IN LIGHT OF THE LAST SEVEN MONTHS I THOUGHT IT MIGHT BE INTERESTING FOR OUR NEW MEMBERS TO READ MY COMMENTARY FROM SEPTEMBER 2008.  THE GOVERNMENT HAS REALLY DONE A BANG UP JOB SINCE THEN!

Let me preface these comments with an admission that I am not covering all the story here, i.e. the bond insurance issues, but no one wants to read a 100 page commentary.  So with that said here’s the story behind the financial crisis we now face and the recession we have to have, the economy cannot go up forever just like house prices couldn’t go up forever.

The whole financial crisis now occurring is the result of government actions over the last forty years and the unintended consequences of those actions.  Why is that important at this point?  I suppose to offer the theory that with more government action, i.e. the bailout, we will again have unintended consequences which will undoubtedly result in an even worse mess than we are currently witnessing.  Here’s my take on how the government is directly responsible for this whole mess and we, as concerned taxpayers, must demand the government stop worsening this situation.

The government created GSEs (government sponsored entities) Freddie Mac and Fannie Mae to offer mortgages to more people.  Previously, if you wanted a mortgage you went to a local bank and got approved for a loan with someone who was familiar with the area and could evaluate the entire mortgage and your ability to pay the loan back.  This was not satisfactory to the government so they created the GSEs to expand home ownership, basically by making more capital available for mortgages.  These organizations were doing fairly well for many years with fairly tight lending practices relying on the local banks to continue to evaluate loans and then buying those mortgages.  In the second term of President Clinton it was decided that not enough people owned a home and the GSEs should make loans on looser credit terms and President Bush continued this policy.  At this point the GSEs were clearly making loans for amounts and to people that would not be approved by any bank having to keep the loan itself.  This created a lot of “buyers” which then started the housing boom of the last decade, driving prices through the roof.

During this same time Alan Greenspan was Chairman of the Federal Reserve.  After 9/11 the Fed lowered interest rates to spur the economy.  Then during 2003-04 the Fed’s overnight funds rate was lowered to 1%!  This ridiculously low and artificial interest rate made credit extremely cheap and lead to the creation of interest only mortgages with payments so low almost anyone could go out and buy a $500,000 home.  Can you say 0% interest teaser loan?  Of course these loans would never be approved by a bank who had to keep the loans on their own books, so what to do?  Well, in a glaring lack of oversight by regulators whose sole job it is to monitor the GSEs activities, many of these loans were packaged and sold as bond investments around the world.  In other words bonds were created and the returns were to be paid by the mortgage payments packaged together.  Now some make the point here that the credit ratings agencies gave these “investment bonds” top credit ratings so they are also at fault.  This is true, but in reality these investments would have never received the ratings they did if they were not primarily mortgages from the GSEs.  Why is this?  Because it had been widely accepted that the U.S. government would never let the GSEs go under and when the chickens began to come home to roost with Fannie Mae and Freddie Mac that assumption was exactly correct, the government just took them over and all their liabilities.  Welcome to the taxpayer’s nightmare.

As we all know, in the last few years people who couldn’t afford the mortgage terms they agreed to, whether it was an ARM or interest only for 3 years, etc. began to stop payments.  Many began to see that they were not going to be able to sell their house for what they owed on it and they began to walk away completely.  This started a housing “correction” with prices going lower as is the normal course of a free market except that wasn’t what the government wanted.  The Federal Reserve began lowering interest rates again.  The lending practices of the GSEs as well as the FHA were loosened even further, creating in many cases situations where someone buying a house could get “cash back” with “no money down”.  The BIG FIVE (Merrill, Goldman, Lehman, Bear, Morgan) investment banks went to the SEC in 2004 and got permission to borrow $40 for every $1 they had in reserve instead of the old $12, this spurred on the credit available for these sham mortgage backed bonds.  Again, the one function government could have been playing in this fiasco, regulatory oversight, went by the way side.  The housing boom waffled, but continued on in much of the country until about a year ago.  Prices began to tank as more and more people just walked away from their houses and entire neighborhoods went through foreclosure.

This brings us to 2007.  Credit began to tighten as the “investors” (mainly financial institutions) began to worry about some of these AAA rated mortgage investments weren’t performing.  Never fear, instead of allowing the correction to continue and accept some level of “pain” in the economy the Federal Reserve made more credit available, lowering interest rates to 2%!  Practically, free credit once again made available by the government and at a time when interest rates set by other central banks around the world were more than twice as high.  This drove down the value of the dollar and dramatically increased the price of commodities, especially OIL!  As gas prices put more hurt on the economy more people gave up paying their mortgages and a couple of months ago the mortgage “investments” began to totally unfold.  The Fed couldn’t lower interest rates any more or inflation would sky rocket, but they could give out loans to financial institutions who were unable to get rid of the investments that were no longer paying off and couldn’t be sold.  This was announced as the solution, not just banks, but any financial institutions approved by the government could borrow money from the Fed until things got better.  This was only a few months ago and was said to solve the looming crisis, but already it has proven not to be the solution, rather it just prolonged the pain and most likely worsened it.

So what to do?  Let’s BORROW 770 BILLION dollars and buy all the bad investments from the financial institutions at taxpayer expense.  No one can explain anything about how this will work out or IF it will definitely work, because no one knows.  This will again create more credit which has been the source of the problem FROM THE VERY BEGINNING!  The taxpayers of this country must say “NO MORE”.  It will be painful, but the pain has only been exaggerated by the actions of our government and will only grow more painful if we allow the government to continue this farce.  We either become a socialist state where the government controls the economy’s markets (please move to France if you like this idea, good luck) or we allow the free markets to operate without government interference (regulatory oversight only) and accept that there will be many good times, but also some bad times.  Contact your Congressman/woman and Senators and tell them to stop this taxpayer bailout, that we do not want to live in a socialist country!