpayment & Zero Dwonpayment Acts.

American Dream Downpayment Act,

That chance will arise when the House is asked to approve by unanimous consent the American Dream Downpayment Act -- a bill that would require the U. S. taxpayers to provide $200 million per year to fund cash grants of as much as $10,000 to individuals and families wanting to buy a house, but without subjecting themselves to the burden of having to save for the downpayment. [4]

Zero Downpayment Act,

The Zero Down Payment Act of 2004, introduced by Rep. Pat Tiberi (R-OH), would require the Federal Housing Administration (FHA) to offer federally insured mortgage loans to certain eligible households to buy a house without a down payment. Although the bill could lead to a very modest increase in the homeownership rate, it would do so by exposing the FHA—and ultimately taxpayers—to major losses stemming from high default rates, as evidence from similar FHA programs shows. The Congressional Budget Office estimates that the new program would cost the government $618 million from 2006 through 2009. [5]

These furthered the initiatives of allowing low income families and individuals the opportunity to gain access to loans that they could obviously not pay back. In summary, the CRA and FSMA were tools and venues brought about by poor decision making by Congressional Republicans and Democrats and the Clinton White House. The biggest mistake was putting together free market capitalism with a liberal entitlement program. Both fed off of each other and allowed Wall Street to exploit the weakness. President Bush went further along with this "new" philosophy of pairing somewhat far right and left thinking with his contributions; the American Dream Downpayment Act and Zero Downpayment Act, accelerating the bubble into a bust. Due to the length of this post I will cover ACORN, Freddie Mac and Fannie Mae in a separate one.

-CT

"Hunting Happily!"

[1] Subprime Mortgage Problems: A Quick Tour Through the Rubble
[2] Community Reinvestment Act
[3] Gramm-Leach-Bliley Act: A Good Start in Need of Fine-Tuning
[4] American Dream Downpayment Act: Fiscally Irresponsible and Redundant to Existing
Homeownership Programs
[5] Congress's Risky Zero Down Payment Plan Will Undermine FHA's Soundness and Discourage
Self-Reliance

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Market Correcting Itself

CT

In the world of economics and finance these days saying a hurricane has hit is a lackluster description of what is going on. In the past 6 months we have had the Bear Stearn's bailout by JP Morgan-Chase brokered by the Fed, Freddie Mac and Fannie Mae being nationalized (Just saying that makes my skin crawl.), and now Merrill-Lynch and Lehman Brothers disappearing.

But in the case of Merril-Lynch you have Bank of America stepping up to buy them out, creating a huge financial colossus. This is an expansion of commercial banking into the world of financial investment, a rather bold move by Bank of America and JPMorgan-Chase. Although, intuitive, this move was done out of neccessity, but, it is a great example of a potential market correction.

As much as I hate to, I have to give a certain credit to the Fed for brokering the deal between Bear-Stearns and JP Morgan-Chase. If they had not their failure could have caused an economic tailspin that would have caused major problems for the world economy. This also opened the door, I feel, for BOA to expand its horizons into the world of finance banking. Now, the outcome of these bold moves still remain to be seen. But the financial and investment communities may have come up with an interesting way to survive the recent pitfalls of their greed. Although, we are far from being out of the woods, hopefully these institutions have learned their lessons.

CT

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Let's Stimulize Some Reform, Not Stupidity.

C.T.

Well, recession is barking at our door once again. With all the doom and gloom about our economic forecast is it any wonder the average American is sweating bullets about 2008. Not to mention the band fixes being proposed by both sides of the aisle to enhance their posture for the election year. Much of the stimulus package that is suppose to be a shot in the arm for the economy will amount to nothing more than a shot in the pocket book.

The stimulus package is like Britney Spears attempting self therapy, nothing more than a recipe for disaster. It is pointless and not much thinking has been applied to the long term corrections needed to avoid these monetary problems in the future. One fact about the package itself that I do find intriguing is the tax cuts for businesses. The "bonus depreciation," allows a company to deduct qualified investments from their tax liability. This in turn, should make investments more lucrative. Enhancing growth, creates jobs, and strengthens the economy. This portion of the package actually displays some forward thinking, unfortunately it ends there.

The problem with most of the package is the approach the government is using. It is nothing more than fiscal trickery, rather than sound monetary policies. For example, the personal rebates. This lagniappe, Louisianan for "something extra," is supposed to jump start the economy by giving the average consumer some money to spend. Okay, sounds great, until you look into it.

First where is the money going to come from? The Federal government does not have magical money powers like they think. There are only a limited number of sources the federal government can borrow the money from which will either cause future tax burdens, furthering a trade deficit, or less money for investments.

What about consumer attitude towards the money they are going to receive? Most people are living in debt, what do people with excessive debt do with any extra money they have? Pay bills.

This in turn keeps the average person's head above water for a month, maybe two. But what about after that? What has it really accomplished for the economy, other than keeping it going in it's floundering state for another couple of months. Most recipients of the 2001 rebate used their money to pay down their debt. Although, there was increased spending later in the year, credit for this was actually given to the tax cuts. Which consumers viewed as more permanent.

Then there is the households who will actually spend their money. The primary question is what are they going to buy? How many people are going to use this money for a down payment on a new car, a home, or even invest it? Need we forget that most U.S. firms sell their services and goods to foreign businesses? Most American consumers receive their goods from abroad. An increase in spending might be good for the retailers here in the States for a short term, but the greatest benefactor of this stimulus is foreign business.

If there is to be any correction then ideas such as the tax rebates for businesses must be looked into. This type of correction can create both short term and long term benefits for the economy. Other possible avenues are an attitude adjustment by the government. Let consumers and businesses decide how to spend their money and where to invest. A profit driven free market, has proven that if left to its own devices, can be wildly successful. Anytime government has interfered you have the result which we are facing today. Let politicians stay in politics not our pocketbooks.

C.T.

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Omnibus, The Worst Christmas Present Congress Could Give.

C.T.
What is an Omnibus? An Omnibus spending bill sets the budget for each department of the government all at once. Keep in mind it is just one possible outcome for the budgeting process. Every year Congress must pass individual bills for appropriations funding each department of the government that receives its stipend from discretionary spending. Ex. One bill for the D.O.D, one for the D.O.E., etc. When Congress cannot produce these individual appropriation bills they will group them together into one Omnibus spending bill.
Problem with the Omnibus spending bills is that they are inherently full of pork barrel spending and are often thousands of pages long. Well,the typical American may ask, "How does this effect me?" I am glad you asked.
This years Omnibus spending bill is 3,417 pages long, contains 11,331 earmarks costing the American taxpayer about $20 billion. According to Brian M. Riedi, The Heritage Foundation's lead budget analyst, the President and Democratic congressional leaders promised to cut the number of earmarks to half of what they were in 2005.

Earlier this year, President Bush and Democratic congressional leaders pledged to cut the number of pork projects in half--from the 2005 peak of 13,492 to 6,746.[1]

C.T.
Much of the problem concerning the Omnibull..er..Omnibus is the earmarks. In the past the government grants would be distributed to state and local governments through formulas or to specific groups through an in-place competitive application process.[1] Well, not anymore. Congress now, through some mutated form of the legislative process, is the final word on who receives the government grant by earmarking it for a specific group. This is where the "pork barrel" spending comes in. This means that each congressional member has his own personal account with which he/she can fund their own pet projects, or through the lobbying community auction off their grant money to highest bidder. The return for the congressional member is in the form of campaign contributions or a "public donation." As Mr. Riedi points out earmarks are outside of governmental accountability due to the fact that they are not subject to any application process. They very rarely get audited and the result is they are misappropriated.

Here are some fine examples of earmarks set out in the Omnibus spending bill.

[2]

-$100 million for security at the upcoming political conventions even though it is widely known that presidential elections happen every four years.

-$602 million for crop disaster assistance and livestock assistance despite the fact that farmers had record incomes last year.

-The Charles Rangel "Monument to Me." ($1.95 million)(I love this one)

-Rodent control in Alaska. ($113,000)

-Olive fruit fly research in France. ($213,000)

-A river walk in Massachusetts.($1 million) (Isn't this what local taxes are for?)

-The Advanced Technology Program, which provides research grants to mostly Fortune 500 companies including IBM, 3M, and General Electric, received $65 million in the omnibus.(i.e corporate welfare Oh, and Congress de-authorized this earlier in the year.)

-$20 million increase for the National Endowment of the Arts

-$3.7 million in non-competitive grants to the AFL-CIO

-$16 million for a new House office building although the House already has four office buildings and the Capitol Visitors Center has not been completed.

Mr. Riedi has this to say about reforming earmarks.

Eliminating earmarks would not reduce FY 2008 grant spending, but it would ensure that grants are distributed by merit rather than politics and would stifle the enormous appetite for federal largess. Worthy projects should have no trouble securing funding based on merit; only the unworthy projects would lose funding.[1]

C.T.
I disagree. Rather than reforming the process, phase it out all together. Some of the problems that cause Congress to use this Omnibus is partisan disagreement, party infighting, and Congress's inability to form a budget in a timely manner. Since there seems to be no auditing process in place then there is no way to actually estimate the amount of money being spent uselessly. Do not allow Congress the ability to create earmarks to the budget after the fact. Make them do their jobs and form the budget in a timely manner. If their is still a necessity for such a program as governmental grants, bring back the competitive application process with a timeline stipulation. If the application is not filed by a certain date, then it will not be considered for that fiscal year's budget. $20 billion dollars may not be much when to Congress when you consider the size of the overall budget of the United States. But, if this program exists and accounts for this much abuse, then how many other ones are there without any auditing system in place. This may not solve all of America's woes but it sure as hell is a start. Let's start making the President and Congress, in particular, accountable for their spending habits. I'm not dipping into their bank accounts. Buying my friends and family gifts for Christmas with their money. So why should they do that to us?

Two great articles from the Heritage Foundation which I drew from for this post. I highly suggest reading them.

[1]Omnibus Earmarks Out: President Bush Should Cancel Congress's Pork Spending

[2]Omnibusted: The Top 10 Worst Problems with the Omnibus Spending Bill

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