Friday, January 30, 2009

What Went Wrong With Our Economy?

More bad news today. The U.S. economy in the fourth quarter of 2008 shrunk by 3.8%. Although economists feared the decline might be even worse, it's still the sharpest quarterly plunge since the 6.4% dive in the first quarter of 1982.

So what's the problem? Everyone knows that the poor economy has something to do with the "housing bubble" and the "credit crunch." But where did these problems come from? There are lots of popular villains to choose from, be it President Bush, capitalism, Wall Street fat cats, or just plain greed. But the simplistic answers, in this case, are not the right answers. There are several factors which contributed to the meltdown of 2008.

In the book, A World of Wealth: How Capitalism Turns Profits into Progress (FT Press 2008), Thomas Donlan suggests several reasons for the housing bubble and ensuing credit crunch. The book as a whole is uneven and awkwardly written at times, but Donlan's list of "candidates for blame" is extremely helpful.

1. Allan Greenspan. He led the Fed to lower interest rates far below normal and supplied credit to almost anyone. The result: people were borrowing at alarming rates.

2. George W. Bush. The President and the Republicans in Congress did not reign in spending.

3. Bill Clinton. His administration's legislation and regulation made borrowing and lending easier and easier.

4. William R. Fair and Earl J. Isaac. They started a credit analysis company called Fair Isaac which is used in three out of four U.S. mortgages. Fair Isaac's "objective analytics turned credit decision making from a character judgment into a commodity." Now hundreds of loans with the same credit score could be packaged together and sold to another buyer.

5. Wall Street Invesment Bankers. Bankers packaged thousands of mortgages into "collateralized mortgage obligations" (CMOs). Investors and speculators started buying up the CMOs, with the promise of high returns. Investors didn't analyze these bundles on their own. So when bankers started slipping in more and more risky mortgages (people with low credit scores, shady loans, houses appraised too high, etc.), investors didn't take the time to figure out they were purchasing damaged goods. But as along as investors kept buying up the bundles, people kept getting loans and housing prices kept going up.

6. Rating Agencies. These are the agencies, like Standard and Poor's, that rated the CMOs. They also believed the hype and gave the securities higher ratings than they deserved. Plus, those issuing the CMOs pay the rating agencies to rate their products. So the rating agencies have an interest in giving good ratings, so as not to bite the hand that feeds them.

7. Investors. Even though the CMOs were producing a relatively small yield on average, investors were still dreaming of high rewards. They ignored the increasing risks and kept investing anyway. That's where the bubble came from--too much money going too fast into something that is not producing a strong return (like the dot com bubble in the 90s where investors were pouring millions into companies that had yet to make a profit).

8. Predatory Lenders. Some lenders wrote mortgages just because they could. They collected the fees (from people who didn't need to refinance or couldn't afford the loan) and sold the mortgage to a hungry market. Some lenders also started selling unhelpful products that put people into loans they could pay in the very short term (because of subprime interest rates), but had no way of paying in a few years once the rates automatically went up.

9. Predatory Appraisers. Lenders need appraisers to assign a high value to a home. Appraisers need the work that the lenders bring their way. The two groups were often happy to help each other out in ways that hurt the consumer. Houses got appraised far too high. As long as prices went up, people bought and sold houses, sometimes buying them just to "flip" them for a profit. Meanwhile builders were building at a record rate, figuring that they could sell their houses at the inflated prices. Eventually reality caught up with prices and the bubble burst.

10. Predatory Borrowers. The fault was not all with the bad guys in corporate America. Many borrowers lied on their loan applications. They lied about income, about assets, about employment, about credit history, about their intentions to live in the house. "As many as 70 percent of mortgages that defaulted in the first year turned out to have false information on the original loan appplication."

The mess we're in, as the list makes clear, is complicated. It's not the fault of any one person or any one orginaztion. It's the product of sinful motives and sinful actions as well as honest mistakes and unintended consequences. These things happen and they don't allow for simplistic explanations. Or, for that matter, simplistic solutions. Beware the silver bullet. And beware the love of money.


George said...

Do not overlook the influence of ACORN Housing Corporation (AHP) in this matter, either. They became a major news item in the Midwest during the pre-election months of 2008 for voting fraud, but their real mission was "forcing" lenders to make risky loans to borrowers who would be unable to qualify under normal circumstances. News broadcasting panel interviews with various Midwestern lending institutions around that time indicated that rural bankers were having few credit problems whereas those in urban areas were struggling. This condition was the direct result of pressure in the way of threatened anti-discriminatory lawsuits by ACORN if the lenders refused loans to poor risk clients.

Now that the bubble has burst, so to speak, we hear nothing of ACORN and its deeds in this matter, another way the media has of pushing things they champion out of the limelight when they turn sour.


Murf said...

Not sure I would put to much blame on ACORN. At the end of the day Wall Street is about making money, and they are not going to proceed with an operation that appears to be a money loser, so no one is going to "force them" to make money losing loans. The reason they were happy to lend was that they sold off all the bad loans to unwitting investors so it was win/win for them.

The economy contracted at a 3.8% annual rate in the fourth quarter, not 3.8% FOR the quarter.

Philip said...

The ACORN action above was made possible by something called the Community Reinvestment Act. Thanks, Jimmy Carter!

Arthur Sido said...

Murf, part of the modus operandi of ACORN and other community organizaing groups is extorting corporations. It is far easier and cheaper for a bank to make some bad loans and sell them off than to face a boycott. Bad press is expensive.

SPQR said...

Hi Pastor Kevin,

Let us not forget the spiritual roots of this crisis, which merely has manifested itself in the economy (not just US, global) and potential social unrest.

"Do not love the world or anything of the world. If anyone loves the world, the love of the Father is not in him. For everything in the world - the lust of the eyes, the craving of sinful flesh, and the pride of life - comes not from the Father but from the world" 1 John 2:15-16

As one working in the financial markets (including managing a fund involved in global financial companies), here are my 3 takes on the practical visible sources of the mess we are in:
(1) the lust of consumers ("Gotta have it now" - our ratios of debt to income, not only in the US unfortunately - inflated bubbles not just in home prices but in plasma tv's and autos)
(2) the greed of bankers (Why are the banks in such a mess? What used to be called "top rated" could actually be a "top rated" IOU on the Brooklyn Bridge, otherwise known as a CDO or structured bond investment, on subprime mortgages made to people earning less than $30,000 yet buying homes for $500,000 and up.)
(3) the excess of politicians (Think of why not once have you seen your property taxes come down - the politicians can brag about all the expanding services in your neighborhood because "real estate never goes down". Where was the proper regulation that prevented Biff the mortgage broker from getting his client to buy a house where he was well over his head in the first place?)

Sorry for the long ramble, but we need to put aside the politics and get down to the heart of the matter.

I am all for capitalism, but I am a Christian first. God allows us to enjoy material blessings to the extent He has blessed us with income. However, it is not for us to lavish it solely on our creature comforts, let alone to spend beyond what we earn.

BTW it is great to see your blog. Also, your book "Why We Are Not Emergent" is very well done. Our church is involved in a project to gently and truthfully examine the emergent movement in our area. Your book was very helpful in terms of analysis as well as firsthand quotes.


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