Most of us who do not spend our spare time dawdling in the dismal science of macroeconomics and global financial markets have a hard time grasping exactly why a small percentage of high-risk mortgages in the USA could have triggered the current liquidity crisis on Wall Street. David Leonhardt, of the New York Times, has written a simple and clear primer on the subject. He does answer my questions which are why this has happened now and why it has never occurred before.
But the overwhelming majority of homeowners are doing just fine. So how is it that a mess concentrated in one part of the mortgage business — subprime loans — has frozen the credit markets, sent stock markets gyrating, caused the collapse of Bear Stearns, left the economy on the brink of the worst recession in a generation and forced the Federal Reserve to take its boldest action since the Depression?
I’m here to urge you not to feel sheepish. This may not be entirely comforting, but your confusion is shared by many people who are in the middle of the crisis.
Additionally, Dr. Tyler Cowen, George Mason University economist, tries to clarify things about alleged “Federal bailouts” and the misapplication of that label:
If you’re a critic of bailouts, you can’t have it both ways. If the Fed or Treasury is guaranteeing loans, yes that does put taxpayer dollars on the line. But if you think the system can hold up, as do most bailout critics, those guarantees are unlikely to cost very much. The Fed or Treasury may even turn a profit. If you think the system cannot hold up, the bailout is probably necessary even if costly. So you can’t claim: “The bailout isn’t needed” and also “The bailout will burden taxpayers.”
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I just cannot understand why someone who overspends on a purchase, or someone who loans money irresponsibly should get a bailout. I am sure that 99% of the people here spend within their means. I say let the people who can’t handle money, learn how to do it. So they lose their house. Let them get an apartment. Life is rough, but you have to live within the rules. I am tired of paying for others mistakes.
Two words, GREED & STUPIDITY.
bigmck…I agree and the bailout is not helping anyone. Spendthrifts need to know what it feels like to continue bad habits and if they are sincere in improving, only time will tell. Some people never learn.
I’m not financial, so a lot of this article was confusing. For some reason I cannot understand, it says the bailout will not be costly, or even make much of a blip in the big scheme of things. Or, as I often do, I misunderstood. Bear Stearns is gone. That’s significant. With it’s demise, won’t there be jobs lost due to a new company buying them and duplicate positions? I just get the peon feeling it’s a house of cards and the whole thing may tumble any minute.
Texpat, where’s the part about Congress in the 1990s breathing down the neck of lenders and threatening them with hearings and action because they didn’t make enough loans to poor people or minorities who couldn’t afford them? Congress seems to forget they are the ones who browbeat the lending industry into making these loans, and then the lending industry just found a way (they thought) to make some huge money quick which they hoped would cover any future losses.
I am what AW calls “financial” and I knew as soon as I heard of the easily obtainable, balloon-note mortgages they were offering folks, and pushing on TV and in the papers, that there was bound to be trouble ahead.
Everyone involved - the lenders, the borrowers, the builders, the real estate people - were counting on housing costs to continue rising in order to hedge their bets. They KNEW they were basically betting on a bull market. How they now can basically deny knowing the risk involved is what irks me. I think the big guys involved (the banks and brokerage houses) figured on the Fed bailing them out if the housing market turned and the little people, the individual “homeowners who had taken out a wishful-thinking mortgages” like some of my friends and relatives, felt a false sense of safety in betting on a bull market, largely because they took their cue from the big guys, who the borrower’s assumed (wrongly) would know better than to offer loans with too high a risk of being defaulted on.
In other words, the whole thing was a giant screw-up, driven by greed and and an unrealistic notion that real estate prices always go up. And now that the screw-up has resulted in such a meltdown in so many other areas of the financial markets, both here and abroad, unless the Feds step-in to slow the foreclosures, the wound this debacle has caused will continue to bleed onto other areas of credit - as it is now doing - and cause a negative ripple effect on our entire economy.
So, as much as I hate bailing anybody out of a situation they caused themselves through greed and ignorance, I don’t want to see our entire economy suffer needlessly for their mistake. There is always the spiralling whirlpool effect to consider, namely, when a large chunk of the economy starts spinning downward it tends to pull down other, nominally related areas as well. Thats what the writer of this article is talking about when he says,
I just hope the Feds can turn around this mess and then make some much needed changes in the rules about leveraged debt (basically betting money you don’t have) and the ridiculously complex insurance policies on the mortgage debt that the banks were issuing on loans that they made that they should have known not to make in the first place!
BTW, I don’t see where the writer of the analysis claims that the bail-out won’t be costly. He says that it will likely be LESS costly, over the long-term the broader economy, if we bail-out the lenders. It’s gonna cost all of us tax-payers, directly and indirectly, no matter what happens believe me. It is indeed a “house of cards”, AW!
Try this article on breaking this mess down to simple terms.
Mr Williams has a really great knack for speaking on a complex subject and un-mudding the waters.
http://www.townhall.com/columnists/WalterEWilliams/2008/01/23/subprime_bailout
#6 - I’m not a financial genius by any stretch, but even I know that you don’t buy more house than you can afford. IF a bank paints a rosy picture for me and tries to talk me into a subprime ARM, I am going to automatically assume that the rate will go up. Period. So while there’s plenty of blame to go around for this, the greed of the homeowners getting into more house than they can afford is a big factor.
So if I understand all of you right, Congress bares no blame in telling the mortgage industry that they better come up with a way to make these loans?
#6 thank you so much shiner blonde, you helped a lot.
#9 Big45, they are all guilty. IMHO, the person who creates the loan is the most guilty. Even if congress places pressure, can’t the lending institutions explain how dangerous it is and simply say NO?
#7 Ford, great article, thanks
#6 Shiner Blonde
I agree with many of your points, but disagree with the assumption Wall Street players didn’t care because Uncle Sam would just bail them out. The feds applied alot of pressure to see the JP Morgan buyout of Bear Stearns go through. Pension funds, profit sharing, stock values all were destroyed. The former CEO and largest stockholder saw his 1.1 billion dollar BS stock go to 14 million bucks. Mailroom guys lost 20, 30, 50K and worse. The upper level execs who have anything left will spend it all on legal fees once the feds move in and start hurling subpoenas and warrants around. Nobody takes a risk thinking the feds getting involved is a good idea.
#9 Big45Iron
You are right about congressional interference in mortgage lending practices, but the Clinton era regs have just become standard operating procedure now.
#7 fordf350 (i paid $128 to fill mine up last night)
One of the economics blogs I enjoy is written by Don Boudreaux and called Cafe Hayek. He writes plainly for the general public about economics and how it relates to everything on earth. The best thing I can say is he is Walter Williams’ BOSS.
Here are two posts he wrote that are good:
http://cafehayek.typepad.com/hayek/2008/01/i-worry-much-le.html
Read about the widespread and rampant fraud on loan apps over the last 10 years by home buyers:
http://cafehayek.typepad.com/hayek/2008/01/tylers-latest-i.html
The US economy is only a house of cards if a majority of the people in this world believe that it is. Confidence and long term optimism are categorically required for the survival and continued success of any financial market and economy. You constantly hear the words “confidence” and “stability” used by everyone from the Fed Chair to Secretary of the Treasury. Consumer confidence is regularly measured, as is the confidence of CEOs and financial managers.
Our economy is generally stronger and more resilient than what most people on Main Street believe, but the collective confidence of all involved is critical for the markets to function. The irrational thinking and choices people make are based on fear of losing, fear of losing money and fear of losing a job in the financial sector. The 14 trillion dollar US economy doesn’t just exist in the imaginations of economists and investment bankers, it is very real and tangible.
#13 - You pretty well nailed it down - the whole system rests on public confidence. That’s why the regulators are so quick to remove an ailing institution from the rest of the body - to shore up that confidence. With the Bear, it looks to me like those who should have lost money did (and quite a bit); those who should not have lost money did not; and there can now be an order liquidation of the inferior quality assets of the company rather than a fire sale.
I blame the Dimwits who insisted that everyone have affordable housing, even if they didn’t qualify. That’s where subprime came in and helped create this mess. But this is a typical “big government” step in and help, don’t worry you screwed up, we will help you out!!!!!
Big Iron and Robertm are right. It’s also Congresses fault for spending so much. Surely the Dollar and Oil would swap places if we thay had been more resposible.
some call it vote farming….the IRS now offers ITINs for illegals so they don’t have use phony SS numbers….that way they can legally qualify for the stimulus package. Who are you gonna vote for?
#17 Where is ” ghostbusters” when we need em?
#17 - that is so wrong for ILLEGAL aliens to get any part of the tax stimulus package. Shame on the IRS and Congress!
#17 & #19 / Stimulus Bill Checks for Illegal Aliens
Unless something changed, Congress amended and corrected that oversight in the Stimulus Bill once it was pointed out to them. There was a specific clause inserted to prohibit illegal aliens from receiving checks. If anyone has evidence to the contrary, I would like to see it.
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this process will spiral out of control. it has just started. we still have to repo the homes of the recently laid off folks. the laid off folks will also probably lose their second cars as those are financed after they renege on their credit cards.
then you have the commercial real estate market that will collapse after all of this takes place.
ya know i once remember a guy who put in price controls and just how good did that work?
i might add this problem is similar to what happened in the depression of 1929.
that is people back then were buying stocks on margin with no rules and financing the equity they had to begin with. when the market dropped they could not meet their margin calls and the securities were worth less than his equity the person had in them. so who paid? who is going to pay for this fiasco? they did this mortgage thing with almost no equity just like 1929. well that was a really bad one as i suspect this will be. that is the similarity to 1929 and a great percentage of the money back then was in t he market. today we have 401k’s ira of many types and so on, so is there a similarity? how much money is involved in this mortgage mess - no one can answer that - amazing!
be careful buying the dips for you stock players this will take a couple of years to play out.
here is an article with a couple of guesses on the mortgage crisis.
http://apnews.excite.com/article/20080323/D8VJAKKG0.html
The message in Church on Sunday was one of hope. I’m going to hold to that, and live my life with that hope.
I will keep hoping that we will all be okay. I live within my means and put some away for when things get rocky. That’s all I can do. I can only hope and pray that it will all be okay.
For some good info on the history of the banking industry in U.S., you can search on wikipedia for Glass-Stegall Act, and Gramm-Leach-Bliley bill, and then click on link of PBS,near bottom of page. It gives a really good history of how things progressed/digressed. Glass-Stegall was put into place during Great Depression to keep banks from engaging in risky ventures that threaten depositors’ money. Over the years,lobbyists hammered away successfully at Congress, culminating in the republican-sponsored & supported Gramm-Leach-Bliley bill.What a shocking wakeup,to realize that the party I used to believe in for being more careful & more honest, seems to have sold out to the big money guys, big time. So,we have Congress to blame, in big part,for kissing up to the big money. Gramm also enabled Enron,with a helpful bill. Time for a huge house-cleaning in gov’t, with honesty(is it possible?)& integrity as priority in candidates,rather than voting party line.Off with labels, focus on honesty,integrity,& representing the PEOPLE,not the big corporate guys.Ron Paul stands out,even if one is not totally aligned with all his views.