I find the discussion by the mass communication media failing to heed Nixon’s advise and continues to talk down to us on a matter so important to the future of our way of life. Both sides of the argument are guilty. The subject is covered in generalities or by repeating the key words and phrases used by the pundits and public to address the Great Recession. I am not blind to the business model of talking to the lowest common denominator to attract the greatest audience, but an issue of this gravity attracts audiences on its’ own.
One side addresses the fear of liberty loss by a change in the political economic order. Individual freedoms are in jeopardy and initiative is being taxed by growing government involvement in the nation’s life. The only salvation is to let market forces take their natural course. Their main point is change is coming and that’s bad. I’m reminded what President Kennedy said in his speech at Vanderbilt University “all things yield to change, except change itself.”
Just as simplistic is the other side of the argument. Originally, it appeared to be turning up the conversation but soon turned down to take advantage of the juxtaposition of the various agents vying to lead the choir of the oppositions’ song. Recent public display of this position has either enticed the dysfunction of the leader of the band, or simply recited the litany of prayers of the public scared of the lack of tomorrows promise and the angry against the most recent supposed villain architect of this tragedy.
What is missing is plan talk and an open explanation of how we arrived at our present situation and what can be expected in the near future? A conversation free from hyperbole and jingoist catch phrases intent only on rallying crowds of torch and pitch fork weaving loyalist but rather clear thought provoking prose and an openness to give equal weight to opposing beliefs because, truly, this is an argument for the hearts and minds of the country. This is what I intend to offer you.
The cause of the Great Recession was born out of the unbridled deregulation that was the touch stone of a generation. Free rain (yes, water falling from the sky) to act was first principal. Housing might have been the visible tip of the iceberg that hit our economy but our unwillingness to enforce existing regulations that required uniformity of lending best practices was the current that brought this lumbering threat to bear down upon us.
As far back as the 90’s the Congress had enacted rules that required nontraditional home mortgage lenders to act in a more responsible manner under the direction of the Federal Reserves authority. The inaction of Federal Reserve Chairman Greenspan to enforce more conservative lending practices under his authority to act was more an expression of his microeconomic belief system (attitude) towards regulation then the general attitude that the U.S. economy was unsinkable. Congress attempted to compel enforcement, but then House Speaker Delay block this initiative, and the housing industry continued on course at full speed.
The largest part of the housing iceberg was the new financial instruments created to improve the efficiency of capital markets. The success of these new instruments resulted in trillions in new capital to be lent with the promise of future income building up balance sheets with empty promises. Greatly was the promise of above average returns that investment blocks entered with leverage take over’s of corporations. Investment backers found rewards based on short-term profits not long term growth and were encouraged to engage in like behavior that increased leverage capital growth. These factors became a marriage of convenience
Mortgages and loans were conveniently provided. The original terms were of less importance then the belief that better terms were available, eventually. The immediate profit from the fees collected and the bundling and collateralizing of the mortgages, the added warranties sold with the bonds, fed the need to repeat the cycle to generate additional income. This story is well known and repeated as further justification to oppose any plan that rewords bad behavior. If the situation we currently find our economy in is the result of bad behavior or a belief in the promise of a way of life that is no longer in reach of every citizen, I have yet to determine.
The excess of the past years cannot be ignored simply because they are not the headline news. The action by Chairman Greenspan to reduce and keep interest rates low as a function of monetary policy and government involvement to stimulate and maintain the economy is no less intervention despite its’ percentage of GDP. The growth of private equity funds capable of moving capital across boarders in an instant and leaving a whole in domestic credit markets is good business when opportunities move from one country to another. The policy of investors leveraging the balance sheet of Mervyns Departments Stores to finance it’s take over and sale its retail property, only to lease it back at a higher cost, further reduced Mervyns profitability to cause its’ bankruptcy can be seen as extremely rewarding bad behavior if not good business.
The resulting unemployment, reduced consumer spending, and lost or foreclosed homes is only the first of many of the same that continue to be the story of the Great Recession.
End part one.
The tip of the iceberg is housing, but the base is financial innovation that built wealth on the promise of future earning. Traditional capitalist economics requires increasing demand that drives profits that allow for increased capital expenditures to provide greater capacity to meet increasing demand and help reduce inflationary pressures.
The profitability built into the housing market came from fees to brokers and the ability to then commoditize the loans. This provided additional fees to the brokers when the mortgages were converted into bonds further increasing the distant between the lender and the borrower. The source of the funds provided to lenders was also borrowed from investment funds looking for easy profits as U.S. interest rates were lowered to support the economy.
All this activity drew capital into the U.S. increasing the availability of cheap money. Lending spilled over into Alt-A and eventually the Sub-prime mortgage. Eventually, home equity and real estate speculation help to inflate real estate prices creating the now infamous “exuberance.” Unfortunately, the housing bubble had already taken off and brokerage firms were in over their head with long term Mortgage Back Securities and Credit Default Swaps.
Borrowing against future earnings now drove the growth in the economy. The consumer took the advantage of easy credit; the homeowners took the advantage of rising equity to supplement income; the investors further pushed up real estate prices by speculating on housing. Industry began to build retail stores in the newly built communities, borrowing against future revenue to support new stores when traditionally business expansion was paid with profits from past sales. Housing prices grow, standards of living grew, business growth caused job growth and the country prospered. Never was heard the cries of bad lending practices or over extended activities now commonly heard around neighborhoods.
Regulations did exist to require a closer relationship between leaders and borrowers, but cries of government bureaucracy and nanny state regulations were principals counter to those the nation had embraced since Reagan. (Or so we were lead to believe) Despite how loud the cries were of the pending crises, not enough of the country realized how they were personally invested in the problem. When the problem finally arrived in the retirement statements and home values did we begin to take a closer look at what we had allowed to occur as we stood on the sidelines safe in our belief of the promised dream.
The inflated value in the Stock Market by the abundance of liquidity began to leak out as cash began to leak out of the U.S. financial market. The first significant sign of this was when the presidents of Major U.S. financial firms were fired or removed. The one exception was the banks that stayed out of the mortgage market or business bank regulated out of the mortgage market. Still, little public attention was given to this event.
The leaders of business were experienced, and even today the cries of inexperienced elected officials trying to direct the business environment are criticized as interventionist. Blameless are the business leaders operating in an environment that gives their allegiance to micro economic principals of owner interest above public good. The effect on the macro economy where we live our private lives was devastating.
End part two.
The fall of the financial markets was due in large part to the withdrawal of cash from speculative markets to safer investment instruments. The short-term commercial paper that brokers sold to finance long-term speculation dried up as interest rates reset on variable mortgage and foreclosures rates rose. The compounded leverage on loans created trillions in paper wealth based on future earnings that depended on others ability to make payments. This house of card became the trillion dollar pyramid scheme that slowly began to fall from its lake of a solid economic foundation.
Federal Reserve Chairman Bernanke began to increase interest rates to slow growth in the U.S. economy. Unaware of the actions put in motion by Greenspan, variable rate mortgages already scheduled to reset, increased larger then expected. Home owners did not receive the increase in wages necessary to continue to make mortgage payments when the interest rates reset higher then expected with the increase in Feds fund rate. The increase in commodities prices, gas, and food further reduce the consumer spending starting the Great Recession in December of 07.
The economy began to slow down as consumer demand dropped and Christmas sales fail to meet expectations. Earning reports showed reduced future earning and short sellers headed for the door. The Dow industrial average began to fall as so did oil prices. By summer both had become harbingers of what lay ahead that we continued to ignore.
Private equity funds started the flow of cash out of the economy. As oil prices fall, investors understood that industrial demand for oil meant lowered output and lowered economic demand. Our service economy had reduced the percentage of the economy that was oil based delaying the impact on reduced domestic economic activity. These ice flows in our path were the danger signs that people began to notice floating on the service of our economy.
When the iceberg hit and we all looked for a life boat to get into discovered there was not enough for everyone in the economy. Those with third class tickets would once again be sacrificed.
End part three.
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AuthorChris Mathews quoted President Richard Nixon; “fight up, not down.” This inspired me to begin writing weekly rants on topics I’ve heard rolling around in my head. Archives
May 2012
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