Friday, September 19, 2008
History: In the 1980s there was land flipping, nefarious real estate appraisals, Danny Faulkner condo construction and easy credit at the corner savings & loan. The bubble burst and the Resolution Trust Corp. was created in 1989, closing or reorganizing 747 institutions holding assets of nearly $400 billion.
Fool me once, shame on you. Fool me twice...
In the 1950s a 20% down payment was generally required to purchase a house. Lending institutions, obviously in the business of making loans, came to the realization that more people could qualify for loans if the down payment was lowered to 10%. Uncle Sam came out of the Great Depression hangover and started promoting home ownership as an economic force. Regulations of financial institutions became myopic (ex: Freddie Mac & Fannie Mae) and the downpayment threshold fell to 5%, then 3%, then 1%. Credit score requirements fell as well. The condo buying spree of the 1980s became the single family house buying spree of recent memory. Values rose so fast that it became almost de rigueur to get a mortgage is excess of what was paid for the house and buyers could walk out of closing with a check to buy new furniture.
Then the bough broke and the baby fell. Homeowners walked away when they couldn't sell their house for the amount of their loan. Lending institutions became laden with illiquid assets. Unable to sell this "paper," money dried up to make new loans. America, indeed the world, found itself in a credit crisis. Treasury Secretary Henry Paulson: "...the root cause of the stress in the capital market is the real estate correction."
Bear Stearns had to be adopted by JP Morgan Chase (with the Federal Reserve's help) in March. It's involvement in the world credit market was too great to ignore. Earlier this month Fannie Mar and Freddie Mac had to be "purchased" by the government. Their tentacles in the country's mortgage necessities are entrenched too deeply to ignore and the only sane thing to do with them is to break them up into regional units. The other evening the Fed gave a two-year, $85 billion loan to AIG in exchange for a near 80% ownership. AIG's massive billions dollars losses in bond default insurance could not be ignored. Also not to be ignored was the agreement among Secretary Paulson, current Fed Chairman Ben Bernanke and former Fed Chairmen Alan Greenspan and Paul Volcker that these bailouts were needed.
Would these actions have been necessary had there been adequate regulations in place? And is asking that question anathema to my free market beliefs? I think not. On both counts.
Further worries: Panic has set in so much that yesterday before dawn the Fed injected $300 billion into global credit markets. Sensing other measures necessary, the Fed tossed in another $50 billion followed by another $50 billion to maintain a 2% federal funds rate.
And emergency legislation is now being discussed for more government intervention by buying distressed mortgages. Details are being worked out but time is of the essence in that Congress is scheduled to adjourn Sept. 26. Elections are Nov. 4 and Iraq will draw little attention.
Short selling, and today's DJIA: