Wednesday, September 24, 2008

Let’s Be Certain We Find the Real Reasons for This Financial Crisis

The recent upheaval in the financial sector has some people in a panic, most people bewildered, and others busy aiming their pointer fingers at whomever they think is guilty of doing something that contributed to this problem. The presidential candidates are in the latter category. They aren’t quite sure what to do or what to say, but that doesn’t stop them from saying something, anyway.

John McCain made a decisive statement, attempting to show leadership, but his statement was not a very smart one. Barack Obama, by contrast, simply blamed Republicans.

Few things are as simple as politicians make them seem in an election year. Political candidates succeed by issuing pointed statements that are easy to understand and that connect with voters; truth and accuracy are not the primary concerns.

The important thing right now is to figure out what actually happened in the financial sector, and fix things so it can’t happen again. We must ignore the tremendous amount of speculation about what “might” happen, and the doom and gloom soothsayers who tell us that the sky is falling or that the end of the world draweth nye.

Because of its complexity the current financial situation invites simple political messages that connect with voters; it does not lend itself to full explanations that illuminate.

So, when Sen. Obama says that “it’s the Republicans’ fault,” he is expressing a simple idea that a lot of people buy into, but doesn’t explain anything. It is a silly oversimplification unworthy of a man who would be President. It appeals to emotional prejudices and ignores inconvenient realities, and most important of all, it is just plain wrong.

When Sen. McCain suggested that Securities and Exchange Commission head Christopher Cox didn’t do his job, and if he were president he would fire Mr. Cox, the Senator didn’t offer specifics. We’ll know more about Mr. Cox’s role as time passes and we learn more of the details, and can then judge if Mr. McCain’s simple message to voters about firing Chris Cox was a proper evaluation of the situation.

Sen. Obama described the current agony as "the most serious financial crisis since the Great Depression,” ignoring all the recessions since then, even the ones in the 80s and the one following the 9-11 attacks, both arguably more serious crises. Of course, it remains to be seen just how serious this problem will ultimately be, but given Mr. Obama’s abysmal understanding of things economic, we would do well to take his prognostications with a grain of salt.

The root of this problem is the housing market’s subprime loan crisis. A subprime loan is a loan made to someone who under normal circumstances would not qualify for a loan, based upon their income and their ability to make payments. That begs the question: Why would a bank make a loan to someone it believes is unable to make the payments?

The Community Reinvestment Act (CRA) was given life during the Carter administration, and empowers four federal financial supervisory agencies to oversee the performance of financial institutions in meeting the credit needs of their entire community, including low- and moderate-income neighborhoods. Whenever an institution wants to make virtually any change in its business operation, such as merging, opening up a new branch, or getting into a new line of business, it must first prove to regulators that it has made ample loans to the government's preferred borrowers, those in low- and middle-income neighborhoods who normally would not qualify for a loan. Lenders with low ratings can be fined by the government.

The Carter administration used tax dollars to fund numerous "community groups" that helped the government enforce the CRA by filing petitions against banks whose “cooperativeness” didn’t measure up, and sometimes stopping their efforts to expand their operations. Banks responded by giving money to the community groups and by making more loans. One of those organizations was the Association of Community Organizations for Reform Now (ACORN). An active associate of ACORN in the 90s was a young public-interest attorney named Barack Obama.

So, starting in 1977 the federal government began “encouraging”—perhaps “strong-arming” is a more accurate term—banks to make loans to people to whom they normally would not make a loan, and in 1995 the Clinton administration pushed through revisions to the CRA that substantially increased the number and amount of these loans.

All of the bad loans weren’t caused by the CRA, of course, but billions of dollars in CRA loans did go bad, as should have been expected. When Fannie Mae and Freddie Mac came along and made it possible for banks to escape the risk associated with these ill-advised loans, conditions were just right for a large portion of the banking industry, even institutions that did not fall under the CRA, to become involved in making loans to unqualified borrowers, and banks participated in big numbers.

The federal government’s fingerprints are all over this crisis, and the Democrats who are today so righteously indignant and blaming the administration are at least as guilty as the Republicans.

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