The recent reluctance on a debt deal in the senate by the democrats have caused some serious issues with me thus far. The democrats will not sign any deficit plan without a proper discussion and inclusion of additional tax revenues, tax revenues meaning raising taxes for everyone. Considering they are labeled the party for the people, I think it is needed to do a little recap of how this mess started. This story will show how contradictory and irresponsible some democrat politicians really act.
Everyone should own a home. At the end of that sentence there should be an addition of “in a utopian society.” Regardless, this was an initiative of the Clinton administration. Bill Clinton and other powerful democrats at the time put in work to get this initiative done. They are all smart people and they understood that under the current banking system this wouldn’t be possible.
The banking system prior to that time was not perfect but it was functional. Pretty much banks would write mortgages on a fixed or variable interest rate for creditworthy individuals with a down payment of at least 20% of the price of the home. If this was a variable rate it would probably remain stable for a couple years, then the rate would fluctuate based on market rates. If this was a fixed rate the interest rate would remain constant. Now after these mortgages were written, chances were the banks would sell these mortgages for a small markup (under 5%) of the present value of the loan. Now this seems strange for a bank to do, but it is a common practice. The banks do this to free up their books to be able to write more loans, therefore keeping the credit markets flowing.
Throughout the years this has been a common practice for Wall Street to purchase these loans, package them up, and sell them as individual securities known as mortgage backed securities. These securities accounted for a small probability that some of the underlying assets might default, but it was priced in the security. As mentioned earlier, this was a necessity to keep the credit markets flowing. I guess the question arises, who would buy these MBS’s (Mortgage Backed Securities); Insurance companies, other banks, hedge funds, public sector pensions, private sector pensions, mutual funds, and personal investments. Long story short MBS’s were everywhere, which was not a problem because they were backed by solid assets with mortgage participants with satisfactory credit.
This was the practice of good business, the type of business that most people don’t know about. The type of business that is fine without government interference. The type of business that if tweaked in the wrong way, could lead to a catastrophic result. This leads me to “the everyone should own a home” initiative put forth by the democrats.
Now, as mentioned the current way in which MBS’s were bought and sold was effective and necessary for the credit markets to operate efficiently. The democrats knew this and they thought to themselves, how do we include more people in this process? Clarification: How do we allow people who can’t afford homes, because of a low income and bad credit rating to buy homes? They knew that Wall Street firms would not purchase these risky investments, because they wouldn’t be marketable to the above list of investors in the MBS market. Because of this, two “private” sector entities were created, Fannie Mae & Freddie Mac. These two companies are considered government sponsored entities. From a PR aspect these two entities were created to add more flow into the credit markets, they would assist Wall Street in the creation of MBS’s because that was there specialty. Mortgages were what they specialized in. The truth of the matter is that these GSE’s (government sponsored entities) were created for the sole purpose of advancing “the everyone should own a home” initiative. They were used as a dump, a dump for subprime mortgages. The democrats and analysts knew that if they could find a way to filter all of the bad mortgages to these GSE’s, then they could advance the initiative. Banks made the loans, because they knew Fannie and Freddie would purchase them. It’s that simple. Banks are only as powerful as they are allowed to be, and when there is a market for a loan then they are going to sell. Capitalism at it’s finest.
The lending standards for these subprime mortgages started innocent enough. People with low paying jobs, subpar credit, and debt could buy inexpensive homes with a modest down payment and variable rate mortgage stretched over a long period of time. Variable rate mortgages are a serious problem, unless you plan on flipping the house within 24 months. Things only got worse though, after a while people with no job, no money, and no down payment were buying homes that they could never afford or even manage to make the monthly payments. Remember banks are only as powerful as they are allowed to be, and the only reason they wrote these mortgages is because the risk could be passed on to the GSE’s. Also, the exposure that the MBS market offered would be problematic if issues occurred.
The issue with these GSE’s is that all of Wall Street, all insurance companies, all banks, all personal investors took the government sponsored entity more serious than some expected. Everyone purchased MBS’s filled with subprime mortgages from these GSE’s because it was implied that, upon default, the government would compensate any losses generated from the default. On a small scale, this isn’t a huge issue, but on a macroeconomic scale this is a catastrophe. (As expected, when these subprime mortgages defaulted the governments stepped in and bailed out Fannie Mae and Freddie Mac. If you like to criticize the bailouts that were issued in 2008 & 2009 just look at how much the GSE’s have received.)
Considering the size and exposure the MBS market offered, especially now that they were plagued with these MBS’s filled with subprime mortgages, any hiccup in the system would cause ripples throughout the financial markets. After a while, the subprime mortgages were written, sold, packaged, and sold again as an MBS. Inevitably these subprime mortgage holders started to miss and eventually default on their loans. This causes inconsistency in an investment that used to be viewed as consistent and as credit worthy as a US treasury bond. This made everyone contradict the credibility of the MBS market, therefore freezing the credit markets because mortgages had to be kept on the banks books and couldn’t be sold off to the highest bidder. Also because of the overwhelming amount of defaults that occurred across the subprime mortgage market, you had giant Wall Street firms, pensions, and insurance companies loosing a ton of money and some going bankrupt because of these defaults. And a little know fact is that pensions and insurance companies can not loose money. They need to keep x amount of reserves always available for policies being cashed in and pension benefits being paid out. The result of default was the absolute and utter catastrophe that happened to nearly every state pension and large insurance company. Hence the recession that is still in effect, in my opinion, and a country that is in complete fiscal crisis at the moment.
Now that the story is told, we have to learn from our mistakes right? Not necessarily. Remember the democrats created this mess by advancing some sort of social initiative to make America a better place to live. The result of this philosophical and impractical idea was the absolute destruction of the MBS market which effected nearly every financial institution domestically and abroad. The democrats had their chance, it didn’t work. I can guess that their way of selling this was that there would be an increase in property taxes in the areas in which these subprime mortgages were issued, a newfound accountability and responsibility in low income areas, and a booming real estate market that would increase tax revenues because of increased profits for high net worth individuals. Clearly none of these myopic outcomes were a result of the housing initiative.
It’s time for a conservative fiscal solution for the country. A balanced budget, and regulation to ensure that this recession caused by the crashing of the real estate market never happens again. We need to make sure that along with deep budget cuts for social entitlement programs and a nixing of Obamacare that we put forth regulation to make sure that we don’t repeat the mistakes of our past. Not everyone should own a home, it isn’t feasible. The GSE’s need to be dismantled and destroyed so the banks don’t have the temptation to accept and write these subprime mortgages. To take this a step further, Democrat leaders in the Senate and House need to vote for a Republican led deficit reduction plan. They need to understand that a social agenda can not be executed in periods of stagnant economic growth and high unemployment. FDR passed the new deal when the economy was booming because of the GDP boost due to the manufacturing sector during WWII. Could FDR pass the new deal during the Great Depression? Of course not, and that’s the point. Put politics aside and give the country a chance to be great again. Reduce the deficit, so in fifteen years we can debate the same irresponsible and myopic policies the democrats want to put into law. Right now, our priority is to get the country in a better fiscal position for the future because of the failed social agenda that was promoted fifteen years ago. Politics are measured qualitatively for the most part, business is always measured quantitatively. When the two mix, the results become convoluted and inefficient. Let’s not make that mistake again.
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