Congratulations. You have gotten a job, earned some money, paid some taxes and are now supporting hundreds of people who are living beyond their means. Recent events in the past few weeks have brought the long discussed ‘credit crises’ to a boiling point. The events of the past week clearly indicate a major reform and overhaul of Wall Street and the Investment Banking Industry;, it is not the taxpayers’ responsibility to bail out banks that took too large a risk in lending, or borrowers who took loans they cannot afford.
The sub-prime mortgages – loans made to people who can’t quite afford to repay them – have been bundled together and sold as asset backed securities in the form of CDOs (Collateralized Debt Obligations) and SIVs (Structured Investment Vehicles). Large investment banks have been turning a profit on these CDOs and SIVs for years because mortgages are a comparatively safe bet. Sure, a mortgage will fail here and there, but the equity in the loan and the value of the foreclosed asset ensures that losses are small and most people manage to avoid defaulting on their mortgages. The problem began when banks made poor lending decisions, offering loans to people who could not pay them back, banking on the fact that if they defaulted, the foreclosed home’s value would recoup the bank’s losses. The problems were compounded when, because of lacking regulation, they were able to bundle these sub-prime mortgages with prime mortgages and sell the whole lot of them in SIV’s and CDO’s rated as ‘AAA’ (The highest rating). No one can now tell how many bad loans are in the SIV’s in which they have invested. Imagine buying barrels of oil that you are told may contain a little bit of water – the catch is you won’t know how much water is in the barrel until you buy it and open it up. It could be 20% water, or it could be 80%, and there is no way to tell in advance, you just may end up with a worthless barrel of oil.
The problem continued when people began to default on the mortgages, driving up interest rates and abruptly halting the housing boom, lowering the value of homes as the supply of buyers evaporated. Now, the house the bank forecloses on and the equity in the loan is insufficient to cover the amount of the loan the bank initially made, and losses begin to pile up. The large investment banks around the world are now stuck with trillions of dollars in SIV’s that may not be worth the paper they are printed on. Freddie Mac and Fannie Mae owned approximately half the mortgages (approximately $5,000,000,000,000) in the US and faced collapse if the government did not bail it out. If Freddie and Fannie did not get a bailout then the banks that made the initial loans would almost certainly fail, causing runs on banks and most likely a depression. The investment banks insured their investments with companies like AIG, who easily possessed the capital to shield the bank from the expected number of defaults but did not anticipate the immense number of claims they received, bringing it to the brink of collapse as well. Because the underwriting behind their investments is worthless, the bank is fully exposed to all of the losses and faces collapse.
What it all boils down to is that companies like Freddie Mac and Fannie Mae (public companies operating for profit) were allowed to take too much risk and hold the Federal Government hostage for a bailout because the alternative would be to risk a depression and catastrophic failure of the banking industry. The government has now used your money to cover the backsides of people who royally messed up and have escaped the normal market consequences of such a failure. It is illogical that the government should be responsible for the health of private financial institutions outside of its control. The government should get out of the loan guarantee business as soon as is now feasible and establish regulations that control the following: A.) create concrete lending guidelines to prevent sub-prime mortgages in the future. B.) Stop public funding for Freddie Mac and Fannie Mae. It is a conflict of interest for a publically backed company to operate for profit and the government doesn’t belong in the industry. C.) Regulate the bundling of CDO’s and SIV’s so that the risk associated with each SIV is uniform and easily discernable. D.) Create guidelines for companies that established a ceiling for the risk institutions take if their survival is crucial to the well being of the United States. E.) After the situation is stabilized, stop making bailouts to non-essential businesses immediately and allow the market to right itself. F.) Hold accountable executives who make greedy decisions that undermine the US economy and screw their shareholders and fellow taxpayers.
You and I have many needs the government must help to provide: defense, education and affordable health care to name a few. Underwriting Joe Smith’s mortgage in Fargo, North Dakota and giving $85 Billion to an insurance company that underwrote more risk than it can afford is not something the government is obliged to do. No matter what happens in the next few weeks, you can be assured there will be inflation, higher taxes and a burden on you and your fellow Americans for years to come because of the events of the past couple years. It is time that companies faced the music for their decisions, and part of getting this second chance means making right what they did wrong in the first place. They should pay back the American people and the American people should not be saddled with their mistakes in the future.
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