The Financial Crisis: Yesterday, Today and Tomorrow
George Boelcke FCI
October 08, 2008
As the financial turmoil continues from the banking problems to the stock market, and lack of available financing and credit, what go us here, what could we have seen coming or done earlier? More important, what are the implications for us as individuals and what might happen over the next few years:
10 years ago: Some basic regulations and restrictions could have been set up for subprime lending.
5 to 10 years ago: The insurance industry should have dealt with the insurance products involving subprime mortgages. Unfortunately, the SEC has no authority in this area, and 50 different states have 50 different sets of regulations and couldn´t possibly be expected to deal with these international companies and complex issues.
5 years ago: In the initial phases of the subprime "wave" and the start of stupid lending, minor regulatory changes would have prevented the majority of ninja, no-documentation or fraudulent loans.
The size of Fannie Mae and Freddie Mac was already being discussed and should have been taken a lot more serious. Just like nobody should have all their investments in one single stock, no two companies should have controlled the vast majority of the mortgage market.
Limitations could have been placed on the cancerous mortgage backed securities and credit default swaps which investment firms were selling, rating agencies were blessing, almost nobody understood, but everybody thought were as safe as treasury bills.
2 to 5 years ago: Investment firms should not have been allowed to reach a leverage ratio upwards of 40 to 1. When an individual borrows $40 for every dollar, there´ll be a price to pay down the road. But when these firms have a global reach in the financial world – well, we see the consequences today.
Millions of families should have asked a lot more questions, starting with why they would be sold (or take on) an adjustable rate mortgage when rates were at historic lows and had only one direction they could possibly go.
Last month: Government officials could have done a better job of explaining the mess, the implications, and their consequences for average families, the economy, country as a whole and the world.
Today: The bailout package will take some time to be implemented and start taking effect. It wasn´t an option, it isn´t a final solution, but it also won´t fix the financial world overnight.
The Federal Reserve has now used one of their biggest weapons in reducing interest rates by half a percent, along with other countries ranging from Canada to China and England. Australia reduced theirs by a full percent already, the Irish government has guaranteed all bank deposits irrespective of amounts, and the pain in Germany, England and Spain keep compounding worse than in the U.S. What happens in Vegas might stay in Vegas, but this problem is global, negating any questions of why bailouts are a necessity.
One of the biggest issues right now, along with a dozen other urgent priorities the Treasury Department and Federal Reserve are dealing with, is the lack of available credit. Lower rates are great, but businesses need access to credit in the first place. If we were to be honest, most individuals could do without more borrowing. We´re buried in debt and it´ll take years to pay down our balances even if we stopped making things worse with more debt we can´t afford. But for businesses, borrowing for inventory, payroll and operating lines is a necessity and not an option. Yet, right now, banks don´t even trust each other with overnight loans, never mind lending to businesses when banks have very little liquidity themselves.
Anyone with cash or a consistent monthly investment plan will do very well. After all, when Macy´s has a 50% off sale, everyone goes. But now Wall Street is having a huge sale in much the same way for anyone who isn´t retiring for the next five or ten years and is not purchasing mutual funds or stocks with borrowed money.
Before the end of the year: There will likely be a further need for some kind of bailout package or drastic action of one kind or another.
For 2008: The pain and daily roller coaster of stock market will continue for a while. Part of it is due to uncertainty in the market, recession worries, a bandwagon effect, flight to safety, and concerns over the length of the economic slowdown. Any bailout or rate reductions are part of the solution in a very complex, massive world-wide jigsaw puzzle of financial transactions. Yes, the world is getting smaller and money has absolutely no borders.
It is likely that job losses will reach almost 1 million this year, which makes matters worse – much worse. Anyone unemployed is not going to be helping to stimulate the economy, paying taxes or potentially even be able to pay their mortgages.
For the next year: There is likely no way to avoid a recession, and probably no quick way out. It´s not as though this Christmas shopping season will create much economic activity for retailers, never mind that the key selling period from Thanksgiving to Christmas is a full week shorter than last year.
Next year: The AIG bailout will have been resolved and paid in full since the company had to put up so much collateral (80% of the company) and pays such a high rate of interest (around 11%) they are certainly motivated. It may be why the Treasury Department is considering using the $700 billion bailout package to purchase equity in financial firms rather than purchasing mortgage backed assets.
For the next 2 years: There is likely to be very little growth in the economy as all of us adjust to a very new financial reality.
Hopefully the FBI will be charging many of the mortgage brokers, company executives and others as their investigations continue into fraudulent activities which contributed to where we are today.
Financial regulators should be drafting legislation and policies for investment firms and financial institutions. As a start, is it unreasonable to demand income is properly verified for mortgage applications? Would it seem reasonable not to allow investment firms to borrow up to 40 times their assets when their potential failure ripples way beyond their shareholders? Would it be unreasonable to disallow anyone taking on debt beyond a maximum percentage of their income? Or perhaps it warrants consideration of whether shareholders could be allowed to sue executives for reimbursement of insane bonuses up to two years back when the company has failed?
In 5 years: Should the Treasury Department use the $700 billion bailout they will have recovered the vast majority of the investments in re-selling these mortgage securities back into the market. After all, wouldn´t you jump at the chance to buy back your own mortgage for around 50 cents on the dollar? How do we assure that´ll happen? If the majority of people pay their mortgage, it will.
In 10 years: There´ll probably be another financial crisis. Sadly, we often deal with the "today" problems, and deal with them very well and with a single-minded focus. But we often don´t look down the road at what´s coming next. Sadly, re-active has become more common than pro-active. Isn´t that exactly what many of us do, too? How much of our focus is on the "today" monthly payment versus the balances we owe and the total debt we´re liable for?
At that point, around 2018, according to David Walker, the former head of the US Government Accountability Office, Social Security and Medicare costs will start to explode. Today, the amount is around $54 trillion and there is nothing about that conversation, or the tough actions needed, that is either easy or painless. Think of it as you having a massive "don´t pay for 20 years" debt which you´ve ignored because – well, it´d not due "now."
10 years ago: Some basic regulations and restrictions could have been set up for subprime lending.
5 to 10 years ago: The insurance industry should have dealt with the insurance products involving subprime mortgages. Unfortunately, the SEC has no authority in this area, and 50 different states have 50 different sets of regulations and couldn´t possibly be expected to deal with these international companies and complex issues.
5 years ago: In the initial phases of the subprime "wave" and the start of stupid lending, minor regulatory changes would have prevented the majority of ninja, no-documentation or fraudulent loans.
The size of Fannie Mae and Freddie Mac was already being discussed and should have been taken a lot more serious. Just like nobody should have all their investments in one single stock, no two companies should have controlled the vast majority of the mortgage market.
Limitations could have been placed on the cancerous mortgage backed securities and credit default swaps which investment firms were selling, rating agencies were blessing, almost nobody understood, but everybody thought were as safe as treasury bills.
2 to 5 years ago: Investment firms should not have been allowed to reach a leverage ratio upwards of 40 to 1. When an individual borrows $40 for every dollar, there´ll be a price to pay down the road. But when these firms have a global reach in the financial world – well, we see the consequences today.
Millions of families should have asked a lot more questions, starting with why they would be sold (or take on) an adjustable rate mortgage when rates were at historic lows and had only one direction they could possibly go.
Last month: Government officials could have done a better job of explaining the mess, the implications, and their consequences for average families, the economy, country as a whole and the world.
Today: The bailout package will take some time to be implemented and start taking effect. It wasn´t an option, it isn´t a final solution, but it also won´t fix the financial world overnight.
The Federal Reserve has now used one of their biggest weapons in reducing interest rates by half a percent, along with other countries ranging from Canada to China and England. Australia reduced theirs by a full percent already, the Irish government has guaranteed all bank deposits irrespective of amounts, and the pain in Germany, England and Spain keep compounding worse than in the U.S. What happens in Vegas might stay in Vegas, but this problem is global, negating any questions of why bailouts are a necessity.
One of the biggest issues right now, along with a dozen other urgent priorities the Treasury Department and Federal Reserve are dealing with, is the lack of available credit. Lower rates are great, but businesses need access to credit in the first place. If we were to be honest, most individuals could do without more borrowing. We´re buried in debt and it´ll take years to pay down our balances even if we stopped making things worse with more debt we can´t afford. But for businesses, borrowing for inventory, payroll and operating lines is a necessity and not an option. Yet, right now, banks don´t even trust each other with overnight loans, never mind lending to businesses when banks have very little liquidity themselves.
Anyone with cash or a consistent monthly investment plan will do very well. After all, when Macy´s has a 50% off sale, everyone goes. But now Wall Street is having a huge sale in much the same way for anyone who isn´t retiring for the next five or ten years and is not purchasing mutual funds or stocks with borrowed money.
Before the end of the year: There will likely be a further need for some kind of bailout package or drastic action of one kind or another.
For 2008: The pain and daily roller coaster of stock market will continue for a while. Part of it is due to uncertainty in the market, recession worries, a bandwagon effect, flight to safety, and concerns over the length of the economic slowdown. Any bailout or rate reductions are part of the solution in a very complex, massive world-wide jigsaw puzzle of financial transactions. Yes, the world is getting smaller and money has absolutely no borders.
It is likely that job losses will reach almost 1 million this year, which makes matters worse – much worse. Anyone unemployed is not going to be helping to stimulate the economy, paying taxes or potentially even be able to pay their mortgages.
For the next year: There is likely no way to avoid a recession, and probably no quick way out. It´s not as though this Christmas shopping season will create much economic activity for retailers, never mind that the key selling period from Thanksgiving to Christmas is a full week shorter than last year.
Next year: The AIG bailout will have been resolved and paid in full since the company had to put up so much collateral (80% of the company) and pays such a high rate of interest (around 11%) they are certainly motivated. It may be why the Treasury Department is considering using the $700 billion bailout package to purchase equity in financial firms rather than purchasing mortgage backed assets.
For the next 2 years: There is likely to be very little growth in the economy as all of us adjust to a very new financial reality.
Hopefully the FBI will be charging many of the mortgage brokers, company executives and others as their investigations continue into fraudulent activities which contributed to where we are today.
Financial regulators should be drafting legislation and policies for investment firms and financial institutions. As a start, is it unreasonable to demand income is properly verified for mortgage applications? Would it seem reasonable not to allow investment firms to borrow up to 40 times their assets when their potential failure ripples way beyond their shareholders? Would it be unreasonable to disallow anyone taking on debt beyond a maximum percentage of their income? Or perhaps it warrants consideration of whether shareholders could be allowed to sue executives for reimbursement of insane bonuses up to two years back when the company has failed?
In 5 years: Should the Treasury Department use the $700 billion bailout they will have recovered the vast majority of the investments in re-selling these mortgage securities back into the market. After all, wouldn´t you jump at the chance to buy back your own mortgage for around 50 cents on the dollar? How do we assure that´ll happen? If the majority of people pay their mortgage, it will.
In 10 years: There´ll probably be another financial crisis. Sadly, we often deal with the "today" problems, and deal with them very well and with a single-minded focus. But we often don´t look down the road at what´s coming next. Sadly, re-active has become more common than pro-active. Isn´t that exactly what many of us do, too? How much of our focus is on the "today" monthly payment versus the balances we owe and the total debt we´re liable for?
At that point, around 2018, according to David Walker, the former head of the US Government Accountability Office, Social Security and Medicare costs will start to explode. Today, the amount is around $54 trillion and there is nothing about that conversation, or the tough actions needed, that is either easy or painless. Think of it as you having a massive "don´t pay for 20 years" debt which you´ve ignored because – well, it´d not due "now."
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