Confused on the origins of this Wall Street crisis?
Filed under: Borrowing, Investing
Depending on who you talk to, America might be in the midst of a Wall Street crisis, Main Street crisis, credit crisis, subprime mortgage crisis, or some other dire-sounding crisis. But how many consumers really know what this means or how we got here? If you ask someone like felon-turned-fraud-investigator Barry Minkow, the situation's primary roots are in those who lied to get mortgages on properties. They got caught up in the hype of owning a home or investing in real estate, and were willing to lie in order to get their mortgages approved. But don't think he's letting Wall Street off the hook. A lot happened there which contributed heavily to the mess we're in now.
Today I found an article that probably gives the most straightforward explanation of the entire situation to date. Mike Flynn, director of government affairs at the Reason Foundation, reminds us all that while Wall Street is having fits, our economy as a whole still isn't doing all that bad. Our economy is still growing, even if it's at a very slow rate, and unemployment is contained at just over 6%. That's in contrast to the Great depression, in which the country's economic output had fallen dramatically and unemployment was extremely high.
Flynn gets a little controversial when he says that we're not having a liquidity crisis. To hear the media tell it, no one can get credit anywhere. Yet, Flynn reports that consumer, commercial, and real estate loans this year are all up from last year. The idea that no one can get credit simply isn't supported by the hard numbers.
Then comes the more complicated part of this equation: the root cause of what's going on with Wall Street. It all hinges on the Mortgage Backed Securities (MBS). This investment vehicle took a bunch of mortgages from different banks, and packaged them together and sold them as an investment. Because the mortgages which were part of these investments were collateralized by real estate, the investments seemed safe.
But as our government officials pushed the idea that more home ownership is better, there was pressure to make mortgages available to anyone and everyone. Government incentives to write the mortgages ensured that fancy footwork got just about anyone through the application and underwriting process.
At some point, however, this strategy can't be maintained. Real estate prices were run up because everyone was competing for property. Newer mortgage products and incentives became available, and more subprime mortgages were being written than ever before. This trend of funding more and more mortgages could only go on so long, and eventually there weren't enough buyers for the real estate. Real estate prices dropped, fewer mortgages were being funded, and buyers of the incentivized mortgages were beginning to default.
Call all of this the perfect storm. Investors were making money hand over fist with the policies that encouraged more consumers to buy property and obtain mortgages. Even though only 1% or 2% of mortgages are in foreclosure, these mortgages had been spread around via MBS and lots of investors are suffering.
The credit market is tighter as banks have less available cash to lend and more mortgages on their books that are looking sketchy. But all of those mortgages won't go bad. It's just that the banks don't know if they're worthless or not, so they can't assign much value to them, and there are not a lot of buyers.
So do we do a "bailout" or not? Flynn suggest that we don't have to. Banks still have money to lend, and if they really want to get rid of the mortgages they deem "bad," there are buyers out there. The buyers just aren't offering the banks as much money as they want for the questionable securities. (Especially if the alternative might be the government giving them a gift by buying them at higher prices.)
Personally, I'd rather not have taxpayer money fund this fix. Let the banks take their lumps and sell their investments for pennies on the dollar if necessary. No need to spend my hard-earned money to give the banks more than they deserve for securities that they should have been more careful with. Let the market decide what those securities are worth and let the banks find their way out of this.
Tracy L. Coenen, CPA, MBA, CFE performs fraud examinations and financial investigations for her company Sequence Inc. Forensic Accounting, and is the author of Essentials of Corporate Fraud.
Reader Comments (Page 1 of 1)
10-03-2008 @ 7:05AM
diTesco said...
Now that is a totally different point-of-view. At this point, it seems that there are fingers pointing all over the place. The question is what's next? This bailout money will eventually evaporate and the big guns will remain big guns. I agree that in a sense that many people have to lie to get their mortgages approved. Another question is why do they have to. High housing cost, high interest rates, high almost everything is also to blame. Now if this is the case, and eventually the bailout package will come from taxpayers pockets, then shouldn't the taxpayers get some benefit from this too? Get rid of all those CEO's who makes tons of money, doing what, I don't know.
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10-05-2008 @ 8:07PM
Old Fogey said...
Good explanation, however you did not go far enough to uncover the original source. Accorn a PAC organization pushed their friends in congress, and FannieMae and Freddymac to back loans to households of questionable financial ability. They were also pressured to ignore the normal rules and oversight. This was encouraged by congressional names like Maxine Waters, Barnie Franks and oh yes Barrock Obama. These players encouraged President Bill Clinton to sign a bill setting aside the 1933 Glass Stiegal Act that separated Banking from the Investment and brokerage banks which allowed the creation of the colateralized securities you mentioned. I have not identified anyone by party affiliation because I support neither. They both deserve to be tossed out of the game. However, lets give credit where credit is due on this "Credit Crisis." Where risk are allowed and indeed encouraged to exceed good financial practices someone eventually has to pay. This time as ususal it is you the reliable tax payer. You were not given a choice in all this but you elect the players who decide where and how much you will pay.
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10-06-2008 @ 9:32AM
Mary Vesely said...
I have a solution to the FannieMae and Freddie Mac crisis.
Lets put Barney Frank and senator Dowd in charge of restructuring these agencies into one of the biggest rental agency america has ever seen. They would get paid on a commission basis only. Think of all the jobs this would create .
This would also make all the democrates happy since ever poor person living in the U.S. of A could live in a house that would never require the dwellers to make any repairs. The new plan would be able to employ many construction workers for years to come. The rents charged would also include a monthly fee for school taxes and insurance.
Add this all up and see how profitable this could be for FM and Fmac. If the new plan runs into problems you can just bundle up the rents and sell them on the open market.
This could keep all the people in their homes longer until they
work out all the details.
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10-10-2008 @ 1:09PM
Fred said...
The Birk Economic Recovery Plan
I'm against the $85,000,000,000.00 bailout of AIG.
Instead, I'm in favor of giving $85,000,000,000 to America in a We Deserve It Dividend.
To make the math simple, let's assume there are 200,000,000 bonafide U.S.
Citizens 18+.
Our population is about 301,000,000 +/- counting every man, woman and child.
So 200,000,000 might be a fair stab at adults 18 and up..
So divide 200 million adults 18+ into $85 billon that equals $425,000.00.
My plan is to give $425,000 to every person 18+ as a We Deserve It Dividend..
Of course, it would NOT be tax free.
So let's assume a tax rate of 30%.
Every individual 18+ has to pay $127,500.00 in taxes.
That sends $25,500,000,000 right back to Uncle Sam.
But it means that every adult 18+ has $297,500.00 in their pocket.
A husband and wife has $595,000.00.
What would you do with $297,500.00 to $595,000.00 in your family?
Pay off your mortgage - housing crisis solved.
Repay college loans - what a great boost to new grads. Put away money for college - it'll be there. Save in a bank - create money to loan to entrepreneurs.
Buy a new car - create jobs.
Invest in the market - capital drives growth. Pay for your parent's medical insurance - health care improves. Enable Deadbeat Dads to come clean - or else.
Remember this is for every adult U S Citizen 18+ including the folks who lost their jobs at Lehman Brothers and every other company that is cutting back. And of course, for those serving in our Armed Forces.
If we're going to re-distribute wealth let's really do it...instead of trickling out a puny $1000.00 ( "vote buy" ) economic incentive that is being proposed by one of our candidates for President.
If we're going to do an $85 billion bailout, let's bail out every adult U S Citizen 18+!
As for AIG - liquidate it.
Sell off its parts.
Let American General go back to being American General.
Sell off the real estate.
Let the private sector bargain hunters cut it up and clean it up.
Here's my rationale. We deserve it and AIG doesn't.
Sure it's a crazy idea that can "never work."
But can you imagine the Coast-To-Coast Block Party!
How do you spell Economic Boom?
I trust my fellow adult Americans to know how to use the $85 Billion We Deserve It Dividend more than I do the geniuses at AIG or in Washington DC.
And remember, The Birk plan only really costs $59.5 Billion because
$25.5
Billion is returned instantly in taxes to Uncle Sam.
Ahhh...I feel so much better getting that off my chest.
Kindest personal regards,
Birk
T. J. Birkenmeier, A Creative Guy & Citizen of the Republic
PS: Feel free to pass this along to your pals as it's either good for a laugh or a tear or a very sobering thought on how to best use $85 Billion!!
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