An expensive lesson in social engineering

How expensive? Well, it looked as though the bill would start with the 700 billion Congress planned to borrow to help the financial markets stabilize. Now, who knows what will happen? The 'rescue plan' or 'bailout plan' depending on who was selling the idea, would have infused the markets with cash to add liquidity, so banks will start loaning to borrowers and each other again. The 700 billion dollar would have taken decades to pay off. I am not optimistic about these assets gaining value and turning from red ink to black anytime soon, if ever.

What ever action the government takes, it will be too late for those who have already lost their homes to foreclosure. Some borrowers who had good credit may have bitten off more home than they could afford, but the root cause of this crisis is political. Many people with questionable credit or no credit, saw their friends and neighbors buying and selling homes during the last ten years, and they wanted in on the action. With the backing of Democratic politicians along with a handful of Republicans, they were offered a seat at the table, with disastrous consequences.

The Community Reinvestment Act first passed by the Carter administration, was changed dramatically in 1995 under President Clinton. To help low income residents buy homes, the banks were requiring to lend to them or face penalties. Think of it as affirmative action for banks, you either loan money to sub-prime borrowers or the feds will come down on you. Many of these loans were funneled through liberal 'community organizations' like ACORN. With the banks making so many loans to people who could not qualify for them traditionally, an influx of buyers who had no business being in the market for homes drove prices through the roof. Enter Fannie Mae and Freddie Mac, ran by former Clinton officials Franklin Raines and Jamie Gorelick, they bought billions of dollars of these sub-prime loans from investment houses like Bear Sterns. The investment houses packaged the risky loans into mortgage-backed securities and sold them to other financial brokers along with Fannie and Freddie. Franklin Raines and Jamie Gorelick also made millions in bonuses while cooking the books.

With willing buyers taking this 'bad paper' off their books, banks started to really get 'creative' with their sub prime mortgages by offering teaser rates, variable rate loans and interest-only loans. Once looked upon as very risky loans, they were offered to buyers as a way to buy a home they could not afford. Some of these loans were NINJA loans, No Income - No Job- no Assets, just write down your income and we won't even check. With home values rising every year, the banks and the borrowers hoped it would only be matter of time before the value of the house caught up with the loan-to-value of the mortgage and they could refinance to a 30 year fixed. That was the plan, and as I always say, 'hope is not a plan'.

With all the new buyers in the market, builders went into overdrive, building suburbs with an endless sea of rooftops. Everyone was making money and no one stopped to ask if the annual double digit increases in home prices was a good thing. Like a hot dice roller at the craps table in Vegas, everyone was betting on the come. When all the money was on the pass line, the dice came up 7. All these variable rate and interest only loans started to mature and with a huge supply of newly built homes on the market, home prices started to level off and then started to fall. Buyers who could not refinance their loans saw their mortgage payments shoot up while the value of their homes dropped just as fast. The snowball grew larger and gained speed as foreclosed homes added to the supply and prices plunged.
Crash.

The politicians are blaming Wall Street, but they were warned about the coming crisis in 2004 by then Fed Chair, Alan Greenspan. The democrats denied there were any problems with Fannie and Freddie's mismanagement and quietly killed a banking reform bill in the Senate. Congress caused this crisis by changing the lending rules banks had followed for centuries. The lending rules of ten to twenty percent down payment and proof of income are there for a reason. In an effort to 'be fair' and make the American dream 'available for everyone' the politicians manipulated the free market, creating a false economy. When told they were heading for a cliff, they did nothing.

Government does few things well, I would be happy if the mail came on time. Trying to make the free market 'fair' is something far beyond its ability. It is also way beyond its intended design.