Anatomy of a Meltdown, Volume I

Crisis begets irrationality. Or is it the other way around? Or is it both? The financial meltdown has led to so many fanciful causation statements that I have decided to make it my quest to find truth, or at least as close as I can get to it, about the causes of the crisis we are experiencing. I do feel it is important to figure the causes, because as Sen. Obama astutely said last night, we need to know the causes to craft the best solution. But it is pointless to engage in the blame game because contrary to what some would like us to believe there is no single cause.

Let me start by saying what the “cause” is not. The cause is not: 1) Barney Frank – for most of the relevant time period, Rep. Frank was at best the ranking minority member of the Financial Services Committee. Only in the last two years did he garner Chairmanship of that committee. So unlike say a President who controls the ultimate decision on such issues as waging war in Iraq; Barney Frank is not, nor has he ever been, “The Decider”. Positions he advocates require the support of other legislators in not only the House, but the Senate, and ultimately the White House (perhaps some of us need a refresher on the classic Schoolhouse Rock ditty, “I’m Just a Bill”). 2) Low Income Housing Loans – When you hear this, or its corresponding phrase, “personal responsibility,” cited it is nothing but a racist and classist dig at the ideal of promoting home ownership to lower income individuals. First, this subset of loans, in and of itself, could never bring down the financial markets simply because the banks would have factored in the failure of these loans right from the start. In fact, these loans were structured as such to fail. They were laden with duplicative and exorbitant closing costs, and infused with predatory lending terms. If the mortgagees were able to make it a year under these mortgages it would have been a miracle. The loans were front-ended so the banks, or the entity that ultimately purchased the mortgage, could recover not only its costs, but a premium, prior to the inevitable foreclosure. Even with all this I am sure there are still some “responsible” individuals doing all they can to remain current on the mortgages. And banks were not forced to make these loans. This was reparation for decades of redlining where they refused to lend to low income areas without even looking at an individual’s credit. Coupled with redlining was a credit rating system that was not designed to judge credit worthiness but credit marketability, i.e., which individuals could banks make money off of. Banks did not want people with no credit, who paid their bills every month. They wanted people who would take out multiple lines of credit and only pay a portion of it, because they make their money through confiscatory interest rates (and don’t get me started on how they can ramp up rates if your payment is a day late, but other companies, such as ACME, can’t even raise rates without a full blown regulatory proceeding). Banks lapped up the invitation to low income areas because they knew now they had the backing of the government, and lax regulatory oversight, so they could make loans that were destined to line their coffers, and leave the mortgagees vulnerable. 3) House flipping and speculation – Read the papers. They are filled with tales of con artists who would have 20-30 outstanding mortgages at a time and finance one mortgage off another. And the banks and credit agencies that should have been aware of this apparently turned a blind eye to it. These mortgages were literally a house of cards; once one failed, the others failed, and not just the house crumbled. 4) Lax oversight – while Sen McCain was rash in his “firing” statement about SEC Chairman Cox, he is correct about letting the hens guard the henhouse. Today’s WSJ reports how the SEC knew two years ago that Bear Stearns was ripe for collapse, yet they did not intervene at all. They had enforcement weapons at their arsenal, but did nothing. Because, that is the theory of the free market, right? Let Adam Smith’s invisible hand guide it. But what happens when that hand is hand-cuffed.

More to come . . .