27 June 2009

Economic Discussion

I posted this in a discussion I was having in macroeconomics. Just thought I'd put it here too.

Many people have expressed a lack of understanding on how we came to be in this economic mess in the first place. I did some reading and here is some of the factors that caused the meltdown. First there was the Community Reinvestment Act of 1977. This created an "affirmative obligation" that banks had to give more loans to poor people and minorities. In 1989 Congress changed the Home Mortgage Disclosure Act and made banks record racial and other personal data on mortgage applications.Then in 1995 the Clinton Treasury Dept. began tracking loans by neighborhoods, income groups, and races. They used this data to rate the performance of banks. These ratings were used to determine if bank mergers, acquistions, or new bank branches would be approved. So the government encouraged banks to give more loans to poor and minorities. Groups like ACORN and other community activists began extorting banks and pressured them into making more bad loans. With all of this going on banks were forced to abandon traditional underwriting standards. Otherwise the government would not allow the banks to expand. This government interference created the subprime mortgage market. Then in 1992 the Dept. of Housing and Urban Development created government corporations Fannie Mae and Freddie Mac to buy up bundles of these sub-prime loans.This diversified the risk and made more money available for banks to make more risky loans.Then Congress passed something called the Housing Enterprises Financial Safety and Soundness Act. As with most legislation the title did not match the bill. This essentially mandated that companies had to buy 45% of all loans from people of low to moderate incomes. In 1995 the treasury dept. established the Community Development Financial Institutions Fund and provided banks with tax money to encourage even more high risk subprime loans. Fannie and Freddie were not regulated or forced to adhere to standard business and oversight practices. When people called for them to open up their books and comply with ethical and financially sound regulations top congressional allies of Fannie and Freddie, including Barney Frank Chris Dodd, Chuck Schumer, and others resisted all efforts of reform. Meanwhile Fannie and Freddie executives cooked the books and awarded themselves millions in bonues. Government interference and social engineering created the derivatives market. Deriviatives are contracts. One bank would sell the risk associated with a mortgage to another company in exchange for payments based on the loan's value. It was kind of like buying insurance. People were gambling. They were betting on which mortgages would be foreclosed and which would not. This practice spread and multiplied the risk of bad mortgages to other parts of the economy. The last factor that played a huge role in the economic crisis was the Fed. From Jan. '01 to June '03 the Fed slashed interest rates from 6.5% to 1%. So the Fed imposed an easy money policy that artificially manipulated the housing market, interfered with normal market conditions, and destabilized the economy. When everything began to crash the government started spending money like crazy. First it was TARP at the end of '08. This program alone might exceed $1 Trillion. or 7% of our GDP. $350 billion of that TARP money is currently unaccounted for. The Fed also began bailing out companies like Bear Stearns and AIG, and of course Fannie and Freddie got $200 billion. The Fed all together gave out $7 trillion. Then of course there is the so called stimulus package which has also been a staggering waste of money. Thus far it has been a slush fund wrought with corruption and fraud. All of this spending has slowed economic recovery and will cause a lot of pain in the future. This thing is not over yet. So all in all there are a lot of culprits responsible for this economic meltdown. Its origins are further back than people realize. This storm has been coming for a long time and there are no clear skies in sight. So cheer up the worst is yet to come! ;-)

W. Epler