HOW DID WE GET HERE BEN?

USA Today’s interview with FED Chairman Ben Bernanke (April 4, 2009) See: http://blogs.usatoday.com/oped/2009/04/4-questions-4-answers-from-ben-bernanke.html


Asked how did we get here Ben? The USA Today piece (April 4, 2009) records Mr Bernanke response in this manner. “At the most basic level, the role of banks and other financial institutions is to take the savings generated by households and businesses and put them to use by making loans and investments. In our global financial system, saving need not be generated in the country in which it is put to work” said Bernanke (according to the USA Today report) Bernanke explained that in our present global system banks need not be limited by American savings alone. In fact much of the funds which entered our nation came from abroad. In the last 10-15 years nearly a trillion dollars entered the USA from abroad. That represented about 6% of our GDP or nearly a trillion dollars worth of potential investment money. The banks were awash in funds and they began to compete aggressively for borrowers.

The result was that “credit to both households and businesses became cheap and easy to obtain”. The result was a mortgage barn sale and a massive housing boom in the US. Mortgages were cheap, auto loans were cheap…money in general was cheap to borrow. People borrowed with abandon. “ Unfortunately much of this lending was poorly done” according the Bernanke. The loans were agreed to with little or no down payment and insufficient oversight on how the borrower could pay for the loan. These were later characterized euphemistically as “sub-prime” loans rather than what we in common parlance might simply call “worthless paper” (my quotes). How did this happen? Regulations were lax. USA Today does not ask Mr. Bernanke how this came about, but it well known that Bernanke and his predecessor Alan Greenspan were partly responsible for this “poor lending” and lax regulations when they looked the other way while Congress and the Clinton and Bush Administrations both sought to limit such regulations.

But it was not simply a boom in bad mortgages that caused the crisis. Bernanke states, “To satisfy the enormous demand for investments both perceived as safe and promising higher returns, the financial industry designed securities that later proved to involve substantial risks — risks that neither the investors nor the firms that designed the securities adequately understood at the outset.” To put it in simpler terms the ‘financial wizards” (my characterization) of Wall Street saw a means of limiting their risks (of these sub-prime loans) by spreading it across the investment spectrum. Such a strategy (bundling high risk securities with lower risk) would limit the lending bank’s exposure and of course increase the lending institution’s profits. And without a regulator in sight and the FED uninterested or unable to warn the consumer and the government of these machinations the proceeded to invent “designer securities” based on these bad mortgaged backed loans to sell world-wide. These “securities” (another euphemism) which according to Bernanke “later proved to involve substantial risk” made enormous profits for the banks and financial institutions who bundled them and sold them as triple “A” paper.

“The credit boom began to unravel in 2007, when problems surfaced with subprime mortgages”states Bernanke. But to my mind what happened was that the great building boom stuttered and faltered just when higher gasoline prices peaked in late 2007 and continued rising to over $4.00 a gallon in 2008 (the Iraq War effect, booming economies in China and India where factories were working overtime to export goods to nations where housing booms were creating rooms to fill with furniture ) and at the same time as the building boom reached a point where the glut of housing simply caused the prices to fall. Thus the Ponzi Scheme of Wall Street (my characterization) began to unravel when in early 2007 the relentless building boom created its own pit-fall. The glut of housing caused house prices to fall. With falling house values, many mortgage holders found themselves with what is termed negative equity. In October of last year 20% of homeowners (or about 7.5 million homes) held mortgages which were higher than the value of the equity they held in their houses. See http://21cvision.blogspot.com/2008/10/20-of-us-homeowners-have-mortgage.html.

A to be nameless person I know, took out a second mortgage on his house. The older house had an original mortgage of two-hundred thousand and since houses in the neighborhood were selling for five-hundred thousand, this person took out a second for three hundred thousand. His total indebetness was now $500,000. His mortgage payment was higher but he had a big bunndle of money in hand. He used the funds to make needed repairs, add a garage and fix up his basement. He also somehow took his family to Disney World that summer. But that was the summer, house prices in the neighborhood hit the skids and his now formerly $500,000 property was assessed at only $350,000. He now owed more ($150,000 more) on his mortgage than his house was worth. Then, disaster struck when gas prices rose to $4.00 a gallon, (he had a long commute) and when he lost his overtime at the plant, and his wife was laid off from her job, he found it impossible to pay his monthly loan. He tried to sell, but there were no buyers. One night a few months back he and his wife packed up a utility trailer he had hidden in the big new garage. I saw it one day when the doors were open. Then they left one night. We heard they went to Florida where they both found work and are renting a house.

When house prices fell, “Mortgage delinquencies and defaults rose.”, states Bernanke. “Then investors began to pull back from a wide range of credit markets, and financial institutions cut back their lending. The crisis deepened last September when the failure or near failure of several major financial firms caused many financial and credit markets to freeze up.” That’s what caused the crisis.

In summary, Ben explains we got here because banks were awash in nearly trillion dollars of foreign money. With little to lose and much profit to make and no one watching them (certainly not Bernanke or the FED) the banks began competition to aggressively to lend money. The result of their endeavors was that credit became easy to get. Too often credit was extened to those not qualified to repay their loans. Banks and financial institutions were making good profits but they wanted more. Greed drove financial institutions to develop myriad forms of designer securities many of which were based on the prommisory notes of the money they had already loaned out (mortgages) and were already producing a profit. That profit was not enough. They designed security products which based on prommisory notes (mortgages) which could be resold or “recycled” as new securities to be sold over and over again. I think my term:“scheme” fits this type of financial transaction quite well. Then disaster struck when the housing boom produced a glut of houses and the demand for housing fell and with it house prices. Mortgage holders defaulted and those holding these worthless papers were left holding the bag. That is until bailed out with government largess.

Unbelieveably after accepting the US bailout some banks, still in their excess spending mode, had the nerve to give annual bonuses to those who had created the crisis. You many read today where the Bank of America gave out $3.5 billion dollars in bonuses to Merrill Lynch employees when B of A took over that company. Yes "b" billion dollars! See: http://www.washingtonpost.com/wp-dyn/content/article/2009/04/13/AR2009041302745.html?hpid=moreheadlines. So the proverbial “house of cards” built by the financiers simply collapsed, but not quite around their own ears….the cards fell around us all--- the not guilty, suffering, homeowner, and taxpayers.