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The Green Sheet Online Edition

March 28, 2011 • Issue 11:03:02


Further thoughts on the economy

Brandes Elitch's article "Thoughts on the economy (in hindsight)," The Green Sheet, March 13, 2011, issue 11:03:01, drew responses so substantive that we expanded our Forum section to make room for them. Ideas on what set the stage for the Great Recession fill this page and continue on pages 54 and 55 of this issue.

The first response is from Scott Bolster, Vice President of Finance at National 1st Credit Union, who begins by addressing author Michael Hirsh's perspectives, which were discussed in the article.

The second response is from Steve Mott, Chief Executive Officer of BetterBuyDesign. He highlighted a section in the article pertaining to the author's use of "we" when discussing California's economy. Mott wrote, "I think you need to state that you are in California, which is why you start to use 'we.'" He then offered the feedback that follows Bolster's comments herein.


As for Michael Hirsh's conclusions about how we got here, I must say I agree that it was Washington, that without Washington opening the door, it never could have happened. But I differ on the key driver(s) and who is responsible. While I haven't read the book, unless you have worked in a bank, several credit unions and a mortgage bank as I've done over the last 20 years, you won't have an insider's view. Most economists will focus on the policies they don't like when evaluating outcomes.

To my mind, the collapse of the housing market had nothing whatever to do with Milton Friedman or Ronald Reagan. I'd be interested to hear how Hirsh reached such a conclusion and what action was taken in the 1980s to foster it. With your patience and forbearance in advance, I'll share with you what I think were the five main drivers:

1. The Community Reinvestment Act, passed by Carter and the Democrats in the late 1970s, that was originally intended to prohibit redlining in housing but was used by the Clinton Administration to enforce more lending to the key Democratic constituency of minority and low-income Americans.

I have personal experience on this front, as I recall the National Credit Union Administration calling us up at Redwood Credit Union and telling us we needed to do more lending in the Roseland area of Santa Rosa - or else. We told them, if the person was a member and was qualified, we were doing the loan. They laid off of credit unions after the initial attempt at coercion, but the big banks were not so fortunate. They were told to loosen up their underwriting and do more lending to minority and low-income Americans, which they did until they were full-up and couldn't take any more of those loans safely from an interest rate risk and credit risk policy standpoint. This precipitated my third driver below.

2. Reduced underwriting standards pushed by the Clinton Administration in the above-mentioned push to increase homeownership for low-income and minority Americans. I refer you to this article by Bloomberg Businessweek and note that Bill Clinton has accepted partial blame in an interview I saw him give: www.businessweek.com/the_thread/hotproperty/archives/2008/02/clintons_drive.html.

On the face of it, increasing home ownership is a laudable goal, but we can see the results: unqualified borrowers all too often don't pay off loans, which is how the historical norms for debt-to-income and loan-to-value ratios were arrived at. If someone was qualified to get a home loan, they usually got one. Mortgage brokers in particular are in the business of making loans, not discriminating against a live one on the line.

When I bought my first home in 1995, you could not go above 38 percent for your debt-to-income ratio, but for the first time you could put down 10 percent using an 80 percent loan-to-value (LTV) first mortgage and a 10 percent LTV second mortgage. Eventually it got to nothing down, NINJA (no income, no job) loans in the mid 2000s.

3. Fannie Mae and Freddie Mac accepting and collateralizing Alt-A (less than prime) and subprime mortgage loans, that is to say, buying them and selling them into the secondary market. Clinton's appointee to run Fannie Mae agreed, at Clinton's insistence, to become a secondary-market conduit for other than prime loans, which they had never done.

Initially they were purely a conduit, but to protect the huge bonuses those at the top were receiving, and the social engineering goal of having more home ownership, they started keeping some of these loans in their portfolio. It got to the point in 2006 where there were so many nonperforming mortgage loans that Fannie Mae and Freddie Mac were making payments to bondholders on behalf of homeowners so that they didn't have to recall the bonds and pay them off as the debt covenants called for them to do.

Republicans such as John McCain called Fannie and Freddie on this in congressional hearings in 2005 and 2006, but the Democrats in Congress called them racists for doing so, and once the Democrats took control of Congress in 2006, it was certain nothing would be done to keep the train on the tracks. Could the Republicans have done more earlier? Yes.

Were they directly to blame? No. At least I have yet to hear a convincing argument documenting why they should be held accountable.

Finally, Fannie and Freddie ran out of all their capital, and that's when the Treasury seized them in 2007, and has been making payments to bondholders ever since with printed dollars instead of recalling the bonds and writing off the loans. These types of bonds represent much of the $1.4 trillion in bonds the Fed bought from the Treasury in 2008.

4. The government naturally likes to blame Wall Street, but in truth until the Clinton Administration's policies created a glut of Alt-A and subprime loans in response to their strong-arm enforcement of the Community Reinvestment Act, before the 1990s, there was no secondary market for Alt-A and subprime loans.

Once the banks, then Fannie Mae and Freddie Mac, had their fill of these loans and couldn't take any more because of their capital ratio requirements, Clinton first, in 1999, repealed - along with the Republicans - the portion of the Glass-Steagall Act, which prohibited banks from trading stocks and bonds, while concurrently asking Wall Street if they would create a secondary market for these Alt-A and subprime loans in which they would collateralize them and sell them off as bonds.

In Wall Street, the government found a partner only too willing to make some money off of this. Wall Street went on to go hog-wild with jumbo loan collateralizations and creation of derivatives to hedge the interest rate risk. Our former Treasury Secretary, Hank Paulson, created the first collateralized debt obligation, or CDO, the first mortgage-backed derivative I'm aware of, which came out in the 1990s.

I've been saying since 2007 that the whole concern about derivatives is a huge red-herring; if they aren't paid off, you essentially aren't paid off on an insurance policy. The real loss comes from owning the bond, not being able to collect on insurance you had for it. So blaming Wall Street for the financial crisis is like blaming a horse that gets out of a barn - never would have happened if the door had been kept closed.

5. The Fed's accommodative monetary policy exacerbated the problem with cheap money, driving up the value of homes and thereby increasing their fall. However, if debt-to-income ratios had never been increased and loan-to-values had not been allowed to go beyond 80 percent as a result of government carrot-and-stick policies, we'd never have gotten to where we are.

Lastly, I would say the whole TARP bailout and the AIG bailout are a ruse. Hank Paulson used those funds to pay out dollar for dollar on total garbage that was now worthless to Goldman Sachs, the largest banks and some selected hedge funds whose clientele would read like a who's who in Washington and Wall Street. In effect, Paulson made sure he, the Bushes and other key Republicans and Democrats holding this trash in their hedge funds were made whole with taxpayer dollars. Now Bernanke's going to pay us taxpayers back in newly printed and devalued dollars over time.

So there, my friend, is my view of the housing bubble and the consequent, subsequent "financial crisis."

Scott Bolster
National 1st Credit Union

The second view

Ironically, while the rest of the world is increasing its middle class (some estimates have 1.3 billion formerly poor people moving up to middle class status in the next few years), the American middle class is actually retreating, as concentration of wealth has been exacerbated by the bank-led global recession.

This is largely due to 30 to 40 percent drops in housing prices, which constitute most middle class assets (and wealth), and were the source of 'piggy-bank' equity loans - and subsequent debt - wildly promoted by banks that should have known better. In effect, banks trying to be like Goldman Sachs have achieved more wealth-creation-for-the-few than the Republicans under Bush 43 were able to achieve politically.

Consumer aversion to future debt sprees threatens to return retail banking to its historic, near utility-like role in the economy (which it would have retained had not the politicians - from both parties - and banks scuttled the Glass-Steagall Act in 1999).

Fundamentally, this means that bank revenues - the 'table' from which ISOs and all other payment industry participants have eaten heartily for decades - were artificially inflated for a decade or more. Thus, the chorus of cries from bankers that they have to raise fees to recover any largesse of revenue removed by the Durbin Amendment makes the incorrect assumption that society should value and reward the business of 16,600 banks and credit unions at existing levels.

In fact, in a competitive marketplace, the industry's $300 billion in annual payments revenue (a McKinsey & Co. number) is probably artificially inflated by up to $100 billion or more. For debit cards alone, Durbin takes out $14 billion a year in interchange, and the overdraft legislation requiring consumer opt-in for NSF fee coverage will take out another $7 billion (the FDIC reports that 41 percent of the overdrafts at the 4,000 or so banks that they regulate come from debit cards). That's a cool $21 billion off the top right away (assuming the Fed's proposed rule-makings stand).

Credit cards are still in Congress' gun-sights, along with other capricious, market-power fees and rates enjoyed by mostly a handful of big banks. So ISOs need to realize that the gravy days of payments are coming to an end, and they - as well as everyone else in payments - need to figure out how to create and drive real value in an increasingly digital transactional economy (read mobile), and get fairly (not lavishly) compensated for that.

If they don't, it won't take Apple, Google, AT&T and others long to figure out how to take away business that labors under an artificial pricing umbrella.

Steve Mott

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