Practically every day someone on twitter tries to convince me that evil “Big Business”, “Wall Street”, “capitalism” or “bankers” caused the financial meltdown Obama “inherited”. I’m told that if I support any of these things, I, myself, must be evil, selfish, stupid, and some other things I can’t put into print. I try to school them in the facts of what caused the current situation, but it’s hard to do Economics 101 in 140 characters. For those who want a detailed explanation of what caused the financial meltdown, I recommend you read, “Reckless Endangerment” by New York Times financial analyst Gretchen Morgenson. For those who don’t have the time or patience, I’ll try to give you the layman’s version.
What caused the financial meltdown was government interference (as is so often the case) in the free market. It’s true, the meltdown was caused by the housing bubble and the derivatives market, but the banks and Wall Street were only reacting to government interference.
In 1977, President Jimmy Carter signed into law the Community Reinvestment Act http://www.occ.gov/topics/compliance-bsa/cra/index-cra.html. Isn’t that a nice title? Most leftist policies have nice titles. This particular bill opened the housing market to people who didn’t have the credit-worthiness to buy a home. How compassionate, right? Giving access to the American Dream of owning your own home to people who couldn’t afford it. When Clinton came into office, he doubled down on how many sub-prime loans the banks had to make. As with everything, there is a cause and effect. The cause was the Community Reinvestment Act. What was the effect?
Over time, the Community Reinvestment Act increased the number of people buying houses, which, in turn, increased the prices of houses. As you know, if there are more sellers than buyers, prices go down, but if there are more buyers than sellers, prices go up. Because of these new buyers, prices for houses increased way beyond their actual value, which caused a housing bubble.
Traditionally, banks made a practice of loaning money to people who have demonstrated the ability to pay it back. The Community Reinvestment Act told banks that if they wanted their home loans to still be insured by Fannie and Freddie (which insure 80% of all mortgages), a certain percentage of their loans had to be sub-prime. People who know they would never pass a credit check normally don’t flock into banks to apply for a mortgage. Banks had to recruit low-income families for these sub-prime loans (which is how these people came to blame the banks for their woes). Enter ACORN. ACORN opened storefront offices to show low-income families how to get these sub-prime loans.
As the number of sub-prime loans grew, banks did what responsible businesses, who have shareholders they have to answer to, do. They found a way to minimize their possible losses. They bundled some of these sub-prime loans with good loans and sold the bundles on the derivatives market. This is the factor that allows anti-capitalists to blame Wall Street. Those evil, greedy investment bankers, hiding bad loans among good ones, and selling the whole kit and caboodle under a triple A rating! But, wait, it was the SEC, whose job it is to rate such things, that rated them triple A. Why? The SEC knew, as well as the banks, that the sub-prime loans were buried in the bundles. They knew that sub-prime loans were causing the housing bubble. And they know that all bubbles eventually burst. So, why did they give the loan bundles a triple A rating? The SEC is a government agency. Good luck getting an answer!
The Community Reinvestment Act wasn’t the banks’ idea, it was government’s idea. And, as the disastrous effects of the CRA multiplied, many Republicans became concerned. They held congressional hearings. Leftist congressmen fought back, hard. They insisted there was nothing to be concerned about. They condemned the Republicans for wanting to deny low-income families the ability to own their own home. Barney Frank told everyone the sub-prime market was solid….. Nothing to see here, move along.
Of course, the very people whom the Community Reinvestment Act was supposed to help were the ones hurt the most when the housing bubble finally burst. They were the first to lose their homes. The sub-prime loans allowed for interest-only payments (which made the payments deceptively small) for a certain number of years. Then the homeowners either had to pay a big balloon payment, have their payments increased, or refinance their mortgage. They believed (because that’s what they had been told) that their homes would increase in value, so that in five years they could refinance and get the same level of payment. When their homes lost value, they owed more than their homes were worth, and couldn’t refinance. As usual, a leftist policy meant to help people hurt the very people it was supposed to help (just like minimum wage!)
At the same time, those bundles of mortgages being sold as triple-A crashed the banking industry. They were now holding worthless bundles. Just finding out who owned whose mortgage became a nearly impossible task. This is what caused Rick Santelli to have his famous rant and call for a Tea Party.
People need to understand it isn’t capitalism, big business, or Wall Street that are the problem, it’s big government and its incessant meddling.