Don’t Bank On Banks

The economic dislocation of the past weeks reveals a disturbing underside. The bubble in bad mortgages, we learn, was fueled by politicians pushing Fannie Mae and Freddie Mac — the government-backed secondary market for mortgage packages — to encourage bad loans to minorities using the 1977 Community Reinvestment Act passed under Jimmy Carter as a massive affirmative action initiative.

Under Bill Clinton in the 1990s, the movement to push bad mortgage loans reached a crescendo, ginning up the number of total mortgages backed by Fannie and Freddie. As standards were abandoned for minority loans, the requirements for non-minority loans declined too. The sinister ACORN entered the fray, threatening banks and mortgage lenders to make bad loans to minorities or have their mergers halted or their charters revoked. The bubble grew and grew.

The politically appointed executives of these two semi-government agencies were making obscene salaries and commissions, a situation they obviously wanted to maintain. To keep their sinecures, they handed over large campaign contributions to Members of Congress and the Senate sympathetic to the cause in the name of a grand gesture to minorities. The top recipients included Congressman Barney Frank and Sens. Christopher Dodd and Barack Obama — who somehow was not tainted by the association, while John McCain, who stood up to the bubble at Fannie and Freddie, was stained.

Meanwhile, the sharks swimming up and down Wall Street smelled easy money. Said the Great White to the Hammerhead: “The low interest rate environment during the last decade forces investors to keep the stock market going as cash investments pay too little. If we can concoct investment vehicles with high rates of interest, everyone will buy and we can ooze on down to the Caribbean laden with cash before anyone knows what happened.”

Thus the Sharks invented the “mortgage-backed security investment vehicle,” comprised of the surfeit of mortgages pluming into the financial ether, keying on the factor that high-risk mortgages charge punitive interest rates to the under-qualified. The Sharks packaged huge portfolios of mortgages — mixing the good and the bad with their high rates together — and slinked around to their associates in charge of investment portfolios around the world offering investments paying 10-15 percent — far above the going rate. And the packages were rated Triple-A by Moody’s and Standard & Poor. The financial bureaucrats never stopped to think the return was so high because many of the loans were risky. Instead, they jumped at the chance to make their bones for their bosses with a can’t-lose investment offering unheard of returns.
Fannie and Freddie and the Sharks created an insatiable demand for mortgages. Investment firms leveraged everything to buy more and sell more. Standards for mortgage qualification fell further in the melee. Then the other foot fell. Inevitably, a large portion of the mortgage-holders couldn’t make their payments. The underlying asset of the packaged securities vehicles started tanking. Frantic calls from the institutions who bought the packages ensued. Take it easy, the Sharks said, the packages were rated Triple-A. We even bought “insurance,” we called it a “credit default swap” to avoid insurance regulations.

But the rating firms did not audit any of these packages when they gave them Triple-A status. Since they were “insured,” they were rated as golden. Then the perfect storm hit. Huge insurance providers — most notably AIG — could not meet the claims as defaults piled up. Down goes AIG and others and the US government had a problem of thermonuclear proportions. On top of bailing out investment firms and Fannie and Freddie, you and I now own 80 percent of AIG.

To its credit, the Bush administration has a plan in place to settle down world markets by pumping cash into the system so banks will go back to borrowing from the Fed and from each other and lending to customers — which is how we do it in the US with no central bank to intervene. But, while you can lead bankers to the credit window, you can’t make them lend it to customers when they are interested in investments, not loans. That is why conditions are still unstable.

While ordinary people and small businesses — the engine that makes the economy run — are berated for taking on debt to grow their businesses and live a decent life in the land of free markets, we learn that banks — big and small — run entirely on credit they leverage mostly to invest rather than loan. They borrow like drunks, and when they can’t pay, there are no KGB-like calls at dinner threatening to ruin their credit. There is no consequence to the culprits in management, only to their shareholders, like the thousands of North Carolinians who put their faith in Wachovia thinking they were actually a bank.

We should revolt against the naked fact that sanctimonious bankers who say “no” to their customers never hear it themselves. New banks don’t even worry about attracting local depositors. They simply go online and purchase deposits from other banks to manufacture an asset base to — you guessed it — borrow against to make investments.

And now the economic plan is faltering, and I think I know why. The banks haven’t been lending for 20 years, so why do the federal planners think they will now? It’s a lot easier and more profitable to take the new money and invest it than it is to stimulate the economy with car loans and small business lines of credit.

Worse, bankers criticize ordinary people for not saving enough and using credit to live a proper life while they leverage every day. If banks would restore local lending without requiring customers to take out yet another high-interest credit card or refinance their homes — which helped fuel the current crisis; cease allowing kids to overdraft at the ATM; and offer compound interest on savings accounts, the problem could be fixed. As I asked a banker recently, what ever happened to the 90-day note?

Bankers, heal thyselves before you inflict any more damage on the rest of us.

Notes From La-LA Land
Missing Person Alert: Where is Libba Evans?, the Secretary of Cultural Resources, on “sabbatical” since March, only surfacing to be tainted with a junket to Estonia and Russia that is raising eyebrows around town? Rumors abound but no one seems to know, except perhaps King and Queen Easley, closeted in the royal palace on Blount Street where secrets are jealously guarded as state government falls into continued disarray. Has the Bobby Knight of government grandees, who purges employees with impunity, been “eliminated,” or is it to do with business dealings better left unsaid?

(Read commentary by Bernie Reeves in his Between Issues column online at www.metronc.com.)

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