An interesting read that I found. Reflects great intelligence:
The crisis is not just a crisis on Wall Street. If left unchecked, it will worm its way into Main Street. What is Main Street; it is the credit market that directly affects the working man’s car loan, mortgage rate, and credit cards. It also affects the business he works for. A small business has to have the cash to pay bills and payroll on a weekly basis while they wait for their money from sales to come in on a monthly basis.
Very few people pay with cash anymore. Businesses hardly ever pay with cash. Every time a credit card is used or a check is written, someone is using money from some bank to make that transaction.
How did the problem start? Well, it started over 20 years ago when credit requirements for everything from credit cards to mortgages started changing. Believe it or not, there used to be a time when a home mortgage required a credit score over 700, income equal to four times the house payment and 20% down. This means that a home could devaluate 20% before the bank loaned your more than a house was worth.
A person could never get a credit card without having a job. Now the typical unemployed student receives mailings several times a week offering a credit card. As you can see, it does not take long for the economy to be full of loans and extended credit with nothing to back it.
Boom and Bust: When things are booming, values and incomes go up. A 90% loan on a house can turn into a 75% loan in just a few short months when prices are sky rocketing. Bad loans become good loans. But what happens if there are a bunch of bad loans out there and houses stop selling for more money each month? The reverse happens, 90% loans become 110% loans. In a short time, a bank finds themselves holding a bunch of loans that are greater than the whole of the assets they represent.
Writing off bad loans is when a bank of financial institution fesses up and tells their stock holders and the world that the loans they hold are of greater value than the property they represent. It also means that people and companies decide for one reason or another NOT to pay back the loans. The financial institutions take back the assets and now own a piece of property they are not able to manage and take care of that is most likely worth less than the amount of money they loaned in the first place. When this happens they are unable to loan money to others, they do not have enough capital to meet the minimum requirements by law, people hear about this and stop putting their savings in the institution. As the savings they hold drops, it compounds the problem creating a run on the bank. At a certain point, the government must step in and take over the bank and guarantee all the money in the bank over $100,000 (now it is $250,000) per individual and the government then takes the loss.
Because as a nation we are buying more goods from other countries than we are selling them we have created a trade deficit. This means that those countries end up loaning back all their extra trade surplus money to the US government lowering interest rates. This allows people to borrow lots of money at low interest rates while the banks loan this money with little regard for the risk.
Banks got sneaky. They took all those loans they were giving out and bundled them into Structured Investment Vehicles (SIVs) and put loans and other debt into them. They then got even more creative and started borrowing money on the short-term commercial paper markets to fund the SIVs and made as profit the difference between the low short-term rates on commercial paper and the higher long-term rates on the loans in the SIV. These SIV’s had a AAA rating making them sound safe. Everyone from around the world caught on to this idea and the stage was set for a disaster.
The boom turned to bust and because of a new accounting rule enacted after the Enron Scandal called FASB 157, banks had to value their long term investments (SIVs) to the most recent market price of a similar security that actually had a trade. Once the word got out about the quality of these SIV’s tied to mortgages and other long term debt, investors backed away from purchasing them. Who wants to buy a mortgage on a house in California that is more than the value of the home?
This chain reaction virtually stopped the transfer of short term debt to cover long term debt. At the same time, banks were unable to raise capital to cover these SIV’s that were losing money on a daily basis. With the Mark to Market (FASB 157 rules) they were getting hammered every day with less value even though they were not selling the bundled mortgages (SIV’s). The bust of SIV’s froze the movement of cash between banks causing a credit freeze.
Who had the power to fix this and who has the power to stop the bust cycle?
First of all, a capitalistic free market is very good for our country. It has served us well over the last 100 years. Most other systems have failed or stunted the growth of their economy. In fact the US economy is the driving force in our world and even in this crisis, after all the grumbling from over seas, the US is where people put their money with they are looking for a safe bet.
Over the last 10 years, the government has not updated the lows that monitor investment banks as they have with regular banks. As we know, man is basically evil, so when left un-checked, man will do bad things with power and be self serving when the opportunity arises.
What we need is a Stabilization Plan and a review of our regulations governing capital requirements and leveraging in the markets. What we DON’T need is government intervention in the free markets. The government needs to act as a regulator of the markets. In the short term, the government needs to step in with some long term money and buy up SIV’s at current auction prices and hold them for a while until they can sell them back into the system once the housing market bottoms out and starts to be bullish again. Only the government has the
staying power to hold SIV’s until they return to a reasonable value.
The government also needs to establish capital requirements and limit leveraging for ALL publicly help financial institutions. These requirements would then filter down to Main Street and although for the short term, people will feel the pain; in the long term money will not be loaned without sufficient collateral or income support.
Lastly, the government needs to reduce legislation the acts as social engineering. For example, the congress decided that everyone should be able to own a home. Thus, they set up systems to loan money to prospective first time home owners that allowed them to purchase a home that they would normally be unable to purchase. This legislation promoted by the Democrats sounds on the surface warm and fuzzy but in the end, if you loan money to people who can’t pay it back, eventually someone will have to take away the property they owned or write down the bad debt on their books.
In conclusion, as you walk to the polls to elect the next president, remember that a free market with capital and leverage regulations is the fastest way to get our country back on track. Watch out for anything close to a free ride for anyone. The best way to continue on our course is to allow the free markets to correct themselves with oversight.
Lastly, remember that if you see any politician blaming another for the problems we currently have. Remember that the Democrats have controlled the House and the Senate for the last two year. Why didn’t they see this coming and why didn’t they propose bills that included oversight of these risky investments? Well, the truth is that they were sleeping on the job.
I have not heard why the Democrats did not propose legislation to solve this problem and it makes me nervous that they are blaming a lamb duck president for a period of time in our great history when they controlled what landed on his desk. I am even more nervous when their solution is a man whose only experience in the real world is two years in congress working with a party that did nothing to prepare our nation for today.
Labels: Presidential Campaign, Wall street crisis
