Gather ’round, children, so you will hear
A tale of woe from far and near
A crisis made with patience then haste
’cause you never let a good crisis go to waste
1. How DID we get here?
Once upon a time, farmer John ran an apple orchard. He loved his orchard and the big beautiful apples he was growing with great care. His apples were the best on the market, and, accordingly, usually also the most expensive. He knew enough about marketing to send his most charming, most pleasingly well endowed daughter dressed in her prettiest, well off-the-shoulder peasant blouse to sell his apples. Her customers were happy, and she always sold all the apples her father was able to send to the market.
But not everybody was able to pay his price, and some could only look longingly at those big beautiful juicy apples.
So one day the government’s farm agent decided that it was not fair that everybody could not afford farmer John’s apples. He said farmer John must make his apples available to everybody, even if they can’t pay his price. The government agent said, the reason his price was so high is that he is too careful about selecting only his best apples. If he only threw in a few lower quality apples, even some that are bruised, then he could offer his apples at a lower price and everybody would be able to buy them.
So, against his better judgement and under the government agents threat to revoke his permit to grow apples and take them to market, farmer John packed bushels of his beautiful apples with a few lower quality apples thrown in. Eventually his daughter noticed that some were even going rotten by the time she got them to the market, and when she mentioned it to the farm agent, he said, never mind. They were all hopeful if not fully confident that the customers would know enough to sort them out immediately, before the few rotten apples would ruin all the others. And it would still look like they got a bargain.
Some customers had fancy ideas. They capitalized on farmer John’s good name and reputation for high quality, now that they were able to get his apples at a lower price. They baked pies and offered them as ready-to-eat deserts and snacks. They made apple sauce. They made juice and cider. They did not care that they processed all the good apples and the few rotten apples all mixed together, because the good taste of the good apples would overwhelm the bad taste of the bad apples and nobody would notice. And certainly they would not complain about the great bargain they are getting.
But somebody did notice. Somebody did complain.
And all of the sudden, nobody wanted to buy apple pies, juice, or cider; nothing. The apple processors, who made all these apple products, were in great trouble. They had no income to pay their workers, they had no income to buy more apples and make more pies and juice and cider. And nobody would lend them any money to tide them over until they turned things around. So they went to the government agent and demanded that he compensate them for their loss.
And they demanded that farmer John be punished for selling them all those tainted bushels of apples.
The other farmers, who originally were not able to compete with farmer John on quality, and were envious of his former success and great reputation, joined the chorus calling for his head. They too demanded help from the government, because nobody wanted to buy apples and apple products from anybody anymore. They all blamed farmer John, and of course totally ignored the other part of their problem which was that their own apples were not very good to begin with.
And of course, led by the government agent who caused all this, they ran around like Chicken Little, “the sky is falling, the sky is falling.” Some demanded government grants and loans to help them get past the crisis. Others demanded that the government buy up all the bad apples and all the tainted apple products. If the government would not help, the entire apple industry would disappear. They demanded that the government also buy up everything any food processor ever produced in an apple processing plant, apple-related or not, or the entire industry would disappear.
They all blamed anybody and everybody, except the real culprit, the source of all these problems, which was the government agent who first thought it was unfair that only the best apples would be taken to market because those with very little money are not able to buy them. Only a few looked suspiciously at the government agent, correctly guessing that this is all part of a power grab so he would control everything from the orchard to the store shelves, like some benevolent, omniscient, omnipotent dictator. HE would decide who grows what, HE would decide when to take it to market, HE would decide what the price is, HE would decide what resellers and processors will to make of it.
2. What does any of this have to do with apples?
Now, children, make the following substitutions, and you will understand the real story behind the original bail-out of the financial sector in 2008, followed by more bail-outs, more “stimulus” spending packages, and outright take-overs of several industries by the Obama administration since 2009.
The farmer’s voluptuous daughter represents the often elusive American Dream of owning your own home and the benefits and responsibilities that come with it.
Farmer John represents all the experienced old bankers who followed time-proven sane-and-sober conservative lending rules and were running the mortgage industry, before all the “redlining” propaganda in the 1990’s that has led to all the sub-prime mess which has effectively collapsed the housing market by 2008.
The apples represent the mortgages. The nice big healthy juicy apples are the mortgages that were solid, traditional, conservative, financially sound deals — local buyer with local job, local property, local lender, 20% down payment, good credit, adequate income, and secured by a well-maintained house in an attractive, stable, safe neighborhood. The rotten apples are the mortgages that went to people with low or no down payment, inadequate income, poor credit, on a poorly maintained house in a run-down, crime infested neighborhood.
The apple pie, the apple juice and the apple cider represent the “mortgage-backed securities” and other “derivatives” invented on Wall Street to spread the risk.
The food processors represents all those “greedy Wall Street types” who invented all those derivatives and sold them to unwitting investors, thereby spreading all that bad paper (and thereby committing outright fraud) throughout the world, as well as Fannie Mae and Freddie Mac that the government created to buy up mortgages, good or bad, with the intention of injecting “liquidity” into the market.
The government agent represents all the politicians, usually the so-called “Democrats,” who originally clamored about “redlining” and for “fairness” in the mortgage industry, and have effectively taken over the banking and investment industry, and are putting the government in charge of running this neo-communist New World Order, especially now that Obama and the marxists masquerading as “Democrats” won the elections in 2008 and again in 2012. God save us.
3. Who cares about legalities?
Well, someone should.
If the politicians had really been trying to fix the problem they created, rather than engaging in treason by staging a multi-trillion dollar socialist coup against the American Constitution, they would have proposed a simple solution, the most direct solution to the problem and the least violence and damage done to the Constitution. Such a solution would have consisted of
(1) buying up, at a discounted market price, only the specific individual bad loans (individual borrower, individual property) which the government had forced the lenders to make;
(2) specifically not buying up or even guaranteeing any of the mortgage-backed securities that were infected by these bad loans;
(3) leaving it up to Wall Street to do the bookkeeping and clean up their derivatives, once the government had removed all the bad loans from the market.
And (4), as the American Republic is not a socialist dictatorship, the government would not remain as the owner of these failed mortgages. They would be offered at auction, one by one, case by case, so that any investor, big or small, would be able to participate in the bargain. As an example, I as an investor would be happy to buy a mortgage or two at 25-30 cents on the dollar, and re-negotiate the terms with the original borrower and have him pay me 35-40 cents on the dollar. The government would make some money (from the 25-30 cents), I’d make some money (10 cents), the original borrower would save a lot (60-65 cents), and he’d get to stay in his house and even afford to maintain it properly.
This is far preferable to the alternative, which is that the foreclosed borrower trashes and abandons the house, vandals destroy the rest, and the entire neighborhood decays until there is nothing left except the land and a huge clean-up bill. In the meantime, the failed borrower must still live somewhere, so he’ll be paying rent to somebody, easily about 70-90% of his original mortgage. Well, if he is able to pay rent, then he might as well be paying a mortgage that he can afford, stay in his house, and take care of it.
Everybody wins? Well, no.
Somebody loses — the mortgage lenders who lent more money than the borrower was able to repay. But they have already written off their losses, again through the application of totally unrealistic, contorted accounting rules imposed by the same class of know-nothings in government and politics. At this time it would be nice to remember, too, that the bank or mortgage lender did not use his own money. He was just a broker who put together the deal between the borrower and a depositor — who could be the proverbial little old lady trying to generate some interest income on the nest egg that her husband left to sustain her in her final years, or he could be some fat cat oil sheik or Chinese internet millionaire trying to park his money somewhere safe.
4. How DID we really get here?
It is important to remember that the triggers for the crisis were the toxic mortgage loans, the direct result of a perhaps well intentioned but definitely misguided policy made into law in the 1970s, known as the Community Redevelopment Act. We took another huge step down this road when another manufactured crisis destroyed the home-town based savings-and-loan industry in the 1980s and allowed banks to “diversify” into other areas in which they had no expertise. Further revisions of the rules led to further blurring of the lines between Wall Street and the banks. Clinton’s Department of Justice went on the warpath against “redlining,” the supposedly racist and deliberate refusal by lenders to make risky loans to low income people trying to buy in depressed, run-down, crime ridden areas. The high tech bubble in the late 1990s and the Enron debacle in the early 2000s had lead to further misguided changes in accounting and finance laws. By the mid-2000’s we were deep into a housing bubble, when you could borrow 125% with nothing down, no income verification; so why worry when real estate values were skyrocketing? Well, we did not worry, nobody worried, until one lender found itself in trouble, the US Senate held closed-door hearings, and one late Summer day in 2008 day a certain loud-mouth Senator from New York went on television and said that this one lender’s problems have actually infested the entire industry. The bubble burst and the system crashed the very next day.
And so after the bubble burst, you would have thought that the task was to figure out how not to perpetuate and exacerbate the problem by encouraging the very same irresponsible behavior that has led to this mess, right? After all, if the government bails out the fools and crooks this time, why not the next time? And the next time after that? But instead, the lesson in all the bail-outs and stimulus spending that the Congress had been voting for is that if you make a mess then you’d better make as big a mess as you possibly can so the government would have no choice but to come in and save your hide. Indeed, all sorts of other institutions, from the financial, insurance, college loan, credit card, auto and other industries, indeed every Tom Dick or Harry who were feeling a pinch, were coming forward with their hands out. The government’s wise men further confused the issue as they couldn’t make up their minds whether they wanted to do the bail-out by buying up the toxic loans, or the toxic derivatives, or the failed institutions, or, for no conceivable reason except a blatantly socialist power grab, muscle in like the Mafia on still healthy institutions as part owners through forced sale of their shares to the government.
5. What to do, what to do?
Well, if it is to be government policy to let people with inadequate means buy the house they live in, then it should be a welfare program specifically designed and funded for that purpose, and run in such as way that it does not distort the market. However, no experience with government involvement in any economic activity supports any optimism that this is possible; the government action always distorts the market, and the result of any government regulation is always contrarian, it always encourages the behavior it is supposedly trying to prohibit or correct.
Meanwhile, most renters prove, month after month, that somehow they are able to come up with the money to pay it. If it should be government policy to encourage home ownership rather than renting, then the law should require that renters be given shareholder rights in the property they are renting, in any amount over and above actually incurred maintenance costs. This would encourage renters to be interested in keeping the property in good repair, rather than abusing it, because they own part of it and are paying to maintain it. It would encourage rents to come down to the level of actual maintenance cost, as some owners would rather not dilute their share of ownership. Most importantly this would end the blatant rip-off of tenants by owners who expect the rent to cover their mortgage payments as well. Imagine that; the tenant pays the mortgage, i.e., effectively buys the property for somebody else to own. No, accounting rules notwithstanding, finance costs are not and should not be counted as part of the operating costs, and they would not be, if the owner had paid cash for the property. But in fact he made no investment beyond the initial up-front costs (down payment, taxes and fees). And while the tenants pay the mortgage, guess what? the owner keeps all the money when he sells the property, and he does not share his profits with the people who actually made his payments. He cashes in on his investment three ways:
(1) he pockets the difference between the sale price and his purchase price; i.e., his capital gains; but, more than that,
(2) he pockets the difference between the purchase price and what he actually paid out up front, which is the principal that he borrowed and which his renters paid off; and
(3) all along he used somebody else’s money, not his own, to pay off his loan; i.e., the rent they paid him. The people who made his mortgage payments are left with a stack of cancelled checks.
If the landlord had paid cash for the property, he would of course strive to rebuild his nest egg using the income from his property, so he would both own the property and get back the money he laid out for it. Whether he can do so is totally dependent on the rental market, which is why, of course, we have zoning laws and other restrictions on the supply of housing. But in any case let’s not forget that (1) he’ll get his money back if and when he sells out and (2) he’ll also keep whatever he made from his rentals. Let us also not forget that it is always more “fun” and more lucrative to play with OPM — other people’s money, to put other people’s money at risk, not our own.
The bottom line is, the solution to an economic problem lies in economics, not politics. And therefore we should remember, if anybody still cares, that the US Constitution specifically does not allow the federal government to be involved in any of this, at any level, in any form. Nothing in the Constitution requires or permits the government to be the lender or savior of last resort. The US Constitution was intended and designed to enable and promote free enterprise — not government-run mercantilism, New Deal, “mixed economy,” welfare state, socialism, or communism. In a system of free enterprise, nobody is too small or too big to fail. The market is its own corrective mechanism for any error or misdeed, and it would work just fine if only the government would limit its involvement to criminal law enforcement but otherwise keep its hands off and not issue mandates, requirements, rules and regulations designed not by economist who know something about economics, but by social reformers, politicians and lawyers who know nothing and don’t care that they know nothing about economics. But, tragically for us common folk, they do know way too much about government power and the abuse of government power, which is how we get trapped in bubbles, bail-outs, take-overs and perched year after year on the edge of “fiscal cliffs.”.
(Based on a draft I started in the Fall of 2008)