Who Is Responsible for the Financial Crisis?

In the home stretch of the presidential election, sound bites are flying as to who is to blame for the USA's current financial train wreck. Newsweek has a good article that looks at the various arguments and also relies on information from factcheck.org. Personally, I have maintained for over a year that the failure to regain stability in the housing/mortgage market was going to lead to a disaster. Here are some highlights that look at some of the true contributing factors of how things got so screwed up (only by recognizing the real cause - and that lack of regulatory oversight WAS a big factor - can a real solution be achieved.):

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As The Economist magazine noted recently, the problem is one of "layered irresponsibility ... with hard-working homeowners and billionaire villains each playing a role." Here's a partial list of those alleged to be at fault:

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The Federal Reserve, which slashed interest rates after the dot-com bubble burst, making credit cheap.

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Home buyers, who took advantage of easy credit to bid up the prices of homes excessively.

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Congress, which continues to support a mortgage tax deduction that gives consumers a tax incentive to buy more expensive houses.

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Real estate agents, most of whom work for the sellers rather than the buyers and who earned higher commissions from selling more expensive homes.

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The Clinton administration, which pushed for less stringent credit and down payment requirements for working- and middle-class families.

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Mortgage brokers, who offered less-credit-worthy home buyers subprime, adjustable rate loans with low initial payments, but exploding interest rates.

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Former Federal Reserve chairman Alan Greenspan, who in 2004, near the peak of the housing bubble, encouraged Americans to take out adjustable rate mortgages.

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Wall Street firms, who paid too little attention to the quality of the risky loans that they bundled into Mortgage Backed Securities (MBS), and issued bonds using those securities as collateral.

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The Bush administration, which failed to provide needed government oversight of the increasingly dicey mortgage-backed securities market.

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An obscure accounting rule called mark-to-market, which can have the paradoxical result of making assets be worth less on paper than they are in reality during times of panic.

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Collective delusion, or a belief on the part of all parties that home prices would keep rising forever, no matter how high or how fast they had already gone up.

Barclays Sues Bear Syerns Over Sub-Prime Losses - Federal Reserve Might Have Prevented the Mess

It will be interesting to watch and see whether other investors - especially non-US investors - decide to sue the Wall Street firms that packaged and sold these mortgage investment vehicles that have turned toxic for the buyers. Barclays is but one of many foreign investors that purchased these investments and have ended up losing huge sums of money. Among other things, Bear Sterns is accused of fraud and deception. I have no sympathy for lenders and others who recklessly made these dangerous loans and then sold to third parties. Also at fault for this fiasco is the Federal Reserve and the Comptroller of the Currency which had authority to regulate such loan operations and basically did nothing as described in the New York Times piece quoted below. . The perpetrators made out like bandits. Now everyone is suffering directly or indirectly. This story from The Guardian (http://www.guardian.co.uk/business/2007/dec/20/barclaysbusiness.subprimecrisis) describes the lawsuit filed by Barclays. Here are some highlights:

Barclays' exposure to America's sub-prime mortgage fiasco took a dramatic turn last night as the bank sued the Wall Street firm Bear Stearns for fraud and deception over the loss of hundreds of millions of dollars in an ill-fated hedge fund. In a lawsuit filed in New York, Barclays accused Bear Stearns of systematically hiding losses in a fund which swallowed $400m (£200m) of the British bank's money. The fund had to be bailed out in June after reaching the brink of collapse following a disastrous series of investments in mortgage-backed securities.

Barclays described the fund's demise as "one of the most high profile and shocking hedge fund failures in the last decade". The suit alleges that up to the last days before the bail-out, Bear Stearns executives engaged in a cover-up to hide the slump in its value. In addition to Bear Stearns, the suit targets the Wall Street firm's senior managing director for asset management, Matthew Tannin. A third defendant, fund manager, Ralph Cioffi, is already under investigation by US federal prosecutors for withdrawing his own money from the hedge fund while assuring investors not to worry.

"The defendants entered intentionally into a relationship in which Barclays placed trust and confidence in them," the suit says. It describes Bear Stearns' conduct as "wilful, malicious, reckless and without regard to Barclays' rights and interests". According to Barclays, Bear Stearns frequently diverged from agreed guidelines on the type of investments to be made by the fund. Between 75% and 100% of the fund's portfolio was supposed to go into assets with top-notch credit ratings of between AAA and AA minus.

The suit says Bear Stearns and Cioffi "hatched a plan to make more money for themselves" by creating an unauthorised new investment vehicle which they planned to float. Barclays details a series of lunch meetings in New York at which its staff were assured that the fund was going well. But it says detailed updates of performance tended to be provided late and incomplete. Throughout the spring of 2007, it says, Tannin repeatedly used the word "great" to describe progress.

Criminal prosecutors are examining whether Cioffi, who managed the fund, improperly withdrew $2m of his own money while providing bullish updates to clients about the fund's performance - a move characterised as a hedge fund manager "hedging himself". Cioffi recently left the firm, although Bear Stearns has not disclosed the circumstances of his departure.

Here are quotes from the New York Times editorial from yesterday (http://www.nytimes.com/2007/12/19/opinion/19wed1.html?_r=1&hp&oref=slogin):

An article in The Times on Tuesday by Edmund L. Andrews leaves no doubt that the twin crises of the subprime lending mess — mass foreclosures at one end of the economic scale and a credit squeeze afflicting the financial system — are rooted in the willful failure of federal regulators to heed numerous warnings.

The Federal Reserve is especially blameworthy. Starting as early as 2000, former Fed Chairman Alan Greenspan brushed aside warnings from another Fed governor, Edward M. Gramlich, about subprime lenders who were luring borrowers into risky loans. Mr. Greenspan’s insistence, to this day, that the Fed did not have the power to rein in such lending is nonsense.

In 1994, Congress passed a law requiring the Fed to regulate all mortgage lending. The language is crystal clear: the Fed “by regulation or order, shall prohibit acts or practices in connection with A) mortgage loans that the board finds to be unfair, deceptive, or designed to evade the provisions of this section; and B) refinancing of mortgage loans that the board finds to be associated with abusive lending practices, or that are otherwise not in the interest of the borrower.”

Yet, the Fed did nothing as junk lending proliferated — including loans that were unsustainable unless house prices rose in perpetuity, riddled with hidden fees and made to borrowers who could not repay. When all the truth is out, the Fed will have company in the hall of shame. The Office of the Comptroller of the Currency, for example, blocked states from investigating local affiliates of national banks for abusive lending.

If the regulators had done their jobs, there might have been no lending boom and no extraordinary riches for the lenders and investors who profited from unfettered subprime lending. Neither would there be mass foreclosures, a credit crunch and a looming recession.

Loan Crisis Spreading to Businesses and Neighbors

Not surprisingly, the housing market free fall and sub prime mortgage mess are beginning to spill over into other areas and are hurting business as reported in this New York Times story (http://www.nytimes.com/2007/12/17/nyregion/17citywide.html?_r=1&adxnnl=1&oref=slogin&adxnnlx=1197903981-0a+Ly0iuYSOn3EyPS6RuZw). The Chimperator's "too little too late" remedy package does not contemplate what the ripple effect of this problem will be, not that I am surprised since the Chimperator lives in a bubble of delusion. The story also focuses on Wall Street's role in creating the mess. It will be a grim Christmas season for many while the rich are insulated from the damage. Here are some story highlights:

Marcia is not in the holiday mood this year. She is not putting any Santas, reindeer or lights outside her house. She is probably not going to have many presents inside. There will be no home improvements anywhere. The fact is, she does not know how long she can even call the place hers. These guys made millions in bonuses, so they go off and buy Rolexes or real estate while people are being put out on the street,” said Mr. Mumm, who is the executive director of the Northwest Bronx Community and Clergy Coalition. “Now the homeowners are asking for their money back. This is about reparations.”

A little more than a year since she bought her Bronx home for $535,000 with no cash down, she is facing foreclosure. Even if she could scrape together the $7,500 to catch up on her overdue mortgage payments, other calamities await: an interest rate that will rise in coming months and a huge balloon payment hovering in the distance like a financial Hindenburg. “I’m not doing anything to fix up the house,” said Marcia, a nursing home aide who declined to give her last name during an interview at a community agency that offers counseling on preventing foreclosure. “I just work, eat, sleep and hope they don’t take my home. This is the worst Christmas I ever had.”

The binge of subprime loans that flooded this area a few years ago has now given way to foreclosures and forced sales by homeowners saddled with onerous mortgages they could never repay. The effects of this free-for-all are increasingly felt even among those who did not take on risky loans. Longtime neighborhood residents worry that their property values will be sunk by the double whammy of poorly maintained homes and revolving-door neighbors, while shopkeepers on the nearby commercial strip on Boston Road — especially those who sell hardware or home furnishings — say business has plummeted by 50 percent or more, as strapped homeowners cut costs.

Other housing advocates asking the same questions have begun to look toward Wall Street for part of the answer. They note how investment banks made tidy profits and bonuses in recent years by scooping up batches of subprime loans to back lucrative securities. “They were telling lenders what kinds of loans to make,” said Kevin Connor, the author of a recent report on Wall Street’s role in the subprime crisis, sponsored by a coalition of housing advocacy groups. “They built this house of cards on the backs of homeowners.”

Despite the losses taken by investments banks in recent months, housing advocates say that banking executives will still get their bonuses this year, and even chief executives who lost their jobs because of the mortgage losses walked away with multimillion-dollar severance packages. “These guys made millions in bonuses, so they go off and buy Rolexes or real estate while people are being put out on the street,” said Mr. Mumm, who is the executive director of the Northwest Bronx Community and Clergy Coalition.

Buffett: Subprime Woes May Linger for Up to 2 Years

I guess I am not the only one who believes that the U.S. economic woes will be ongoing for some time. Naturally, I'd love to be wrong, but Warren Buffett seems to have the same pesimistic view (http://www.cnbc.com/id/21464380):

American billionaire investor Warren Buffett said Thursday he remains negative on prospects for the U.S. dollar and that problems in the U.S. subprime mortgage sector may continue to cause problems for some time. Buffett said he is still "negative on the dollar relative to most major currencies." He said subprime problems could weigh on consumers for anywhere from another six months to two years. He made the comments during a press conference during his first visit to South Korea.

Personally, I suspect we are looking at a year or more before the housing melt down begins to subside.