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Archive for July, 2011

Every day we are told that the financial mess is the fault of President Bush. To be fair, we should examine the facts of the situation. This mess started in 1977 when President Carter signed the Community Reinvestment Act (CRA) into law! It was an attempt to increase the number of loans in inner-city neighborhoods, even if the risk was high! In 1977, banking was a highly regulated industry in which small, local savings banks or home-town savings and loan organizations provided the home mortgages. Regulations prohibited the banks from branching across state lines and some states even prohibited branching within the state. However, CRA went too far and it changed our entire system of home financing. It allowed banks to expand rapidly and very large commercial banks were slowly formed that had no state boarders. The banks cautiously began to make more loans in the inner-city. The CRA was not very active during the ‘70s or ‘80s, because banks could demonstrate to the Regulators that they were reaching out to the inner city. As a result, only about 100 billion dollars was loaned to questionable borrowers. However, they were still making loans on risk assessment to protect the stockholders and customers. That meant that some people did not qualify or had to pay higher interest rates.

 
This insular world of banking collapsed under President Clinton when he put teeth in the CRA regulations which would dramatically increase access to mortgage credit for inner city dwellers. In addition, Clinton ordered HUD to set quotas for “Affirmative Action Lending” at Fannie Mae and Freddie Mac. These combined Government groups forced the banking industry to make loans that banks would otherwise reject as financially unsound. Subprime loans were virtually unknown before the multiple changes made by Clinton. This set up a system that was not a free market and which resulted in massive, complicated government control. The Clinton administration then forced banks to loan more than a trillion dollars in high risk loans using such income as welfare checks, unemployment checks, seasonal income, occasional part-time work and other questionable sources for income qualification.
 
The Government pushed and promoted the bad loans not only through the power of CRA and HUD but through the carrot of Fannie Mae and Freddie Mac. Freddie and Fannie purchased the bad loans, securitized them and guaranteed the loans made by the various lenders whose debt is implicitly guaranteed by the Federal Government. Thus a wonderful opportunity was set up for greedy lenders to wrap up bundles of subprime loans and sell them to the government backed buyer Fannie Mae and Freddie Mac. The lenders sold trillions of dollars of suspect loans to Fannie and Freddie, sold many bundles to Wall Street, marketed them in Europe and kept some for themselves. Everyone in the world-wide financial community was greedily counting the gold from their golden United States Federal goose. However, they did not realize it was fools gold.
 
In a free market, these actions would result in a disaster. However, the Federal Reserve Board had set up an inflationary policy of artificially low-interest rates which made the subprime loans extraordinarily profitable. The subprime borrowers who could not normally make their expensive payments could do so thanks to payments that plummeted with the Fed Rates. They very seldom defaulted because house prices kept rising and payments kept dropping. If they could not make the payments, they could sell the house at the inflated price and all was well. The entire financial community was receiving a fabulous reward from dubious, bad investments. The largest company involved in this problem said that they had one criteria for a loan. If the applicant could fog a mirror, he qualified.
There were a few Republicans and a few conservative Democrats who waved a red flag, but no one paid attention. Also, President Bush warned congress 17 documented times about the problem. However, the Democrats and Republicans in congress enjoyed watching their supporters and campaign contributors rake in the easy money. So-called “community groups” like ACORN, La Raza, etc. benefitted greatly by a process which was essentially legalized extortion. The CRA is enforced by the Fed, the Comptroller of Currency, Office of Thrift Supervision and the FDIC. A CRA protest by one of these well-organized “community groups” could result in huge financial penalties and fines for the banks and block their plans for expansion. This leverage was used and the “community groups” got millions of dollars from the banks for marketing these loans and they also made the banks promise to make a certain number of future very risky loans in their communities, resulting in more money for the “community groups”.
 
All of these factors enforced by strong government agencies created a situation in which millions of people were buying homes they simply could not afford, but they could fog a mirror. This caused an artificial feeling of financial prosperity for everyone and trillions of dollars were going into bad investments. Suddenly interest rates hit bottom, poor risks defaulted, housing prices dropped, the bubble burst and the rest is history. Now we tax payers must pay for these risky loans and are forced to bail out the irresponsible Banks. We must remove the government’s power to coerce, bribe, reward and bail out irrational decisions. The free market did not fail, the unfree market has caused America to fall and fail. As Jefferson said “History convinces me that most bad government results from too much government”.
 
by Mack W. Hunt
Estes Park, CO 80517
 

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