The Warning Signs Were There

Everyone knew that this was a possibility, but everyone - Democrats and Republicans - went along with the idea, because who isn't for expanded home ownership?

It makes money for everyone when times are good. Banks make money on loans. Homeowners see prices appreciate because there are more buyers who are bidding prices up, and all the spinoff industries that rely on real estate do well (insurers, real estate agencies, and builders among others).

However, if times change and the market enters a real estate correction, the situation changes. Badly.

Even the New York Times noted this possibility back in 1999 when Fannie Mae loosened restrictions on borrowing:

The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.''

Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry."

So, how much will this bailout be? The $700 billion number that's being bandied about is a cap. The initial amount is likely to be $250 billion, and President Bush could get another $100 billion if good cause is shown. Then, if that is insufficient, Congress could then approve another $350 billion.

All that liquidity is seemingly necessary to get the markets back on an even keel.

I'm uncomfortable with the idea of the government bailing out businesses that made bad business decisions and loans to those who were not credit worthy, no matter how altruistic the intention was or how badly Congress and the Administrations at the time wanted to increase home ownership. People were given money they had no way of ever repaying the moment the music stopped and prices began to drop as housing entered a correction.

There are enough ways for a bank to lose money without engaging in the riskier lending practices that got banks like Washington Mutual into trouble. It's not simply that they wanted to be a different kind of bank by not imposing fees for checks or ATM usage. That's chump change compared to the billions in assets that are no where near as close to reflecting market value. These assets are so far underwater that the bank was seized by FDIC last night and sold to JPMorganChase.

That move, in and of itself, is quite unusual and should raise eyebrows - WaMu had been in trouble for months, but no one wanted to move on it because they thought the price was too high. JPMorganChase got WaMu on the cheap via the FDIC action, even taking into account the writedown of $31 billion in bad debts from toxic paper. They've paid pennies on the dollar for the assets - including all the branches and depositors accounts.

So, now we continue to hear about finger pointing and the Democrats are blaming McCain for a failure in the talks, but the numbers show otherwise. Democrats could approve the measure without any Congressional GOP signoff on the deal because they have the votes in both the House and the Senate. President Bush would sign off on the brokered deal, but apparently Democrats, including Reid, Pelosi, and Obama, don't want to be seen as being tied to President Bush and his administration's policies alone. They want to hold the GOP to this as well - and McCain was called upon to deliver more GOP support. They want and need the political cover in case this goes sour. It also means that if the deal gets done, McCain looks good because he helped deliver the package, regardless of the merits - the financial companies will rally on the news of the bailout since it rids them of the toxic paper.

Some financial experts are on down the idea of a bailout, including Chris Whalen. Smaller banks are not in the same mess as some of the larger institutions.

A poll at CNBC thinks that the markets should be able to work this out without the bailout. It's more than anecdotal. I'm inclined to agree; the case for the bailout has not been made to adequate satisfaction, and the idea that the Democrats have larded up with proposal with handouts to groups like ACORN does the bailout plan no favors.

ACORN is responsible for getting subprime mortgages to those who could not afford the mortgage payments, and is routinely involved in voter fraud and corruption at every step of the way. It's part and parcel of what they do. Affordable housing comes about when there's a ready supply of homes, and if people do not have the capacity to pay, the solution isn't to create riskier products to offer mortgages with - such as no money down, low APR adjustable rate mortgages. It's to offer products that show that there is capacity to repay - that there is income verification, and that there are assets backing up the loans in case the market adjusts.

That any money is being considered for this organization is reprehensible at best, and throwing good money after bad at its core.

Speaking of criminality, investigations are now being opened into the Friends of Angelo Mozilo (who ran Countrywide and engaged in a program to give sweetheart deals to major politicians), who include none other than Sen. Chris Dodd, former Fannie Mae Chief Executive Franklin Raines, and others, including California state appeals court judge Richard Aldrich. Dodd is the Chair of the Senate Banking Committee, and has previously claimed he didn't know he received a good deal on his mortgage. Right.

Meanwhile, John McCain will indeed head to the debate tonight in Mississippi. It should be a real barn burner, even though the ostensible topic was to be foreign policy.

UPDATE:
This notion makes sense, which is why a quick deal is unlikely:

Now let me tell you something very simple and very important: You can try to prevent a financial meltdown or you can teach Wall Street a lesson, but you can't do both at the same time.

So which will it be?

You say you want straight talk -- no spin, no bull, no sugar-coating. Okay, here goes.

First, stop fixating on Wall Street executives -- there will be time to deal with them later. Even if you clawed back every dime they made over the past decade, it would come to several billions of dollars. That's a rounding error compared with the size of the financial problem we're facing here.

Second, we need to act quickly. The financial situation is now downright scary. Don't look at the stock market -- that's not where the problem is. The problem is in the credit markets, which are quickly freezing. I won't bore you with technical indicators like Libor and Treasury swap spreads, but if you talk to people who work these markets every day, as I have, they report that the money markets are in worse shape than they were last August, or even during the currency crises of 1998.

That's also why the Democrats idea that we limit executive pay is a nonstarter - it has nothing to do with the crisis and how it can be resolved. It's simply meant as a punishment for some executives, and it also means that others will be dissuaded from taking these high stress positions at this time. There's a reason that many of these executives were highly compensated - they made lots of people lots of money. Now, they're still getting compensated, but the money dried up for everyone else.

I am concerned that a piecemeal bailout and selectively choosing which banks to flush down the market - like FDIC to WaMu - is not in the best interests of the nation. WaMu claimed up until yesterday that it could work its way out of the mess and that it was seeking a sale to another bank. FDIC made it happen in a very visible and naked use of federal power.

UPDATE:
This video says it all on how we got here and who the big players are. Money talks: