Bob Williams

So how did we get here?

Nobody is guiltless. Everyone from Presidents to residents: from moneymakers to money changers. Ignorance and neglect are indefensible explanations.

The federal government has lifted the lawful debt ceiling by $1.5 trillion since July. All of it in the name of bailing out a financial system of its own making—demanding that banks make unsound loans, encouraging people who couldn’t afford to make payments on those loans to accept them anyway, and leaving them with no way out when balloon payments come due.

Then, the housing bubble that so many of us predicted came to pass. The bubble burst. For many Americans, so did the goal of home ownership and starting a small business.

And we taxpayers are left holding the bag and paying the bills.

All of it was avoidable. But while we work our way out of this financial mess, many, if not all of us, will have to adjust our lifestyles to the new realities, learn from mistakes of the past, and teach our children and grandchildren how to avoid financial calamities like this in the future.

I think there are at least four root causes for our current predicament.

First, Government Sponsored Enterprises (GSE’s): Here I am talking about Fannie Mae and Freddie Mac.

Freddie and Fannie purchase mortgages from mortgage companies and banks with the goal of selling some on the private market. Fannie and Freddie own $5.5 trillion in mortgages. As taxpayers, we are on the hook for making good on those mortgages.

Most financial organizations are required to have 10 percent in their cash reserves to cover mortgage exposure. That is because during any 50 year period—regardless of economic conditions—no more than 10 percent of mortgages would be at risk of default statistically speaking. The federal government wanted banks and others to have enough liquidity to cover those defaults.

However, the rules changed for Freddie and Fannie during the Clinton administration. Their cash reserve requirements were reduced to 2.5 percent of mortgages purchased. When the housing crisis hit, neither had enough in cash reserves to cover their losses. The house of cards started to fall. And yet, at the direction of the federal government, both institutions continue to absorb new loans, many of them untenable!

What is going on here?

Politics, of course, not financial prudence. According to Peter Wallison, the former Treasury General Counsel, “Among other things, Fannie and Freddie orchestrated substantial campaign contributions to the campaign funds of their congressional supporters”

They hired former Congressional staffers as lobbyists and engaged lobbying firms that had strong relationships with members of Congress, including people tied to both presidential candidates.

It’s not just about campaign donations or hiring congressional staffers as lobbyists. It is about a politically correct definition of “social justice” that got its start during the Carter administration in the 1970s.

The Community Reinvestment Act was passed in 1977 under Carter and gave regulators the power for the federal government to “encourage” banks to issue high risk loans that would be sold to Fannie and Freddie with federal guarantees. The circling of the mortgage waters around the drain began.

The program escalated in the late in the 1990s under Congressional pressure, leading to no-money-down mortgages, with no proof on income and no verifiable address! As long as home prices continued to increase, the scheme worked. But when home prices started to fall, the game was up.

President Bush talked about this in his State of the Union address in January 2003, but nobody paid attention. Banks were held in detention by the federal government, limiting growth opportunities, unless they agreed to open their bank vaults to financially risky loans. Reform legislation offered to Congress failed to pass.

Then there was the easy money from the Federal Reserve. On January 2, 2001, the federal funds rate was six percent. By June 2005, the rate was down to one percent. The rate fell gradually over the years, but it rearranged what kind of debt loads people and businesses could afford.

Borrowing was easier and loans became cheaper. Mortgage rates went down.

Somebody who could afford to make a monthly mortgage payment of $2,000 per month in May 2000 would have been able to afford a home worth $282,000. After June 2003, that person would have been able to afford a home worth $460,000.

Unfortunately, many of those mortgages came with balloon payments—adjustable rate mortgages that homebuyers couldn’t afford, rather than more traditional 30-year mortgages. In other words, people who had low monthly payments when they first bought their homes were faced with stiff increases in monthly payments at some point in the future. That future arrived, and people couldn’t afford the new payments.

People buying the homes—and the lenders who gave them the money—were gambling that home values would increase and, if you couldn’t afford to make your payments, you’d be able to sell the home to some other person at an enormous profit.

That worked for a while, but the bubble burst.

Aggravating the situation were new accounting rules, such as “mark to market” that was put in place following the Enron scandal. The rule forces companies to value their assets at existing market prices which, in dizzying financial times, furthered the downward spiral.

But the bottom line is that we have a fiscal crisis that was facilitated by the federal government, and which most Americans participated in heartily. After all, we elect many of these people. The rest are appointed by the people we elect. We need to do better.