The Meltdown in a Nutshell?

Me | 9/19/2008 | Me

[agooga]

I am trying to wrap my head around the financial meltdown in as fair and non-biased way as possible, and here are my thoughts for the causes:

1. Repeal of the Glass-Stegallman Act. Spearheaded by Phil Gramm, but passed by both houses by overwhelming, veto-proof margin. Signed by Clinton.

2. Introduction of the Community Reinvestment Act, spearheaded by democrats and leftwing activists, but also trumpeted by republicans and the Bush administration (effort to make as many Americans homeowners as possible).

Distant 3rd: Unreasonably low interest rates by Fed Chairmen Greenspan and Bernanke?

Your thoughts?

[Thane_Banquo]

#1 is highly doubtful as a cause. Lehman, for instance, doesn’t do commercial banking. Nor does Fannie and Freddie. Nor did Bear Stearns. Really there is no major link here.

#2 has a lot of merit.

#3 is central.

[Rapscallion]

You overlook the massive criminality in hyped appraisals, fraudulent lending, fraudulent debt bundling, CEO criminality and greed and more.

[agooga]

“Lehman, for instance, doesn’t do commercial banking. Nor does Fannie and Freddie. Nor did Bear Stearns. Really there is no major link here.”

Wow. You’re kidding? I need more info on this. This crisis is the greatest financial issue of my life— I want to know it’s TRUE roots.

[KarlInOhio]

Add the moral hazard of Fannie Mae and Freddie Mac being government guaranteed. A lot of loans (zero down, variable rate with nowhere near enough income to cover them) were made that no sane banker would make if he expected to keep them on his own books. Instead he could dump them on Fannie and Freddie and go one to make other irresponsible loans.

[agooga]

“You overlook the massive criminality in hyped appraisals, fraudulent lending, fraudulent debt bundling, CEO criminality and greed and more.”

I guess I should have made that #4, but I didn’t overlook it. My belief is that the individuals and institutions will do whatever they can/must do to make a profit and survive, within a defined set of parameters (regulations). Remove those parameters and expect consequences— this is human nature.

The fact that shenanigans occurred INDUSTRY WIDE is very telling. It was not limited to one institution that fostered a policy of corruption and greed.

[xcamel]

Clinton/Cuomo enforced ban on ‘redlining’ started it all.

The rest just added fuel to the fire.

[bpjam]

As Hank Greenburg says “No amount of regulation can replace good management”. These companies were all badly managed. And the ‘regulators’ were devised in the 1930s when LBOs, CDOs, debt swaps and a hole host of other financial vehicles were not invented.

I’m keeping my powder dry on this one. I’ll be interested to see what Jim Cramer says tonight on this show since he can explain from a trader/insider standpoint who is going to benefit most from this and who won’t.

I’ve yet to find a place which can explain to my why the supposedly illegal practice of naked short selling still exists and is rarely prosecuted. I just dont get it. I know what a naked short is but why was it made illegal in the 30s and then again in 2005 (Reg SHO) but the SEC has had to issue updated regs as recently as this summer to curb its use. WTF??!!

BusinessProfessor, can you help me on this?

[LS]

The historical problem with blaming Glass-Steagall's repeal is that it was one of the scapegoat laws passed during the Depression that, in fact, lacked any basis at all.

Eugene White, Regulation and Reform of American Banking showed that the charge was that the banks with "securities affiliates" (i.e., brokerage houses) were using depositor money to "Play the stock market." That, suppsedly, made them weaker. But White found that the banks which DID have securities affiliates were LESS likely to fail and were MORE solvent because they diversified their risk more.

So G-S was a useless law, and its repeal should have been meaningless. There is no reason Schwab cannot offer me a checking account.

[agooga]

“Add the moral hazard of Fannie Mae and Freddie Mac being government guaranteed.”

Excellent point. Thank you. A place for poisoned bundled loans to come and die?

[Rapunzel]

Don't forget all the illegal immigrants that were busy building homes that will fall down within 20 years(some here in Florida already are). All those people were being allowed to purchase homes without proof of income(some of the sub-prime loans were this kind).

The bubble burst in housing and many many people are now unemployed or in other employment than their desired field. Foreclosures are skyrocketing, most of the sub prime homes are now sitting empty and as damaged goods. Bankruptcies are becoming inevitable for some folks that treated their homes value like an ATM. But those of us that played the game correctly will be penalized for remaining in the 'have not' category verus the 'haves'.

[bpjam]

just a couple of notes:

#1 - Lehman was able to get into the mortgage lending biz because of the repeal of Glass-Steagal (of course, our regulatory framework was built for a pre-Glass-Steagal world)

#2 - The Community Reinvestment Act was a Carter idea. Clinton catered to the black vote by essentially supercharging Fannie & Freddie to use that Act to pump money into inner cities (which big city mayors love too)

#3 - rates were low around the world. The perfect storm aspect to this is unrivaled but then so it the potential damage. You have to include the timing of the 2005 tax bill which finally freed up real estate to be sold by zeroing out cap gains taxes on home sales. Real estate had been essentially stagnant since the S&L crisis when Carter devalued all real estate assets and caused the S&L industry to suddenly become under-collateralized.

There are a handful of a major factors in real estate alone which could have been overcome if not for the now discovered 40-1 leveraging by Lehman and others of each mortgage they packaged into LBOs, CDOs and other bond instruments. Nobody in their right mind would leverage an asset 40 times to 1. Apparently, the idea of a UCC search doesn’t exist for financial instruments or a title search on a piece of property. Investors in these mortgage backed investments likely had no idea they were sharing their collateral with an entire football team worth of other investors. So much for transparency.

[agooga]

“These companies were all badly managed.”

I can agree with that to a point— but it seems awfully strange that so many companies have had the exact same problems. This suggests a systemic cause.

“I’ve yet to find a place which can explain to my why the supposedly illegal practice of naked short selling still exists and is rarely prosecuted.”

Can you give me the quick definition of naked short selling?

[Warlord]

“Repeal of the Glass-Stegallman Act. Spearheaded by Phil Gramm, but passed by both houses by overwhelming, veto-proof margin. Signed by Clinton.”

No. The repeal of SGA was smart. In fact, repeal of the GSA is helping us get out of the mess (e.g., BoA acquisition of ML, the potential combination of Wachovia and Morgan Stanley). The credit crisis has nothing to do with a mingling of investment and commercial banking. The crux of the problem is an overestimation by "Wall Street" of "Main Street's" ability to service real estate backed debt.

[theBuckwheat]

Don't forget the role played by FASB Rule 157 that imposed the “mark to market” policy on portfolio managers. The problem with this is that the “Tier 3” assets they were holding suddenly had to be marked down to such a low level that portfolio managers all came to a common decision- to not hold them. This suddenly brought an end to the market on those assets, which meant there were no buyers, so no market values.

Thus this collapse is to some extent caused by well-intentioned regulations that had consequences that were far more costly than the harm they were intended to protect us against.

[Thane_Banquo]

On #1, you never had to be a commercial bank to own mortgage-backed securities and CMOs. They are legally considered securities, and thus investment banks can own them. Salomon, an investment bank, was trading these back in the 1980s, before Glass-Stegall. See the book Liar's Poker. Problem was also OTC derivatives based on these securities.

[raybbr]

The Meltdown in a Nutshell?

Politicians seeking votes and shirking any semblance of responsibility - on both sides.

[agooga]

“The crux of the problem is an overestimation by “Wall Street” of “Main Street’s” ability to service real estate backed debt. “

So, you’re saying this mess is primarily the fault of the lenders, being incredibly greedy, and assuming that whatever consequences they might suffer would be easily corrected by the taxpayers?

[Thane_Banquo]

I think blaming FASB 157 is a bit like blaming the scoreboard for losing the football game. The reality is that these guys were able to hide losing trades in different accounting portfolios in order to pad earnings numbers, and FASB and the SEC put a halt to this.

[r9etb]

I can agree with that to a point— but it seems awfully strange that so many companies have had the exact same problems. This suggests a systemic cause.

There are lots of potential "systemic causes." Without making claims at exhaustiveness, here are a few of my candidates:

First off, these companies all engaged in similar trading practices and financial arrangements. If there's any fundamental problem with the underlying finances of those arrangements, all of the companies would be affected.

Second, I think there is a common "increase the bottom line at all costs" aspect to these companies, which encourages an arbitrage approach to assessing investments. A focus on price differentials tends to obscure the underlying foundations of the markets in play.

Third, I think one must place some blame on the huge consolidations over the past 15-20 years. The companies in question control immense amounts of capital. Failures by even a few of these have wide-ranging implications, just by virtue of the market share involved. It's a lot harder to spook the market when there are a lot of smaller players, instead of a few big ones, because the relative impact of single failures is small by comparison.