The mortgage bailout demystified

by BD Pisani - 2008 sep 23

Nobody I know here in hayseed country is economically astute enough to fully comprehend the current financial crisis. I most certainly don't, but from my vantage point down here amongst the trailer-dwelling, bitter-clinging masses, I've attempted to cobble together a common-sensical understanding.

The problem in plain language

The trouble with trying to comprehend intricate, convoluted, long-festering situations like this financial crisis is that there is simply too much to absorb at once. Also, we common folk don't speak the lingo: Finance-ese, Economics-ese, Government-ese, etc. So what we have to do is break salient points down, one at a time, and translate them into words we can understand.

If what Kevin Hassett, director of economic policy studies at the American Enterprise Institute, states is true, then this mortgage fiasco can be boiled down to something any of us can grasp: Government-funded entities like Fannie Mae and Freddie Mac over-extended capital by becoming key enablers of the mortgage crisis. They fueled Wall Street's efforts to guarantee money for sub-prime loans by becoming the primary customer of all AAA-rated sub-prime mortgage pools. Translation for us back-country bitter clingers:

They bought up risky mortgages forced upon lenders by government social engineering, then couldn't cover them when low-income people who had no business even attempting to purchase homes defaulted.

It is important to remember that the phrase "sub-prime loan" is code for affordable housing -- housing for others paid for in taxes by you and me. Stated another way, it's a good bet that none of you home owners reading this have a sub-prime mortgage loan -- yours is prime.

Sub-prime mortgages are mortgages given to people who can't afford traditional mortgages. They can't afford down payments. They can't afford to make the going rate of interest payments. So new types of loans were invented to get these people into homes but which were extremely risky. There were no down payments, low introductory rates, and sometimes no closing costs.

Fannie Mae and Freddie Mac, in order to show ever-increasing assets on their balance sheets, would buy up these loans which ultimately proved worthless.

So here's the mortgage crisis in a nutshell, pared away to the bare essentials without all of the partisan rhetoric and poli-babble:

1) Risky giveaway affordable housing mortgages default. 2) The likes of Goldman Sachs, Bear Stearns, and American International Group (AIG) fail. 3) You and I as taxpayers wind up stuck with the bill.

History and blame

We always have to assign blame, don't we? Well, blame will ultimately be determined by your political bent and your personal degree of gullibility. But as a common-sense observer who does not pretend in any way to be an economist, I tend to agree with what follows. Here's my synopsis in common-speak you and I can understand without losing its technical flavor:

History. Over a span of years, Fannie Mae alone owned or guaranteed nearly $400 billion in high-risk mortgage investments. Add in the other players and you are talking trillions of dollars.

All of these high-risk mortgage investors created a situation where even mortgage-backed securities held by unstable investors could flourish -- as long as real estate prices stayed high. Ah, but there's the problem. Trillions of low-risk dollars of rising housing market investments suddenly became vulnerable -- high-risk -- once the market began to fall. Fall it did, and the collapse followed.

Blame. As to the question of how it all got started, take your pick. Some allege the crisis stems from:

As to blame, some point fingers at:

This is where your political bias and gullibility factor kick in.

Regardless, all anyone had to do was end government socializing of the free market, take Fannie Mae and Freddie Mac out of the picture or at least strictly regulate them, and this whole mess would never have occurred.

Recent timeline

Congress supported previous administrations when they pressured the private banking sector to make these risky loans and protected Fannie Mae and Freddie Mac when they bought up these loans.

2003 The Bush administration attempted to impose accountability on Fannie Mae and Freddie Mac when they tried to force them to accept outside auditors and require better capitalization. This was thwarted by Congress, led by Representative Barney Frank and Senator Chris Dodd.

2005 Fannie Mae and Freddie Mac were in financial trouble and wallowing in accounting scandals. It was so bad that the Securities and Exchange Commission's chief accountant told disgraced Fannie Mae chief Franklin Raines that Fannie's accounting methods were scandalous.

2005 Alan Greenspan told Congress it was urgent it to act, "If Fannie and Freddie ... continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolios, which they need to do for interest rate risk aversion, they potentially create ever-growing potential systemic risk down the road ... We are placing the total financial system of the future at substantial risk."

Subsequently, a workable Fannie and Freddie reform bill was passed by the Senate Banking Committee. The bill gave a regulator power to crack down, and would have required the companies to eliminate their investments in risky assets. If that bill had become law, the world today would be very different. But Democrats opposed it on a near party-line vote in the committee. Republicans, tied up by rigid Democrat (along with some moderate Republican) opposition, couldn't even get the Senate to vote on the matter.

It is noteworthy that Senator John McCain was one of the three cosponsors of S.190, the bill that would have averted this mess.

Bailout and beyond

Now the government wants to absorb all of this bad debt to the tune of $700 billion to more than $1 trillion. This essentially transfers the burden off the backs of those responsible and onto ours, the taxpayers.

This is the most far-reaching government takeover of a massive part of our economy ever -- and it still isn't enough. Frank and Dodd want even more money for "contingencies" (read slush funds). Obama and Pelosi want oversight -- meaning that the Democrat Party gets to determine where the money goes -- and that means not just for debt relief but for agenda-driven cohorts like ACORN and similar community organizers, unions, and like-minded constituents.

Considering the players involved when this whole mess started, that's like charging the fox to guard the chicken coop.

The current congressional majority wants the American taxpayer to subsidize not only the buyout of bad loans that have yet to fail, but also the money necessary to bolster individuals who, in many cases, shouldn't have bought houses in the first place.

Obama, Pelosi, Reid, and Congress see this as an opportunity to change the identity of the American economy, to redistribute wealth on a scale never imagined by even Franklin Roosevelt when he founded Fannie Mae as a New Deal government agency in 1938.

So there it is, plainly speaking. Welcome to American socialism.