September 16, 2008
How To Create A Crisis
Ever wondered what it would take to create a crisis in a major market segment? One that not only wreaks havoc in that segment but threatens widespread failure of a nation's financial markets and destroys a few major financial corporations along the way?
Well it's really not that hard - if you're the federal government.
You start with some bogus assumptions based on your desire to be a social engineer. You decide that certain minorities are being systematically locked out of the American Dream of owning a home by lending policies that require such things as adequate income to pay a mortgage and sizable down payment. Since those requirements are preventing these people from getting mortgages you decide that those standards were created for precisely that purpose. It never occurs to you that those standards are there because banks make their money by making loans to people who can pay them back.
Next you tell the mortgage lenders that if they don't find ways to give mortgages to these under-serviced communities on their own they will be made to do so by force of government regulation. It probably wouldn't hurt to throw out terms like "fines" and "penalties" every now and then either.
Now if you happen to have a couple of quasi-governmental organizations that exist to buy and sell mortgages to keep the market liquid, it would be helpful to get them to lower their standards for the quality of loans they can trade. You might need congressional help with this.
Having a cooperative federal reserve is also very helpfull. This whole spread the American Dream scheme will be a lot easier if interest rates are kept low. This will make it even easier for lenders to qualify borrowers by starting them out at a really low rate, that will adjust later.
To keep the ball rolling, continue to weaken standards of risk that lender allowed to assume. This can be done by further lowering the standards of what your quasi-governmental agencies can accept. You could, believe it it or not, take this all the way to then point where borrowers don't even have to prove their income. They just tell lenders what they make and lenders say OK here's your loan.
It would be a good idea to enourage the second mortgage/refinancing side of the business too. Get lenders to the point where they'll loan 100% of a homes value. It wil be OK. Prices will alwaye be going up.
That's it for the set-up. You've built your house of cards, now it's time to knock it down.
The Governors of the Federal Reserve can be helpful in this phase.
If they start raising the prime interest rate - just a little at a time - eventually mortgage rates will start to climb. Which means all of those adjustable rate mortgages that were sold when rates were at historic lows, will start to adjust. Upwards.
It will be a trickle at first as the truly low-hanging fruit of your new class of sub-prime borrowers start defaulting on their loans. Soon enough of these loans will have been foreclosed that it will start to make news. And since it's the same groups of people you started out "trying to help" losing their homes, it will of course be big news.
This news will further depress the housing market leading to more foreclosures. Which will further depress the housing market etc. etc.
This is not all going to happen over night. Its going to take a decade or more. Those mortgage backed securities your quasi-governmental agency was selling will get traded and traded and traded. Even though in the sub-prime categories they are little better than modern day junk bonds. A lot of investment firms will have sizable holdings of these derivative securities. Their problem is that assets backing them up are worth less than when the loans were created and those values are sinking lower.
This means those financial institutions will have to write off enormous losses. In some cases the losses will be so big that the companies will not survive.
Here's where you throw a little head fake - the first big one to fail, you step in and bail it out with billions of dollars in taxpayer money and loan guarantees. This gives the rest of them feeling of security. If they believe that they are also too big to fail.
If you're really lucky, your quasi-governmental agencies will be the next victim. It will cost billions but you can take adantage of the opportunity to seize control and make them fully governmental agencies. This gives you serious control over whatever the home lending market becomes after the meltdown.
After that, you turn off the magic bail-out machine. When the next couple fail and you've got a couple more teetering on the edge - you deliver the final blow.
Propose more federal control.
I know it sounds far fetched and no one would ever try to do something so stupid. But it's kind of fun to imagine.
Well it's really not that hard - if you're the federal government.
You start with some bogus assumptions based on your desire to be a social engineer. You decide that certain minorities are being systematically locked out of the American Dream of owning a home by lending policies that require such things as adequate income to pay a mortgage and sizable down payment. Since those requirements are preventing these people from getting mortgages you decide that those standards were created for precisely that purpose. It never occurs to you that those standards are there because banks make their money by making loans to people who can pay them back.
Next you tell the mortgage lenders that if they don't find ways to give mortgages to these under-serviced communities on their own they will be made to do so by force of government regulation. It probably wouldn't hurt to throw out terms like "fines" and "penalties" every now and then either.
Now if you happen to have a couple of quasi-governmental organizations that exist to buy and sell mortgages to keep the market liquid, it would be helpful to get them to lower their standards for the quality of loans they can trade. You might need congressional help with this.
Having a cooperative federal reserve is also very helpfull. This whole spread the American Dream scheme will be a lot easier if interest rates are kept low. This will make it even easier for lenders to qualify borrowers by starting them out at a really low rate, that will adjust later.
To keep the ball rolling, continue to weaken standards of risk that lender allowed to assume. This can be done by further lowering the standards of what your quasi-governmental agencies can accept. You could, believe it it or not, take this all the way to then point where borrowers don't even have to prove their income. They just tell lenders what they make and lenders say OK here's your loan.
It would be a good idea to enourage the second mortgage/refinancing side of the business too. Get lenders to the point where they'll loan 100% of a homes value. It wil be OK. Prices will alwaye be going up.
That's it for the set-up. You've built your house of cards, now it's time to knock it down.
The Governors of the Federal Reserve can be helpful in this phase.
If they start raising the prime interest rate - just a little at a time - eventually mortgage rates will start to climb. Which means all of those adjustable rate mortgages that were sold when rates were at historic lows, will start to adjust. Upwards.
It will be a trickle at first as the truly low-hanging fruit of your new class of sub-prime borrowers start defaulting on their loans. Soon enough of these loans will have been foreclosed that it will start to make news. And since it's the same groups of people you started out "trying to help" losing their homes, it will of course be big news.
This news will further depress the housing market leading to more foreclosures. Which will further depress the housing market etc. etc.
This is not all going to happen over night. Its going to take a decade or more. Those mortgage backed securities your quasi-governmental agency was selling will get traded and traded and traded. Even though in the sub-prime categories they are little better than modern day junk bonds. A lot of investment firms will have sizable holdings of these derivative securities. Their problem is that assets backing them up are worth less than when the loans were created and those values are sinking lower.
This means those financial institutions will have to write off enormous losses. In some cases the losses will be so big that the companies will not survive.
Here's where you throw a little head fake - the first big one to fail, you step in and bail it out with billions of dollars in taxpayer money and loan guarantees. This gives the rest of them feeling of security. If they believe that they are also too big to fail.
If you're really lucky, your quasi-governmental agencies will be the next victim. It will cost billions but you can take adantage of the opportunity to seize control and make them fully governmental agencies. This gives you serious control over whatever the home lending market becomes after the meltdown.
After that, you turn off the magic bail-out machine. When the next couple fail and you've got a couple more teetering on the edge - you deliver the final blow.
Propose more federal control.
I know it sounds far fetched and no one would ever try to do something so stupid. But it's kind of fun to imagine.
Posted by: Stephen Macklin at 05:41 PM | Comments (1) | Add Comment
1
In that last few decades, we've seen a massive increase in the size of the sector of our economy known as the "financial economy". This includes banking, investments, insurance and other paper-pushing enterprises. Meanwhile, the sector known as the "real economy" has been shrinking drastically. This includes manufacturing, software and other activities which produce tangible goods and create real long-term wealth. The products produced here can also be used to offset our massive trade deficits. This is phenomenon is what some refer to as "Wall Street vs. Main Street". In the last decade It has been estimated that the US has lost almost 4 million high-paying manufacturing jobs, largely due to taxes, regulation and corruption. When these jobs were lost, the workers scrambled to find replacements. Unfortunately, many failed to find another job which paid the same as their previous position. Meanwhile, Greenspan stoked up the inflationary fires to alarming new levels causing people save and invest less while borrowing more. The only way many folks could maintain their standard of living was to borrow some of the fed's funny money, a practice which was cheered on by gov't and the fed. - Yes gov't and the fed created this problem and now we're expected to allow the very people who created the problem to fix it. (By the way, they have some really nice condominiums in Florida for sale.) It sounds like the financial economy needs to shrink drastically, so that we can roll up our sleeves and get to work rebuilding our lives and economy. The casino referred to as "the economy", in its current form, is in its death throes. What replaces it is up to each one of us.
Posted by: Wayne at September 17, 2008 10:17 AM (nPltl)
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