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Sent: Sunday, August 03, 2008 9:32 AM
Subject: Please read the entire article

 

How Did We Get Into This Financial Mess?

by Jason Leavitt

LeavittBrothers.com

The financial ?crisis? that exists in the US and world is one that hasn?t been experienced

since the 1929 stock market crash and subsequent Great Depression. Pointing fingers

after the fact is somewhat cowardly, but unless we know why and how we got into this

situation, how can we expect to get out of it and avoid another one in the future? Here?s

my take on who played a role in the financial situation we?re in and who deserves most

of the blame

Federal Government. Banks lend money to home buyers. If the banks planned on

keeping those mortgages, they?d be very careful who to lend to and how much to lend.

They?d really do their due diligence to make sure there were very high odds the

borrower would pay the loan back. But if the bank wasn?t planning on keeping the loan,

no doubt their standards would drop.

Enter the Federal Government sponsored/supported Fannie Mae and Freddie Mac

(both created by the government) which buy mortgages from banks, so the banks can

turn around and make more loans. This implied safety net created by the government

with these two GSE?s (government sponsored enterprise) has had a very negative ripple

effect. Namely, banks are motivated to take more risks and have significantly lowered

their standards knowing they could always dump the loans.

The government also encouraged policies that exacerbated the situation. In short, their

extreme desire to increase home ownership ? especially to lower income folks who

couldn?t afford a home ? completely backfired. But are you surprised? Does any

government program work? There are 300-400 government programs designed to

make housing more affordable. If a couple can?t afford to buy a house, why help them

buy a house?

And I could go on and on about how the government has branded home ownership as

the American Dream, but nothing could be further from the truth. Owning a home is not

an investment, it?s a cost, and that cost is high. If you rented for 30 years and put the

money you saved (lower monthly payments, no property taxes etc) into the stock

market, you?d make a heck of a lot more money than if you put your savings into a

house and held if for 30 years. But for years, people have been brainwashed into

thinking they must own a home because renting is classless ? or something new college

grads do.

President Bush and HUD Secretary Alphonso Jackson First a quick comment --- in

the government and military there is a chain of command. You do what you?re told by

those you report to. If George Bush says: ?I want 5 million new homeowners,? Jackson

either works towards the goal or he resigns his position. There is no middle ground. So

while I could leave the former HUD secretary out of this because ultimately Bush should

take the blame, Jackson did have the choice to say: ?No way, that?s not possible without

creating a mess. I?m outta here.?

Bush was way too eager. He was so excited for everyone to live the American Dream of

owning a home. It was Jackson?s job to work towards this goal, and Jackson was one of

the people who encouraged little- or no-money down loans and interest-only loans. The

ripple effect this had is unknown, but when the Secretary of Housing and Urban

Development encourages totally irresponsible financial agreements, someone needs to

at least step up and say: ?that was a mistake.?

Stupid, Gullible Americans. Regardless of what happens in Washington, Americans

still have the choice to buy or not buy, so ultimately I could blame them. They are, after

all, making the final decision, and they could have easily walked away from the table.

But they didn?t. They bought houses they couldn?t afford with money they didn?t have by

not putting money down, using interest only loans, and/or using variable rate loans they

knew would reset higher than they could afford. If you wanna throw a couple grand into

a stock because you think it?s going to move up, fine; the damage will be minimal if

you?re wrong. But why in the world would you potentially cripple the rest of your financial

life by buying a house you had no business buying?

Banks. The ultimate blame could also be place here too. They are, after all, the ones

lending the money. They do have the ability to say: ?No, you can?t afford that house. We

are not lending you the money.?

Call them greedy. They only make money when they make loans and since money was

artificially made cheap, they couldn?t control themselves. They drastically lowered their

standards and loaned money to parties they should have know could not pay the loan

back. Shame on them.

Standard & Poor?s and Moody?s etc. So banks loan money and take those

mortgages/loan docs etc. and package them together to be sold as CDO?s

(collateralized debt obligations). Fannie Mae, Freddie Mac, Bear Sterns, foreign banks

etc. buy CDO?s without scrutinizing the individual contents because they trust the likes

of Standard & Poor?s to do their due diligence to accurately rate the credit worthiness of

the package.

If Bear Sterns buys billions of dollars of subprime mortgages from a bank, then only

they should be blamed for buying the junk ? the buck stops at their desk. But if this is

the case, why does the entire planet pay such close attention to the ratings?

If Standard & Poor?s inaccurately rates the CDO?s, and banks end up buying chickens

they thought were eagles, who is to blame? Nobody will argue S&P had extremely high

ratings on loans that were total junk. Should S&P take some of the blame? Have they

admitted their calculations where wrong? Moody?s recently said a computer glitch may

have resulted in inaccurate ratings. Is this little admission enough? Were these rating

agencies and the banks working together?

In my eyes, the rating agencies need to either admit they screwed up, or forever, they

have zero credibility whatsoever.

Mortgage Lenders. These are the guys most home buyers work with. I know banks

ultimately lend the money, but most buyers don?t work directly with a bank; they work

with a middleman which may be a big company like Lending Tree or Quicken Loans

(you see their banner adds all over the internet) or a small ma and pop type shop. There

are some very good lenders out there that won?t let buyers get in over their heads (I?ve

bought two properties in the last two years, and each time it was a simple 30-year fixed

with no bells and whistles or special conditions), but there are many that will do anything

to get your business because they only get paid when they hook up a buyer with a

bank. They?re the ones that told people they could afford ?that? house if they used an

interest only loan; they?re the ones that encouraged buyers that putting no money down

wasn?t such a bad idea; they?re the ones that exposed people to such mortgages as

Payment Option Adjustable Rate Mortgage which allows borrowers to pay a small

portion of the interest due each month (but then the remaining principle and interest

balance due is added to what they owe).

If these middlemen collectively were more upfront and honest with buyers rather than

selling them up a river just to get their business, the housing market may not have

gotten out of control.

Alan Greenspan is the man most would like to blame, and while I certainly agree he

played a role, it?s my belief he only added fuel to the fire after the fire was already lit.

The economy?s expansion and contraction hinge most on one thing, and that thing is

liquidity. The more money there is, the more growth that happens. Unfortunately the

opposite is also true. Give me a city full of brilliant entrepreneurs, and without money,

they won?t create much.

Greenspan artificially lowered overnight rates to encourage banks to loan beyond their

reserve requirements. Essentially, he flooded the market with money which you may

think is good, but at some point, if there is too much money, that money is wasted or

used inappropriately.

It?s pretty simple. When money is tight, it?s naturally funneled towards safe investments

just like tight money in your household results in spending only on the bare necessities.

As more money becomes available, riskier bets can be made, and when there?s ?too

much? money, bets that should never be made no matter what the circumstances, are

places.

This is what Greenspan did. He made too much money available, so businesses that

should not have gotten loans, got loans, and people who had no business buying a

house, bought a house, and people who should have bought $300K house bought

$400K houses.

Too much money results in totally irresponsible usage of that money.

A tightening of rates ? or if he at least held them steady ? may have partially choked off

the aggressive lending.

But Greenspan is not #1 on my list because I do not believe people have to sip from the

bunch bowl even though it?s full. Anyone who?s gotten into financial trouble could have

chosen to walk away from the table. Several years ago my girlfriend (now my wife) was

in the market to buy a condo. She was approved for much more than she knew she

could afford. Did she buy up to the limit her lender approved her for or did she buy what

she knew she could afford? You can guess the answer; she wasn?t about to get herself

in trouble.

To say that Greenspan is most responsible for this mess is to desire the Fed play a

greater role in tinkering with the money supply. This is a discussion in and of itself and

not one I wish to go into here. There are some well-known economists (John Maynard

Keynes comes to mind) who absolutely believe the government should stimulate and

suppress the economy to dampen the economic fluctuations. But let?s not get into a

political discussion.

There are many people involved in buying a house. A buyer works with a mortgage

lender to secure a loan from a bank which then packages that loan to sell to GSE?s such

as Freddie Mac or other banks such as Bear Sterns. The system was greased with

artificially low rates, easy money, and extremely irresponsible activity from the rating

agencies. If any of the parties involved would have put their foot down, and said: ?No, I

cannot in good conscious do this,? I would not be writing this report.

But the roots of the problem cannot be traced back to any of these parties.

Bill Clinton. All these people and institutions played a role getting us to the current

housing situation, but ultimately, I blame Bill Clinton. This probably comes as a shock to

most of you because his name is hardly ever mentioned, but in my opinion, if you start

with today and work backwards, seeds of the housing mess were started in 1999 when

Bill Clinton replaced a 66-year old law that restricted the capabilities of financial

institutions with one that vertically aligned the industry and set it on a path to

destruction. Let?s go back in time.

It was believed improper and super aggressive banking activity played a big roll in the

1929 stock market crash and subsequent Great Depression. At that time, commercial

banks took depositors? money and made risky investments in the stock market. Call it

greed, but times were so great in the 1920?s, the desire to be involved and the feeling

the good times would never end, caused many banks to over-speculate with money that

wasn?t theirs. They were literally taking depositor?s money and using it to finance risky

investments. Even worse, unsound loans were made to companies in which the banks

invested in, and they encouraged their clients to also invest. Can you say: Major conflict

of interest?

Remember back in 2002 when Citigroup came under fire for their over involvement with

WorldCom. Citigroup was not only acting as an investment bank which made money

when WorldCom ?made deals,? they were also upgrading the stock, so those deals were

easier to execute. It was a Ponzi scheme that had no system of checks & balances, and

it eventually imploded. This is exactly what was happening in the 1920?s that partially

led to the collapse of the stock market and many years of struggles. Along comes the

Glass-Steagall Act in 1933 which separated commercial banking from investment

banking ? essentially a bank could not also be a brokerage firm and vice versa.

Sectioning off the financial industry incidentally set up a system of checks and balances

and eliminated many conflicts of interest. Also, banks were insulated somewhat from

the stock market.

Since then, there have been periods where housing prices appreciated faster than

historical norms or flattened out for a couple years, but overall, it was smooth and

steady sailing with no major, national interruptions. And although we?ve had several

recessions (recessions are no big deal; they surface every handful or years and we

always emerge from them stronger than when we entered) we didn?t have anything

even remotely close to the financial crisis that followed the 1929 stock market crash.

Why? Because of the explicit system of checks & balances that existed due to

companies not being permitted to have their hand in more than one part of the process.

That?s what the Banking Act did. It said: ?You can?t be everything in the process; you

can?t be vertical integrated.?

But this all changed on November 12, 1999. With the CEO of Citigroup looking over his

shoulder, Bill Clinton signed into law the Gramm-Leach-Bliley Act which repealed the

Glass-Steagall Act of 1933.

The Gramm-Leach-Bliley Act permitted commercial and investment banks to

consolidate, and almost overnight behemoth financial service companies that supplied

everything to everybody were born. Smith-Barney, Salomon Brothers, PaineWebber

and many other well-known and respected investment banks were gobbled up by

Citibank, JP Morgan etc, and while the lay public didn?t have a clue what was going on,

conflict of interests were rampant. Suddenly the banking arm of one of these financial

service companies was pressuring the investment arm to raise its ratings on stocks to

help lubricate the deal-making process.

(As a quick side note, Citigroup played a major role lobbying for an end to Glass-

Steagall. Starting in 1998, the finance, insurance and real estate industries together

spent more than $200 million to get Glass-Steagall repealed, and not so coincidentally,

only a couple days after Clinton signed Gramm-Leach-Bliley into law, recently-departed

Treasury Secretary Robert Rubin was hired by Citigroup as a member of its 3-person

office of the chairman.)

If you start with today and work backwards with intentions of figuring out when ?all this

mess started,? you?ll find many parties that played a role in adding fuel to a fire which

was spinning out of control, but your journey won?t end until November 12, 1999 when

Bill Clinton tore down the walls within the financial community.

I?m not going to go as far to say if Bill Clinton had not repealed Glass-Steagall, we

wouldn?t be in the financial situation we?re in, but I can certainly say it would have been

much more mild and probably isolated. When second and third parties are involved in a

transaction, more due diligence is done, more scrutiny is applied, and less risk is taken.

Bill Clinton started this financial mess.

In Summary Bill Clinton laid the foundation. Alan Greenspan greased the wheels.

Then, extremely unscrupulous mortgage lenders and banks took full advantage of

gullible, unsophisticated borrowers.

By replacing Glass-Steagall with Gramm-Leach-Bliley, banks and investment brokers

were permitted to consolidate, and the natural system of checks & balances was

destroyed. Not to mention the conflicts of interest that were born. Yes, Greenspan aided

the situation by lowering rates and keeping them low, and S&P encouraged risky loans

by giving them AAA ratings, and many idiot Americans who thought prices would keep

appreciating need to check themselves into gamblers anonymous, but if I had to go

back to the beginning, to where this mess started, it would be with Bill Clinton?s

signature on November 12, 1999.

You opinion is welcome and appreciated.

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