The Cause of the Financial Crisis (dart)

[_asbestosman]

Here is a post written by someone named "Suzy" on another forum:

I am an economist by training and spent 25 years in the banking industry. I have personally sat in loan committee meetings and had bank examiners demand that we "not discriminate against low and moderate income borrowers". Never mind that the reason they are low and moderate income in the first place is their inability to make good financial decisions...like establishing a steady work history, paying bills on time, living within their means, obeying the law, buying insurance to guard against catastrophic illness or property loss, (women) having multiple children with multiple men. and on, and on.

Call me ignorant, but I don't think level of income is directly attributable to one's ability to make good financial decisions. Indeed, I think a lot of it has to do with the environment one is raised in. Kids in poverty have more important things to worry about than studying for a math test.

In fact, I know plenty of people with income comparable to me but who are foolish with their finances. They aren't saving for retirement and some of them are impulse buyers. It isn't income that's the problem but rather money management. Indeed, I think a lot of Americans suck at finances. Even I could do better, but at least I've been smart enough to tuck away a good chunk for a rainy day (or year) and also some to start a nest egg for retirement.

[_dartagnan]

Call me ignorant, but I don't think level of income is directly attributable to one's ability to make good financial decisions.

Well, the statistics say otherwise. There is definately a correlation between the two.

Indeed, I think a lot of it has to do with the environment one is raised in. Kids in poverty have more important things to worry about than studying for a math test.

I think kids cannot afford to substitue education with whatever it is you think is more important. Most poor folks are starving in the streets. Most poor folks and poor kids could study if they wanted to but the main problem is parental guidance. It is difficult to expect poorer kids to take school seriously when they probably live with a single parent and they've seen a liquor store more than a grocery store.

In fact, I know plenty of people with income comparable to me but who are foolish with their finances. They aren't saving for retirement and some of them are impulse buyers.

The fact is black folks are twice as likely to file bankruptcy. If that doesn't say anything about financial responsibility then I don't know what does.

It isn't income that's the problem but rather money management

I'd say its both.

Indeed, I think a lot of Americans suck at finances.

True, but those with education, those raised in households of responsible parents, are more likely to know how to handle their finances. Throwing a group of poor folks into middle-class homes and just expecting them to know how to manage their finances accordingly, is just naïve, and I think Suzy makes some really great points.

Even I could do better, but at least I've been smart enough to tuck away a good chunk for a rainy day (or year) and also some to start a nest egg for retirement.

Poorer communities live from paycheck to paycheck all their lives. Saving money isn't something they've been conditioned to do, even if they could.

[_Analytics]

When I said, "Virtually every economist acknowledges that this was a result of the political pressures from Washington," you seemed to think I was speaking of the cause of the crisis. But I was referring to the previous sentence: "Poorer folks have always been trying to buy homes, but only in recent years did the banks hedge on redling to help minorities with less than stellar credit, 'qualify' for loans."

I understand that is what you were talking about. The issue is why did requirements for loans deteriorate over the last few years? Here are my problems with what you said:

1- This issue goes way beyond “poorer folks” and includes a huge band of people with good incomes and good credit scores who wanted to by more than they could afford. Using Palin’s example, It included people who could afford a $100,000 house but wanted a $300,000 house.

2- I’ve never even heard of the concept of “hedging on a redling”, much less heard any economist say this had anything to do with anything.

3- Loans with lower credit standards were usually issued by mortgage brokers who were not subject to the CRA. While the government was pressuring banks to give loans that may have been imprudent, it was not pressuring mortgage brokers.

4- While in response to government pressure the GSEs were tentatively trying to purchase more mortgages from poor people, “private label” issuers had no such pressure and were aggressively purchasing and repackaging such mortgages.

Those last two issues are the ones that “Suzy” doesn’t seem to understand. The main problem wasn’t the GSEs purchasing loans issued by banks in response to the CRA. The main problem was unregulated private-label issuers buying mortgages from unregulated mortgage brokers. The mortgage brokers wrote these loans because the private label CMO issuers wanted to buy them. They wanted to buy these mortgages because they could make money off of selling them. Profit motives—not government pressure--drove this.

The democrats had been doing everything they could to make housing more affordable for poorer folks and they had also been instrumental in pressuring banks to be more "diverse" in their lending practices. Without irresponsible people going beyond their means, there would have been no outrageous increase in defaulted mortgages.

Post hoc ergo proctor hoc. Banks and GSEs had pressure from the government to lend money to minorities. Mortgage brokers and private-label CMO issuers did not. The problem mortgages were written by mortgage brokers, not by banks. The problem mortgages were packaged as private-label CMOs, not GSE CMOs.

The advent of securitization and the poor judgement of the people who purchased these securities was the driving force.

[_Analytics]

Of course, but I have already presented several examples of reputable economists who support what I have been saying. As you saw, economists disagree on the causes as well. We have been discussing the causes have we not? Miron is clearly of the opinion that the biggest problem is the government's role. When I said this you expressed contempt and attacked me for speaking ignorantly. Miron is one of many economists I have read that has been instrumental in molding my own view the way has, and continues to evolve.

Are you sure they have been supporting what you have been saying? Miron’s main point is that the GSEs shouldn’t have even existed—as a libertarian economist, his point is that the government shouldn’t even be in the business of attempting to bring stability, liquidity, and affordability to the housing market. That by their mere existence, the GSEs brought disequilibrium to the free market system.

In contrast, I thought your position was that because of the stupidity and corruption of democrats, banks were forced to write bad loans and the GSEs were forced to repackage them.

Could you clarify your position? Are you saying that the GSEs should be gotten rid of as Miron says? Or are you saying that the GSEs need to be better regulated as McCain said?

[_moksha]

What is your opinion of this informative article?

http://www.motherjones.com/news/feature/2008/07/foreclosure-phil.html

I see it as a smoking gun to how we've been fleeced and who set the fleecing in motion.

.

[Gladness]

What is your opinion of this informative article?

http://www.motherjones.com/news/feature/2008/07/foreclosure-phil.html

I see it as a smoking gun to how we've been fleeced and who set the fleecing in motion.

.

Nominating Phil Gramm as leading perp? I have some sympathy towards that point of view; I think these events have shown that the deregulation crowd was pretty naïve.

It reminds me of the John Donne poem that says, “No man is an island.” It could also be said that no company is an island. We are all interconnected. Lehmann Brothers is the new poster child of this. They took big, hedged bets. When things went well, they pretended that they earned their winnings, and suggested that taxing their exuberant incomes at a higher marginal rate would not only be unfair, it would hurt the economy. Now that things have gone south, the downside is causing escalating ripples that are damaging everybody. If society as a whole is taking on the risk, society as a whole should have the means by which to mitigate and control that risk—i.e. regulation.

Having said that, here is an interesting article that is a bit broader, “I think it was lack of effective regulation of the shadow banking sector in general.”

I think it is clear that if the credit default swap industry would have had sensible regulation, it would have been an entirely different game. Other things being equal, I would guess there still would have been a housing bubble, but it would have been smaller and the effects would have been more contained.

[_Gadianton]

The amount of pressure to be "nice" to poor people in contrast to the risks lenders are/were willing to take to compete with other lenders is marginal. "It's all about money" - that's the response you'll get from lenders and insurers alike. As another example, does anyone think it's tough to get auto insurance if you're illegal and have no license?

[_Who Knows]

Here[/url] is a post written by someone named "Suzy" on another forum:

I am an economist by training and spent 25 years in the banking industry. I have personally sat in loan committee meetings and had bank examiners demand that we "not discriminate against low and moderate income borrowers". Never mind that the reason they are low and moderate income in the first place is their inability to make good financial decisions...like establishing a steady work history, paying bills on time, living within their means, obeying the law, buying insurance to guard against catastrophic illness or property loss, (women) having multiple children with multiple men. and on, and on.

The CRA was well intentioned, and lawmakers from both sides of the aisle rightly noted the positive effects that homeownership can have on a society. The problem was, these middle and upper class lawmakers made the erroneous assumption that if you put poor people in houses, they would suddenly start behaving like financially responsible middle class people. All of a sudden lawnmowers would replace lottery tickets and backyard barbeques would take the place of drive by shootings. Alas, these hopes for change were empty promises as they always are, and borrowers who had to get their down payments from "third party non-profit agencies" (by the way, someone always makes a profit, otherwise why are they in it) had nothing to fall back on when the hot water heater broke or the roof leaked. The houses fell into disrepair and by the time the foreclosure papers were posted, the occupants and hopes of any recovery by the lender long gone. But the originating lender didn't care...the loan had been sold, not their problem any more!

There is more blame to go around...mortgage companies and builders soon realized there was money being printed and there sprung up companies that specialized in getting subprime borrowers into low cost (and low quality) housing. You probably heard them advertising on the radio and saw the ads in the Sunday paper. Did you ever wonder what kind of people would need a no-doc loan? And who would be stupid enough to make such a loan? I think we all know the answer to that now...the ultimate lender was of course Fannie Mae or Freddie Mac, the original loan having long since been sold by the originating bank. All that bad paper, and Franklin Raines out the back door with his suitcase full of money...

For someone who supposedly spent 25 years in banking, Suzy sure is an idiot. I've only spent the last 3 years in banking, and I know enough to know this person is stretching the truth according to her agenda.

As an auditor for a large company, i spent a few months at one of their subsidiaries - one of the top 5 subprime lenders in the country. This business was insane. No regulatory oversight whatsoever. No one was forcing this business to lend to low income. No one was forcing them to do 'no-doc' loans. They weren't in a bank - so they weren't subject to CRA requirements. They didn't have 'fair lending' regulations that they needed to adhere to. They were doing these loans because they knew there was a market to sell them in. Who were they selling to? Morgan Stanley, Lehman, etc. They weren't even allowed to sell to fannie/freddie because these loans were such crap.

This is the stupidest argument ever made. Trying to push it only proves one thing - that you're trying to push your agenda. Why not let the facts speak for themselves?

It's sorta like the apologists defending Joseph Smith's treasure digging - saying it somehow helped train him to be a prophet. The only reason you'd ever say such a thing is because you're tied down to your beliefs that you're not willing to look independently at. Lame.

[_Analytics]

Compare and contrast:

I said the following

The advent of securitization and the poor judgement of the people who purchased these securities was the driving force.

Here is what Alan Greenspan will say today to Congress:

The evidence strongly suggests that without the excess demand from securitizers, subprime mortgage originations (undeniably the original source of crisis) would have been far smaller and defaults accordingly far fewer. But subprime mortgages pooled and sold as securities became subject to explosive demand from investors around the world. These mortgage backed securities being “subprime” were originally offered at what appeared to be exceptionally high risk-adjusted market interest rates. But with U.S. home prices still rising, delinquency and foreclosure rates were deceptively modest. Losses were minimal. To the most sophisticated investors in the world, they were wrongly viewed as a “steal.”

The consequent surge in global demand for U.S. subprime securities by banks, hedge, and pension funds supported by unrealistically positive rating designations by credit agencies was, in my judgment, the core of the problem. Demand became so aggressive that too many securitizers and lenders believed they were able to create and sell mortgage backed securities so quickly that they never put their shareholders’ capital at risk and hence did not have the incentive to evaluate the credit quality of what they were selling. Pressures on lenders to supply more “paper” collapsed subprime underwriting standards from 2005 forward. Uncritical acceptance of credit ratings by purchasers of these toxic assets has led to huge losses.

It was the failure to properly price such risky assets that precipitated the crisis. In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivates markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria.

Correctly, Greenspan puts the blame for lower credit standards on the people who stupidly demanded sub-prime MBSs. The market could supply its hunger for these instruments without Fannie Mae and Freddie Mac, and to a large extent did. It was doomed to play out pretty much the same way regardless of whether Fannie Mae and Freddie Mac would choose to be involved.

Demand from investors in the free market was the driving force--not corruption at the GSEs and certainly not the CRA and other government initiatives to expand housing ownership.