How Did This Mess Start Anyway?

Towards the end of almost every business or staff meeting in my place of work, we all look at each other to begin the process of plotting out the dreaded “next steps.” Of course, there doesn’t need to be any dread associated with moving forward, we should all simply leave the meeting determined to do our jobs, in essence to do what is expected of us.

Now that the State of the Union address is behind us, it is probably appropriate if we all took a deep breath and thought about next steps. As it is with most things moving forward however, it is probably best if we first examine where we have been, take any lessons learned from that experience and then move forward, armed with the knowledge gained from whence we came.

Regarding our economy, it was years of easy money that motivated all manner of financial institutions to provide lending opportunities to both individuals and businesses that at one time were considered a credit risk. Ironically, that time has come again with the strictest requirements for credit seen since the Great Depression. The result of all that credit…….according to Jim Grissett, an adjunct professor of real estate and founding partner of the Parthenon Group, was “Excessive leverage caused by overconfidence in new asset securitization investment products.”

In plain English, what Professor Grissett was saying was that the combination of record low interest rates and relaxed lending rules allowed millions of formerly non-qualified borrowers to become just that—folks who suddenly discovered that they could borrow money after years of being denied loans. The consequence of all that free money resulted in prices rising higher which in the field of residential real estate meant that home builders really went to work, building thousands of new homes and creating a glut of new homes in the marketplace. For those who already owned homes, this new money meant that they could re-finance, spend the equity or open up new home equity lines of credit.

Meanwhile, back at Wall Street, financial institutions purchased, bundled and then re-bundled risky debt while simultaneously borrowing MORE money. In the boldest sleight of hand trick since the 1930s, some of the largest firms in the financial sector boldly designed new financial products burdened with subprime and adjustable rate mortgages (ARMS) and then had the chutzpah to create barely legal and for all practical purposes, un-audited accounting strategies designed to ensure their own triple A or excellent credit ratings—even though they were under a mountain of self-generated bad debt. The criminality of all this is that because they had awarded themselves Triple- A credit ratings, other entities such as commercial banks and pension funds rushed to invest in these debt laden and therefore risky financial products.

President Obama’s administration made the point early in his presidency that the financial meltdown did not begin after he took the oath of office, that indeed, the near collapse of our economy fell squarely in the midst of the Bush presidency. Despite what one may think about our current President, (Full disclosure: I am an admirer of this President) on this point, he is only half correct.

In 2007, the American real estate market began to cool off as the economic ship of the State began to right itself from the wild and crazy ocean of those years where everyone got credit and those with credit borrowed more than they could repay.

As the market cooled, interest rates began to rise, slowly at first, triggering ARMs to reset at higher rates than even the homeowners had been led to believe at the point of purchase or re-finance. Thus, borrowers began to default and foreclosures, an almost unthinkable phenomenon in previous decades, began to rise. Consequently, lenders found themselves with no place to turn with their excessively bundled loan packages and so they were without means to raise additional capital. Then, if that wasn’t enough, government institutions engaged in the mortgage finance business, such as the Federal National Mortgage Association (also known as Fannie Mae) and the Federal Home Loan Mortgage Corporation (also known as Freddie Mac), lost right around 2% of their collateral. According to our Professor Grissett, This was “not the end of the world.” The problem however was that those loans were leveraged at a 40 to one ratio which was the beginning of the end of the world.

History shows that the activities of the financial sector had help getting mired in the quicksand of economic collapse. Beginning around 1980, public policy actually encouraged the kind of leverage that was not only excessive, but as it turned out, was also damaging to the overall economy. During the Clinton era, the administration developed and implemented his National Homeownership Strategy followed up by President Bush’s American Dream Down Payment Act of 2003 which among other things offered tax credits to minority home buyers. These two initiatives while seemingly beneficial actually began the slide to insolvency for hundreds of financial institutions and millions of American families.

Meanwhile, Wall Street in response to the government’s almost manic desire to turn every American into a homeowner or move every homeowner into a bigger and more expensive home went to work designing all manner of products to meet the demand. Government regulators were unable to slow down the innovation and proliferation of new loan products developed by Wall Street and so as Sonny and Cher used to say, “The beat went on.” So, while Democrats blame Republicans and vice-versa, there is apparently enough blame to be shared by both political parties.

As a government, the United States for some time has spent more than it has taken in. In 2007, the U.S. trade deficit was a little over $700 billion. The trade deficit for this past year was more than $10 trillion and moving forward, looms the coming destruction to the nation’s budget caused by increased Social Security and Medicare. The apparent failed attempt by Congress to reform healthcare in this country can only spell certain disaster with regards to the ever rising cost of healthcare.

Despite the cries from certain quarters that “Congress is wasting our money” and the more visceral screams from the tea bag contingent, individual Americans don’t manage their money any better than their government does. As of June of last year, consumer debt stood at $2.6 trillion, more than $8,500 for every man, woman and child who lives in the United States. The real scary part however, is that consumer debt does not even include debt secured by real estate!

The real nightmare that has emerged from this financial meltdown however has been the horrific unemployment rate. The loss of jobs has been staggering at one time averaging more than a million job losses per month. The current administration has at least ebbed the flow of job loss and one can only hope that the current slowdown in monthly job loss will ultimately and very soon turn into no loss and then job gain.

The one thing we have on our side, and maybe the only thing right now, is that America is a country that has been here before. Out of the ashes of the crash of 1929 and the subsequent Great Depression, America rose to become the mightiest and most powerful economic engine the world has ever seen. The spirit of the American worker is unsurpassed and while there is much to be done, it is my sense that we will get there, returning to the economic greatness we once represented, and to some degree—still represent.

While some may criticize the President’s stimulus as a kind of “quick fix” approach, I believe that the stimulus held us at the abyss of total economic collapse, keeping us all from falling in. Yes, there has been some waste, as there is with almost all government spending. Just look at the history of military procurement and one can find enough waste to put every American out of work today back to work tomorrow. And yes, the stimulus hasn’t created as many jobs as was imagined, possibly because some economists such as Paul Krugman have argued that the stimulus wasn’t large enough. Realistically however, jobs have not only been created by stimulus dollars but equally important is the reality that jobs have been retained, accounting for the fact that the slide to joblessness in this country has abated.

Now that we know how this mess happened, we just need to look at each other and determine the next steps.