Sunday, March 2, 2008

Who are the Brains behind the Housing Crisis?

by Tyler P. Berding

Market melt-down! As I write this, the DJIA is down over 200 points this morning alone, and has dropped almost 15% from its high last year. The news is thick with comment about the possibility of “recession.” The economy has supplanted the Iraq war as the most talked about issue in the presidential campaign. The pundits know how all of this got started: the bursting of a housing bubble fueled by cheap and available mortgage money with few rules in place about who could borrow it. Worse, usually reliable and successful investment banks packaged these questionable loans into securities that were sold to a huge number of investors all over the globe for enormous sums of money. And now the bubble has burst, the loans are in default, and the securities are becoming, if not worthless, at least worth a whole lot less than they were six months ago.

And it doesn’t end there of course. Without loans, no one is buying houses. As housing sales tank, developers and lenders lay off employees and tighten lending so consumer purchases can no longer be financed, leading to further layoffs in other industries, and eventually, if it gets bad enough, to a recession, where “deflation” replaces “inflation” or even modest rises in consumer prices, leading to more fall off in consumer spending, etc, etc. In the meanwhile, all of this scares the bejeezus out of the stock market and investors pull out leading to further price dives in a broad base of securities, scaring people even more and causing them to hold back on purchases, and on and on until somebody does something, usually the government with various “stimulus” packages, to get the economy going again. The process can take anywhere from a few months to a couple of years, depending on the depth of the slowdown.

In the meanwhile, of course, people lose their jobs and maybe their homes, businesses fail, retirement funds shrink, and the economy and the mood of our nation and perhaps other nations, is depressed and ugly. Candidates and other politicians blame each other, the private sector, and whoever or whatever else is handy and culpable. Most of the parties upon who the blame will be hung are, in a sense, “innocent” participants in the entire process, but there are some who certainly should have known better. So, where are the brains in this outfit?

We send our best and brightest young people to Wall Street to learn investment banking and figure out new ways to attract investment funds and enrich their firms and themselves. Usually, many are successful and the economy and the country benefit from this economic stimulus that creates capital for investment in new industry, thus creating jobs and purchasing power. So what happened here? Who were the “brains” behind this housing crisis? Which genius or geniuses decided that it was prudent or even smart to lend to people who could not afford to repay their loans and then use those loans as security for other investments? Wasn’t a crash inevitable under those circumstances?

The lenders and the investment bankers knew in advance that certain borrowers were not credit-worthy; would not have sufficient incentive to repay their loans; did not have the income necessary to meet the projected payments, and yet, in what can only be considered a mass delusion, made these loans anyway. Was it greed? That’s a tempting thought, but even the greediest money managers can sense a disaster in the making and find ways to avoid it--perhaps like not making the loans in the first place? No, that would be too simple. I think it’s more a case of a lot of professional people who were too used to believing in the infallibility of their decisions coupled with the pressure to churn out enormous profits to keep their positions intact. A form of “greed” to be sure, but way more sophisticated, at least on the surface. Here we have a large number of very smart people who perhaps were too insulated from the real world. Maybe a sabbatical as a board member of a community association, especially one that now is suffering many foreclosures, would bring them back to reality.

 A quote from Warren Buffet in his annual letter to investors:

"As house prices fall, a huge amount of financial folly is being exposed. You only learn who has been swimming naked when the tide goes out--and what we are witnessing at some of our largest financial institutions is an ugly sight."


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