The Genesis of the Worldwide Crisis Milan Zelený
1. One way in which President Franklin D. Roosevelt responded to the “Great Depression” after 1929 was to found Fannie Mae (Federal National Mortgage Association) in 1938. The aim was to make housing available to the wider American public with the help of the state purchase of mortgages from primary bank funds.
2. In 1977 President Jimmy Carter’s government passed the Community Reinvestment Act (CRA) to assist economically weak communities where the purchase of a family house was unimaginable, and people did not have access to standard mortgages.
3. The outcome of the CRA was the emergence of state-preferred banks which provided mortgages in poor regions. The mechanism functioned under the strict regulation of the Federal Deposit Insurance Corporation (FDIC) with the state guaranteeing the financial risks linked with the CRA.
4. An infamous press conference took place on December 8, 1993. President Bill Clinton’s economic adviser, Robert E. Rubin, (later adviser to President Barack Obama, in obscurity since the near-collapse of Citibank) announced a new CRA initiative for the support of economically weak communities. The aim was to make the provision of mortgages easier, to implement new rules, and to guarantee increased financial flows into poorer localities.
5. In 1995, under pressure from President Clinton, the rules for the regulation of the CRA were radically relaxed and the system of the provision of mortgages subjected to fundamental reengineering. The political aim was to strengthen and speed up the provision of mortgages to socially weaker sections of the population. The world was changed forever and free market capitalism was subjected to an unusual stress test.
6. This “Clinton revision” led to a systematic “points-allocation” for banks based on the extent to which they observed the regulations and aims of the CRA. The banks were forced to relax traditional criteria and standards for mortgages at low-interest (“subprime”) rates. The infection began to spread.
7. Between 1993 and 1998 CRA-guaranteed loans had risen by 39%, a growth twice as fast as other bank loans. As early as April 19, 2000, Secretary of the Treasury Larry Summers (today the head of Obama’s National Economic Council) was unable to hide his enthusiasm over the “success” of the revision: “The First Lady (now Obama’s Secretary of State) says it takes a village to raise a child; we say it takes capital to build a village.”
8. Part of Clinton’s revision was the introduction of what is called the securitization of mortgages and their sale as state-backed obligations (CMOs, CDOs, and other derivatives) to investors at home and abroad. The guarantee was land and houses whose values had risen to historic levels. No one anticipated a fall in the value of property.
9. The first public sale of securitized obligations took place in 1997 through the First Union Bank (later the Wachovia Corporation) in cooperation with the investment bank Bear Stearns. In 2003 the regulated market with the CRA mortgages reached $600 billion. However, the unregulated market was an unknowable multiple of this figure.
10. 1998: Brooksley E. Born (Chair of the Commodity Futures Trading Commission) warned against the nontransparency of financial derivatives and called for their immediate regulation to protect the Americans and the worldwide economy. Alan Greenspan, Larry Summers, and Robert Rubin, government economists, publicly sneered at her; Greenspan said that regulations for derivate transactions, decided privately between professionals, were not necessary; Rubin said that new rules and a regulatory overview could increase legal uncertainty over flourishing global markets.
11. In 1999, Brooksley E. Born resigned from her position. Encouraged, Phil Gramm (Chairman of the US Senate Committee on Banking, Housing, and Urban Affairs) presented an extensive law of deregulation. It was passed, and signed by President Clinton. The gate to a world crisis was wide open. The unregulated value of financial derivatives grew from $50 to $550 billion—greater than all the money in the whole system.
12. A strange new world came into existence. The leading investment houses of Wall Street began to trade with new investment instruments. Clinton’s Chairman of the Federal Reserve, Alan Greenspan, inaugurated a strategy of low interest rates and the fall of the American dollar. Cheap money flooded American markets. Construction firms borrowed money and built new houses; banks borrowed money and provided ever cheaper loans; Wall Street borrowed up to a ratio of 40:1 (the ratio of debts to the value of assets). New financial instruments and a new field of “financial engineering” further stimulated the “creativity” of the greedy. A speculative bubble of irrational enthusiasm and avaricious blindness swelled up almost overnight.
13. Toxic mortgages came along on a conveyor belt. No one verified whether borrowers had the income or the collateral to repay their loans; an insurance deposit in cash was no longer required. The Federal Reserve Bank of Boston capped this state surrealism by deciding that participation in a credit consultancy program was proof enough of the applicant’s ability to manage his/her debts. The world went mad.
14. Local communities founded civic initiatives such as ACORN (Association of Community Organizations for Reform Now) which helped to implement the aims of the CRA and the banks’ points system at a local level. Advertising, propaganda, protest, and political pressure were used against institutions which tried to tighten credit regulations. (One legal representative and “community organizer” of now defunct ACORN was the young lawyer Barack Hussein Obama.)
15. In 2003 President George W. Bush’s government attempted stricter regulation of the state agencies Fannie Mae and Freddie Mac, which in fact constituted the only accessible mortgage market. Thanks to the opposition of the Democrats, a proposal for a law, called the Bush Revision, was not passed. The Democrats not only defended Fannie and Freddie, but attacked Bush for trying to limit what was called “affordable housing” for less well-off groups of the population. President Bush failed: completely absorbed by the events of 9/11 and two wars, he made no further attempts to implement the necessary regulation.
16. By September 1, 2005 the Democrats had implemented another important intervention. Until then, credit institutions with activities of over $250 million had to submit to what was called the three-level CRA qualification test. This qualification limit was raised to $1 billion. Other institutions and smaller regional banks were released from the three-level test completely. Racial discrimination and inability to pay were used as arguments for expanding the influence of the CRA. No American politician had enough courage to face up to the racial line of argument.
17. After 2005, the financial crisis could not be halted. More and more institutions which did not come under even the weak guarantee of the CRA threw themselves into an unregulated market of issues, securitization, and the sale of toxic mortgages. Hundreds and thousands of people without regular incomes and incapable of paying off their debts were lured into signing low-interest contracts. The weak dollar, cheap money, and cheap mortgages enticed even foreign banks, investors, and sovereign funds.
18. The speculative bubble burst in the summer of 2008. This surplus of new houses, virtually unusable land, and houses in default auctions flooded the markets and slashed prices for real estate overnight. Many mortgage debts were greater than the market value of the real estate. Mortgage foreclosures reached critical proportions. The whole global chain of sale and insurance of investments, founded on toxic mortgages, had relied on the irrational assumption of the “permanently increasing value of real estate.”
19. The consequence and main symptom of the crisis was the loss of mutual trust between members of the chain and the subsequent freezing of credit flows. The loss of trust—and the growth of a global chain of mistrust—is at the root of all negative consequences.
20. The role of trust and trustworthiness, the psychology of crowd behavior, the influence of fears and anxieties on the actions of people, human adaptability and flexibility in reactions to technical stimuli, irrationality in making decisions and so forth, do not form a part of classic economics and are not taught at universities. The naive manipulation of interest rates represents the summit of conventional understanding of economic systems.
21. Even though the crisis gathered strength over a whole decade, its impact struck “suddenly” in September 2008; thanks to the toxic mortgages the flows of credit “froze” and trust in the market disappeared. The unregulated investment banks of Wall Street began to crash and today they either no longer exist or have been transformed into regulated commercial banks. While up until September 2008 the government affirmed that everything was in order, over a few days Henry Paulson, Ben Bernanke, and George Bush began to threaten the collapse of the whole of the economy. Their total unfamiliarity with the role of fear in economics prevented them from thinking over the consequences.
22. The solution chosen was government intervention in the economy in the form of massive injections of cash, even though it is known that government intervention limits and destroys the dynamic of the free market, increases distrust, takes away responsibility, and leads to dependence on political decisions taken by government bureaucrats.
23. Henry Paulson’s rescue package, known as TARP (Troubled Assets Relief Package), originally implemented as a plan for the state to purchase toxic mortgages, met with opposition from 70% of the population as well as around 200 leading economists warning against such a rescue package. Nevertheless, the politicians succeeded in implementing the proposal.
24. The first attempt to pass the law failed. On September 29, 2008, the steepest fall in the price of shares since World War II took place: 777 points. The stock exchange was threatened by the governmental campaign of fear about the collapse of the economy; Wall Street anticipated a “rescue” by the government, and thus the first reaction was negative.
25. The political process around the package resulted in the “Christmas tree” being decorated with spending trinkets such as (for example) assistance for the owners of the racing track NASCAR, investors in the dependency of American Samoa, the makers of wooden arrows, and the producers of rum in Puerto Rico. And, of course, $20 million for ACORN.
26. Paulson’s original three-page proposal grew to 450 pages, which no one could responsibly evaluate before it was time to vote. The scaremongering trio Bush, Obama, and McCain agreed to support the rescue package.
27. In mid-November Paulson indicated a massive change in the strategy of TARP: in place of purchasing toxic mortgages, he switched to direct investments in the shares of the banking sector. It was the lack of transparency and responsibility that had made such a radical change in the use of TARP money possible; the legislators were already impotent and irrelevant.
28. There followed a time of “moral hazard”: not only banks applied for government support, but even construction firms, auto businesses, hospitals, and municipal and local administrations. It appeared that the condition for obtaining support was a demonstrated inability to function in the free market. Enterprises and institutions used artificial means to make their results look worse and thus obtain loans worth billions of dollars. A new wave of fear and intimidation arrived. Politicians once again “rescued” the situation, once again with taxpayers’ money.
29. Today, a historically huge amount of cash is being meaninglessly pumped into the American economy, but in spite of this the credit markets have not relaxed; the banks are “sitting” on large financial reserves, and the government has lowered interest rates virtually to zero, as though nothing else was possible. In addition to lack of trust in the economy, emotion, muddle, ignorance, and stupidity have begun to circulate—political viral infections against which economic “antibiotics” have become powerless.
30. A powerful alliance came into existence: Big Business—Big Government—Big Unions, supported by Big Media: an alliance able to implement anything it wanted, put further limits on the functions of the free market and postpone necessary regeneration of the free market, which would make it possible for new enterprises, new investors, and new business models to emerge. The crisis has been prolonged indefinitely.
31. On Sunday, January 17, 2010, President Obama energized a crowd in Boston by shouting “We want our money back!” New regulations of derivatives were then enacted and Goldman Sachs (the largest supporter of Obama’s campaign) was indicted for fraud. The circular reasoning of politics has made a full circle, but the comedy of errors goes on.