Current Economic Woes

THE BAILOUT

  $700 Billion is a lot of money.  It is roughly the amount of money we pay to import oil every year.  The question we are all faced with is should we let the government use our money to invest in the credit market?  Before any of us decide on that, I think we need to have a better understanding of how this happened.

MAJOR PLAYERS: FREDDIE MAC AND FANNIE MAE

  The first and most obvious question about these two entities is: what are they?  Both are Government Sponsored Enterprises (GSE), meaning that the government, while not exactly 'owning' the property, was the primary proponent behind it.  Fannie Mae (Federal National Mortgage Association) was created as part of FDR's New Deal in 1938.  It was designed to participate in the secondary mortgage market.  When 'Bank Awesome' makes a loan to a homeowner, they can then take that loan and sell it to someone else on what is called the secondary mortgage market.  Fannie Mae was designed to buy up and guarantee loans so that 'Bank Awesome' could then take their new money and re-loan it to another wannabe homeowner of small business owner.  The result would be freeing up credit for the next person who needs/wants it.

  Congress chartered Freddie Mac (Federal Home Loan Mortgage Corp) in 1970 to balance their budget and provide competition to Fannie Mae in the secondary mortgage market.  In practice, shat Freddie and Fannie do is buy and guarantee the liquidity of mortgages.  By 2008, Fannie and Freddie owned or guaranteed 50% of the $12 Trillion worth of mortgages in the United States.  

  As a result of their growth, we now have two entities controlling over $6 Trillion worth of the mortgages in the U.S.  The process 'worked' until the Real Estate market took a turn south, interest rates increased, mortgage payments went up, and people who couldn't afford the home they borrowed on started foreclosing.  The ownership went back to the bank (in many cases Freddie and Fannie), who couldn't sell the property because the market tanked and the property wasn't worth the mortgage on it.  So Freddie and Fannie, guaranteeing or owning 1/2 of these mortgages, are in serious financial trouble.  

  But why would Freddie and Fannie take such risks on bad loans to people who can't afford them?

THE COMMUNITY REINVESTMENT ACT

  The Community Reinvestment Act was passed under Jimmy Carter in 1977.  This Act was an attempt to get people who couldn't qualify for a loan for whatever reason the ability to obtain some financing for a home purchase.  Essentially, get poor people in houses that they owned instead of rented.  Despite serious opposition from the banking industry, Congress passed this Act and it became law.  The loans given out to people with bad credit, poor income, who couldn't originally qualify for a loan are what is commonly referred to as 'Subprime' loans.  Basically, 'less than ideal' or 'high risk' loans.  

  The Act evolved over time.  In 1992, the U.S. Congress passed another Act called the Federal Enterprises Financial Safety & Soundness Act.  It required Fannie and Freddie to devote a % of their lending to offer and guarantee mortgages for affordable housing.  Affordable Housing is also designed to get people who financially find it straining to buy a home into something they can afford.  

  In 1995 the Clinton Administration made more changes, forcing financial institutions to make loans to distressed rural and inner city areas.  In addition, it encouraged people to sue financial institutions that they believed were violating the Community Reinvestment Act (CRA) by not providing financing in the form of subprime mortgages.  

  Between 1993 and 1998, CRA loans increased by a whopping 39%, while conventional loans increased by only 17%.   In addition, home prices 'values' at a pace no longer closely related to inflation, created an illusion of value. 

  In 2002, the Bush Administration responded to a review of the changes made in 1995 by suggesting heavy regulation of Freddie and Fannie.  That move was opposed to Democrats in Congress, and since the Republicans didn't have enough of a majority to override them the motion stalled.  In 2005, Senator McCain offered the same warning.

OTHER PROBLEMS

  The CRA isn't the only problem.  50% of all subprime loans were issued by independent banks not covered by the CRA.  The overarching issue is subprime loans, and forcing banks to loan money to those who cannot afford it.

  Adjustable Rate Mortgages, commonly referred to as ARMs, are part of the problem.  Interest Only loans contribute as well.  Bank Greed is another problem.  In order to get people who can't afford the mortgage into a position that they can make the payments, financial institutions got creative.  They structured loans that had no interest for 3-5 years, loans that had no interest at all for 10 and then due in full.  Those loans work fine, as long as at the end of 5 years interest rates haven't gone up and property values have.  Combine higher interest rates with lower property values, and you get foreclosures.

  The Realtor Association (of which I am part) not being willing to tell people to be careful when obtaining financing is a problem.

  But people aren't as stupid as some would have us believe.  Borrowers aren't victims of a heinous crime.  Misled, maybe.  But the final decision is always the borrowers.  As such, I would suggest the general American attitude of "I want it now!" while carrying $10,000 in credit card debt is a serious issue as well. 

HOW TO SOLVE IT

  Senator Obama and Senator McCain are offering very little leadership on this front.  Neither has proposed anything above telling us to advocate that Congress pass this bailout plan, while ignoring the fact that even this plan isn't a sure thing.  There are varying positions from many different economists as to whether this bill is required.  Everyone does agrees that without it, things will tighten up and get very difficult in the short term.  As for how long before the market recovers, no one knows.

  Those for the bailout point to the fact that the government will be buying mortgages that, hopefully, will at some point be worth more than what we pay for them because the Real Estate market will recover.  It would also inject almost $1 Trillion into the credit market that is right now tightening, which would stop the current trend that is making it more difficult to obtain financing to buy a home or expand your business.

  Those against it point to the fact that it increases our debt by almost $1 Trillion, and we don't even know the full cost of the bailout yet, because everything the government touches gets more expensive than the estimates.  Additionally, we already paid $150 Billion in the spring to try and stimulate the economy, so what if this bailout doesn't work either?  Will we see them asking for another $700 Billion in March?

  As a Conservative, I lean towards not bailing out the massive companies that made these horrible decisions.  I'd prefer to see the private sector work this out.  On the flip side, if we trust what the president and some economists are saying, we're sitting on the edge of another Great Depression.  Either way as of right now, we don't know enough to solve the problem.  Too much political jawboning and finger pointing has clouded the water so bad we can't even see our feet anymore.   Both Senator's are content with pointing out the other's shortfalls, without really offering any real solution.

  This is a good starting point: the one thing the bailout plan is lacking is any real solution as to what actually got us to this point in the first place.  We're willing to throw $700 Billion at a problem we haven't fixed.  As a voter, it makes me extremely peeved to know that my elected officials are willing to throw that much money at a problem they don't understand and haven't even tried to solve at the source.  It's like trying to fill up a bathtub without first putting in the plug.  

  It is easy to point fingers at one party or another.  The CRA and other mandates by the Clinton Admin. had very honorable intentions.  There is nothing wrong with trying to get people into their own homes.  To avoid this in the future I would suggest a different focus: providing them with a better education, so they can get a better job, and actually afford the home on their own accord.  We can talk about how unfair life is, but in the end people can either afford a home or they can't.  Forcing one on them only creates problems that didn't exist.

  If we had restrained ourselves and stuck by the ideals of our Founders, we might not be in this mess.  The government has no business in the private sector.  They can regulate to make sure there isn't racism/sexism in the lending process, that is well and good.  But the government should never tell you how to conduct your business.  The problem was and is Big Government forcing the private sector to loan and obtain loans.  You'll excuse me for having doubts that the problem can now become the solution.