Glawe: Government is not only one to blame for ‘Great Recession’
Businessman discussing paperwork with couple. Through the nationwide recession, people often blame the government, but there is more to the story than that.
February 13, 2012
A recent column written by fellow
columnist Barry Snell in response to a Monday column written by
myself reintroduced many vital occurrences that contributed to the
2008 market collapse. Although, I feel that his article did not
place enough emphasis on this great concavity. The recession was
caused by numerous factors, and it would be foolish to place the
blame simply upon low-income loan recipients. There are simply too
many misconceptions about the recession, and, I suppose, it should
be my duty to expound upon the complexities.
Let us begin with the Community
Reinvestment Act of 1977, which sought to require “that each
depository institutions’ record, in helping meet the credit needs
of its entire community, be evaluated periodically.” There is a
tendency to believe that this was government enforcement upon
banks, requiring them to dole out subprime mortgages to high-risk
borrowers. Contrary to that belief, the act, as stated by the Board
of Governors of the Federal Reserve, did not “require institutions
to make high-risk loans that jeopardize their safety.” It was
merely to prevent communal discrimination through a loan practice
known as “red-lining.” Red-lining occurs when banks either deny
mortgages or boost interest rates against specified low-income
neighborhoods.
Banks were not required to make
high-risk loans. In fact, in 1995, after strengthening the act,
President Bill Clinton’s Secretary of the Treasury Lloyd Bentsen
said, “The only thing that ought to matter on a loan application is
whether or not you can pay it back, not where you live.”
If the banks were handing out toxic
loans, why were low-income borrowers accepting them? The answer is
predatory lending and diminishing mortgage-underwriting standards.
Predatory lending occurs when lenders attempt to entice borrowers
by offering very low interest rates for home refinancing. The loans
were given, such as in Countrywide Financial’s standards, with
extensive paperwork. Borrowers were encouraged by lenders to sign
the paperwork because their income-level would satisfy the mortgage
payments, which were around 1 to 1.5 percent interest. The
borrowers did not have the money or the time to sort through the
paper work, and with the bank’s reassurance, signed.
The banks were quite clever,
however, and issued the loan on an adjustable rate. This created
negative amortization, which isn’t usually noticed by the credit
consumer for a very long time. In addition, in the midst of the
Financial Crisis Inquiry Commission, Richard M. Bowen, CitiBank’s
chief underwriter correspondent, testified that approximately 60
percent of mortgages purchased by CitiBank were defective. This is
indicative of the diminishing mortgage-underwriting standards at
the time. In fact, the FBI’s annual mortgage fraud tally indicated
that fraud filings from financial institutions had risen 36 percent
in 2008 alone.
Why were banks giving out such toxic
loans? The answer is: “The Securitization Food Chain.” Through
innovative financing techniques in the 2000s, banks bundled
mortgages together and sold them to investment banks, therefore
dropping their own exposure to risk. The investment banks took the
mortgages and combined them with many other loans, such as car
loans, student loans, etc. This bundle of mortgages and other loans
were then sold to investors in the form of Collateralized Debt
Obligations.
When homeowners paid their
mortgages, it went straight through the chain to investors. The
securitized derivatives, CDOs, transferred credit risk from one
entity to another. Why would investors buy the toxic loans? The
investment banks paid rating agencies, such as Standard &
Poor’s, to analyze and rate the CDO’s. It is by lucrative
serendipity, or perhaps sheer stupidity, that the toxic loans
should be rated AAA, the highest investment rating. This enticed
investors, especially ones managing retirement funds. Investment
banks’ CEO’s and rating agents received huge incentives and bonuses
for creating such profit. They knew the loans were toxic, but in
the short-term, the high incentives were difficult to
ignore.
The economy was set for failure.
Banks made a record amount of loans because they no longer had to
deal with the risk of defective mortgages. The Organization for
Economic Cooperation and Development performed a study, which found
that government regulations led to banks finding circumventions,
encouraging the use of financial instruments such as derivatives.
The conclusion of OECD’s study stated, “Refocusing banks’ attention
toward their main economic functions is a core requirement for
durable financial stability and sustainable economic
growth.”
Based on this overwhelming evidence,
which only scrapes the surface, how could we not say that greed
created the “Great Recession”? Profit motivation and huge bonuses
were fueled by greed. As the consumers, we were thus consumed by
the obsessive behaviors emanating from a character of selfishness.
Vices and virtues formulate character. When this character impinges
upon the rights of other citizens, the government must intervene.
While the constitution does not permit government to define virtue
from vice, it is our duty as a citizenship to prevent the results
of these behaviors. We cannot stop greed and its presence in all of
us, but we can regulate the results in accordance with the
protection of our indelible rights.
Everybody wanted a slice of the pie.
Only the clever ones would dine.