Topic: Federal Reserve Bailout
How the housing market fell apart The history and aftermath of the housing market bubble and the end of the investment bank in Americaby Lord Neuf
(conservative)
Tuesday, September 23, 2008
Goldman Sachs and Morgan Stanley, the last two independent investment banks, have left the field. Both banks are shifting away from investing and speculations and have both become bank holding companies.
Bank holding companies do not take investors, but instead take deposits which are insured by the FDIC, making them more like a commercial bank than a brokerage house.
This move by Sachs and Stanley is to help boost confidence in the banking market and a way to safeguard their investors. Bank holding companies are highly regulated by the US Government, preventing speculation and market manipulation.
But how did this happen? How did one of the most powerful economies in the world have such a massive failure? The answer is fairly simple, the open market killed the investment bank in America, the same open market that caused the Great Depression in 1929.
In a response to the Great Depression, the US Government began to regulate banking and investing trying to prevent such a catastrophe from happening again. This preventative measure was called the Glass-Stegall Act of 1933. This act separated the regular commercial banks from stock market investments, guaranteeing that any activities on Wall Street would not have an adverse affect on the banking industry.
In 1956, Congress enacted the Bank Holding Act, allowing a bank to invest the money of their depositors into stock market securities to bring higher rates of return, beyond the interest rate. Before that time, banks could only invest only 10% of their deposits.
However, with all these regulations, terms and conditions applied that not everyone could meet. For example, banks were not allowed to lend on a mortgage unless the homeowner had 20% as a down payment. Failing to meet 20% as a down payment was seen as to risky an investment. Private mortgage insurance companies would assist new home owners by paying 10% of the 20% down payment, with the homeowner paying on two loans.
Also, banks would hire house appraisers to guarantee the value of the house from the real estate agency. If the bank was going to invest on a $300,000 home, they made sure it was a $300,000 home. This protected both the bank and the homeowner from having a mortgage that cost more money than the property.
All this ended on Nov 12 1999, with the passing of the Gramm Leach Bliley Act, which allowed commercial banks to merge with investment banks, and severely de-regulating the housing and mortgage system.
Banks were allowed to grant loans competitively, allowing those who were unable to afford a house before to secure mortgages, sometimes allowing a 3% down payment without appraisal or insurance. They would then sell the mortgages, allowing investors to pay into the mortgage and take returns as the value of the property increased over time. However without appraisal, homeowners would take out mortgages on properties that would lose value over time.
Mortgages began to be issued in the interest of political correctness, allowing people on welfare and unemployment insurance to use that as a source of income on a loan application. The housing market started to increase in value as demand started to outweigh supply, as banks allowed unsound financial decisions to increase the value of their investments. Everyone from economic pundits to everyday bloggers began to warn of the housing bubble bursting, while on the other side of the coin, other pundits and bloggers championed the GLBA, allowing more people to buy their own home and reaping the benefits of such an investment.
But one thing that was not taken into account was the fact that investors didn't want to put their money into doomed mortgages. This is where the open market enters the game again. Investors didn't invest, investment banks couldn't offload their mortgages, homeowners couldn't make the payments and everything fell like a house of cards. New homeowners were foreclosed upon and the investment banks started to lose value on their stocks, investors lost confidence, everyone loses.
That's how it happened. The government had to act quickly to prevent the entire economic system from crumbling under its own weight. This began the government bailout of the investment and credit markets. The government purchased the high risk mortgages from the banks and gave the bill to the taxpayer. This government bailout is to help the market recover and will try to sell their investments in 2 years after the banks begin to stabilize again.
Only time will tell if this bailout will save the housing market or if it only put of the inevitable, of a prolonged economic disaster which brings us back to soup lines and apple carts.
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Culprits are Clinton’s The National Homeownership Strategy: Partners in the American Dream back in the nineties and Bush’s A Home of Your Own: Expanding Opportunities for All Americans in 2002. The problem is not lack of regulation, but the opposite, government messing with the natural flow of the market. It was the house market "bubble" who brought all this, banks were pushed to take risky mortgages in order to "qualify" for FHA loans.
I have to agree with FC. Government intervention pushed lenders into making loans to people who are credit risks. Loaning money to people who are credit risks is ... well risky. Its no surprise that many of them defaulted on the mortgage.
BTW putting the government in charge shouldn't make you feel better. Those are the same nice folks who created a $9.5 trillion dollar national debt, raided the Social Security trust fund out of $2 trillion and ran up $45 trillion in unfunded future liabilities.
First line of the 10th paragraph, I hinted at the social activism driving the housing market. However that was just a catylist, exploiting an already faulted system.
I felt that the changes to the system were more important to the failure of the system, allowing exploits to happen.
I guess the issue is, to use an analogy, if the brakes stop working in the car, the driver should fix the brakes before they crashes.
While you make some good points with regard to the government getting overly involved so that more people could own homes, some other parts of your article are fundamentally flawed. More often than not, it is government interference with the free market that fouls things up, not the other way around, as you contend. The reason for the housing boom and subsequent bust was more a problem with perverse incentives. The incentive during the housing boom was for mortgage underwriters to write as much mortgage business as possible, despite the fact that the underlying credit on these mortgages was often poor. This is because the originating company had no intent to hold the mortgage on it's balance sheet. The originator was going to immediately sell the mortgage to an investment bank, who would then package it with other mortgages and create a CDO (Collateralized Debt Obligation )or RMBS (Residential Mortgage Backed Security). These would then be packaged and sold to investors, often times overseas investors. So, these lending institutions didn't perform the normal due diligence on the individual borrower that they would do if they were going to hold the mortgage on their own balance sheet. They simply did as much volume as possible, because they knew a buyer of the mortgages was already lined up. If these lenders knew they had to hold the credit risk on their own balance sheets, they would have done much more diligence on the borrower such as document income, assets, liabilities, etc. But since they were going to sell the mortgages, they did not. Therefore, it was not lack of government regulation that caused this problem, but rather over-leverage, misalignment of financial incentives for the lenders to due pure volume and not worry about credit quality, and a lack of understanding on the part of the ratings agencies as to the securities they were rating, because these were fairly new types of securities to the marketplace. The market was overvalued, and now it is correcting, as a normal market should when supply and demand become imbalanced. However, to say that lack of government regulation caused this is simply false. On the contrary, it is government intervention into free markets that causes resources to be misallocated and dead-weight losses to be created. Examples include import tariffs, free trade restrictions, rent controls, farm subsidies, etc. All of these in the end hurt consumers, the nation's economy, and the proper allocation of available resources. The intervention of the government in this bailout effort is not a good idea either, as it is only going to shift Wall Street's and overleveraged home buyers mistakes to all taxpayers, many of whom had nothing to do with this collapse and were financially responsible all along. Companies and individuals should go bankrupt when they make poor decisions. That's how a free market should operate. Otherwise, companies have incentives to take a more than normal amount of risk because they know that they can count on Uncle Sam to come to the rescue if the risk goes bad. So, if the risk goes well, Wall Street makes huge bonuses, and if it goes poorly, the government bails them out. Huge upside and limited downside. Who wouldn't want to take that bet? I sure would.
Posted By: Walt Thiessen
Date: 2008-09-24 06:33:54
The "open market" caused the collapse? Unless you're talking about the Federal Reserve's Open Market Committee, you're way off base. I strongly recommend that you read the book, The Creature from Jekyll Island : A Second Look at the Federal Reserve—by G. Edward Griffin. I think you will find it very illuminating.
Griffin demonstrates clearly in his book that the Fed is intended to be a centerpiece in a game he calls, "Bailout." The object of the game is to allow bankers to inflate the money supply for their own profit and for the profit of the Federal Government at the expense of all the rest of us. Then, when the spam hits the fan (as it is beginning to do now), they claim that if we don't bail them out the entire system will collapse. Hence the name of the game. Bailouts by the taxpayers is what the central bankers always, ALWAYS count on, and historically it's always been given to them.
The part of the story that the fraudsters who manage our money supply don't acknowledge is that the "financial system" they're referring to when they warn of collapse is their system of fraud and pilfering via their control of a fiat money supply, not the free market itself.
The way to end this craziness is to reintroduce hard money as a legal alternative to paper dollars, to give people a safe way to opt out of the fiat money system and protect their livelihoods.
I respond to the information given and give my opinion.
If you find my opinion faulty, then feel free to use my opinions given above as source material to write your own column on the blog.
To restate it is my opinion that regulations were nullified and the mortgage industry had a boom than a bust as the open market dictated the value of said mortgages.
"The government had to act quickly to prevent the entire economic system from crumbling under its own weight. This began the government bailout of the investment and credit markets. The government purchased the high risk mortgages from the banks and gave the bill to the taxpayer. This government bailout is to help the market recover and will try to sell their investments in 2 years after the banks begin to stabilize again."
In other words this was nothing but a corporate welfare scam with the tax payer footing the bill, just like S&L debacle.
The reason the housing market burst had nothing to do with supply.
It was inflated purely by speculation and greed which is evident by the fact that many sub divisions built are virtual ghost towns.
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