05.31.2011 Original Publish Date
06.11.2011 update
02.06.2016 update (replaced broken links, format update)
10.04.2020 This article now archived from Housing Crash FAQ to U.S. Economy.
Top Lobbying Banks Got Biggest Bailouts – But Gov Helped Create the Housing Crash
original article written by Net Advisor™
There was a publication released last week by the National Bureau of Economic Research, reported by Lauren Tara LaCapra and published by Reuters.
The report, “A Fistful of Dollars: Lobbying and the Financial Crisis” written by three economists from the International Monetary Fund (IMF) attempts to draw a link between bank lobbying efforts from 2000-2007 to receiving big bailouts.
The (now former) head of the IMF has been under some controversy as of late. It should be noted that the United States is the largest financial contributor to the IMF, where the U.S. borrows money to bail-out other governments.
“All across America, people are suffering from bailout fatigue. At a time when America is already borrowing 40 cents of every dollar it spends, does it make sense for us to borrow more money (much of it from China) to help bailout Europe?”
— Rep. Cathy McMorris Rodgers (R-Wash.), Source: CBS (PDF) 05-15-2011
With that said, these three IMF economists are indirectly on the U.S. government’s payroll. So any attention to focus a report away from government involvement in the housing crisis, especially nearing a Presidential election year, and instead blame it all on “Wall Street banks,” the better right?
Report Premise Contains a Fallacy of Logic
The correlation of banks who lobbied government over the last seven years (2000-2007) does not imply causation to receiving bigger bailouts. I would argue that this is an example of a cum hoc, ergo propter hoc or “causal relationship.” The economists are trying to draw a link to banks and their lobby efforts over the past 7 years to equate bigger bank bailouts.
Let’s take a look at some of the facts:
[1] Banks and all businesses or their affiliated organizations, including unions, environmental groups, farmers, and anyone else who has an axe to grind will lobby for or against regulations that can impact their business earnings or their political social agenda.
For a business, this is a simple preservation of it’s revenue, which can also impact its bottom-line, and that in-turn impacts stockholder’s equity of public companies. If a company has declining revenue, a company may be forced to move their business to where it is less regulated and more profitable, such as to China, India, Mexico, etc., thus losing American jobs because of such high costs and regulations.
[2] It can also be reasonably concluded that the bigger the business the more money it will have at its disposal for lobbing efforts. Thus, in this case the biggest banks would have more money to lobby than say the smallest banks.
[3] I would agree that some banks were technical failures. I discussed this back in 2007 naming which institutions had financial problems in my view before many, including the stock market or government were willing to admit there was a problem. Scroll down to NetAdvisor’s 2007 Yahoo post here and here to see list of companies with financial problems at that time.
Government Forced TARP on Banks, Not the Other Way Around
[4] The big TARP bailout was forced upon the major banks by then U.S. Treasury Secretary Henry “Hank” Paulson. Paulson forced (PDF) the big banks to take up to $25 Billion each even if they didn’t need the money. Paulson didn’t want to show that some banks were having bigger financial problems than other banks. Paulson thus wanted to put all the big banks on an even playing-field: everyone will hate you equally. Maybe that was not the intent, but Paulson did not want to show which banks were the weakest fearing panic after what happened when Lehman Brothers collapsed.
Paulson also thought that if the big banks took government money in exchange for partial government ownership, then the little banks would be eligible for government bailouts too.
“Under a programme described by President Bush as “unprecedented and aggressive”, the US treasury will buy minority stakes in nine leading banks including Goldman Sachs, JP Morgan, Bank of America and Citigroup. Thousands of community banks will be eligible to follow.
Many of Wall Street’s top banks were unwilling to take the money, fearing it would be seen as an admission of weakness, but they were given little choice by the US treasury secretary, Henry Paulson.”
— Source: The Guardian.UK, (PDF) 10-15-2008
Even though most of us despised the big bank bailouts, I would argue that it had to be done as a matter of public confidence in the U.S. banking system which was moving to massive failure and in rapid succession, especially during September and October 2008.
Side Bar on the Banking-Housing-Credit Crisis of 2008
In my professional view watching every tick of the market and simultaneous newscasts especially during that time I intuitively felt there were several Friday’s where I thought the entire U.S. banking system and the U.S. economy was just ripe to collapse with one last error or another major bank failure.
As a result of this thinking, I advised my private clients to short the S&P 500, and specific banks, especially on Fridays. The thinking was that after listening to the reality of the bad news over a weekend, investors would call up their mutual fund and discount brokers on Monday with orders to sell. I posted a sample of those trades when I was trying to help people on Yahoo with financial questions from 2007-2010 here.
I had a pecking order of which banks were likely to fail based on the trading patterns, charts, intuition, experience, and associated news. I was even buying $2.50 to $5.00 put options thinking the underline stock would go to zero. My max profit was the difference between trading cost less the cost of the put option. Yes, the profit potential was just a couple dollars to near $5.00, but multiple that by the number of option contracts (100x per contract), trading lots of contracts and that’s money. A couple times I gave the U.S. economy about a week before a total collapse. I was betting on more bankruptcies and more bank failures. It took a long time for government to get a clue what was going on and develop a loose plan to stop the economic bleeding.
Keep in mind this was not just about housing, bad loans, or “Wall Street.” The problem grew in 2008 to where no financial institution in the world was willing to loan to anyone fearing their counter-party might go bankrupt. And if their counter-party went bankrupt, that might put the lender in bankruptcy too, and so on. This is what panicked markets.
“Banks were leery of lending to each other out of fear that counterparty risk would materialize.”
— Source: Dallas Federal Reserve Bank (PDF), Feb/Mar 2009 Report
Bail-Out Inc.
So, Treasury Secretary Paulson got ALL the big banks to sign on to his bail-out plan so investors wouldn’t dump the “bad bank” stocks which the Street was doing before the government stepped in. After the government guaranteed virtually everything as the “lender of last resort” the risk of economic failure went from 99% to near 30% in my view. This created stability in the market place giving time for the banks to work out the problems.
However, I argue that the government intervention expanded too far and has become a political agenda to control more of industry (AIG, the Auto’s (GM & Chrysler), Fannie Mae, Freddie Mac, Health Care, etc). The biggest risk to the U.S. recovery, and thus the economy at this point is the U.S. government with its record deficit spending, the smoke and mirrors of pretending there are budget cuts.
Get Me Out of TARP, Please?
[5] All the big banks lobbied to repay TARP as soon as possible with huge interest, and the new Obama Administration resisted this effort because I argue he wanted to nationalize the banks given the crisis in hand.
“Never let a serious crisis go to waste. What I mean by that is it’s an opportunity to do things you couldn’t do before.”
— (Then) White House Chief of Staff Rahm Emanuel, Source: Wall Street Journal
VIDEO:
https://www.youtube.com/watch?v=_mzcbXi1Tkk
Note: As of 05-27-2011, the stock market (the DOW) is up 4,000 points (CNBC Video).
[6] Eventually, through LOBBYING, the big banks begged to repay TARP, and the Obama Administration reluctantly agreed (Source: New York Times & NY Times Deal Book).
[7] All of the big banks have since repaid TRAP – I mean TARP with interest (TRAP – a Freudian Slip). Wells Fargo was the last major bank to repay the government (Source: Market Watch).
Some Banks Still Have Elevated Risk
[8] Some banks are still in financial difficulty in my view even today: (1) Bank of America (BAC) with its $850 Billion (over three-quarters of one trillion) in bad loans. B of A should have never bought Countrywide or Merrill Lynch – both could have been acquired in bankruptcy for a song, and discharged, reduced, or restructured the debt. I discussed these risks professionally at that time. If I recall correctly, I also posted answers/ comments on Yahoo during the time in question. (One may have to search through the 5,000+ posts. I will try to dig through them when more time is available and update here later.)
B of A also took on additional risk by acquiring 180,000 Ginnie Mae accounts from the government’s own home loan portfolio. In March 2011, the Federal Reserve rejected B of A’s request to increase their dividend. The rejection sent a signal that B of A needs to retain its capital to manage their massive bad loan portfolio.
Next, to a lesser extent, Wells Fargo (WFC) still has elevated risks to manage because of its buyout of failed Wachovia Bank.
Now, the FDIC never said Wachovia failed, but in all technical terms, the bank failed, which required a takeover by someone to save it from bankruptcy. Wachovia was a great bank until it made a fatal mistake buying Golden West Financial right near the top of the real estate market – May 2006. By 2008, seeing the writing on the wall, the Wall Street Journal also pointed this out.
As for other banks with financial difficultly, I took Citigroup off my bank watch list. I was long and short the stock at various times. After the 10-1 reverse split on May 9, 2011, I didn’t like the price action in the stock, so I’m currently out of the Citi.
Foundation of the Housing Bubble
[9] Next, the National Bureau of Economic Research report (again, written by three IMF economists) didn’t exactly cover the U.S. government’s involvement in the housing market that went on for decades starting with the Community Reinvestment Act (CRA).
The CRA was passed in 1977 under President Jimmy Carter, and significantly expanded in 1995 under President Clinton with then HUD Director Henry Cisneros. Government and community activists such as ACORN pressured lenders to make home loans more affordable for those who could not qualify for a loan. Government would then guarantee the risky loans via FHA, HUD, Fannie Mae and Freddie Mac.
The 1995 revisions to the CRA included where:
“the Clinton Administration…imposed a quota system on the mortgage loans of banks…(where)…the GSE and CRA…reduced lending standards across the board.”
— Source: Common Sense Economics (P8 of 21 page PDF Report)
The government through its then quasi-backed agencies, Fannie Mae and Freddie Mac accelerated the housing risk to taxpayers by eventually guaranteeing about half of all the mortgages in the USA:
“The expansion in risky mortgages to underqualified borrowers was encouraged by the federal government. The growth of “creative” nonprime lending followed Congress’s strengthening of the Community Reinvestment Act, the Federal Housing Administration’s loosening of down-payment standards, and the Department of Housing and Urban Development’s pressuring lenders to extend mortgages to borrowers who previously would not have qualified.
Meanwhile, FreddieMac and FannieMae grew to own or guarantee about half of the United States’ $12 trillion mortgage market.”
— Source: CATO Institute Report (PDF), 11-18-2008, Executive Summary
The U.S. government forced a 2008 takeover of Fannie Mae and Freddie Mac in the world’s biggest balance transfer to U.S. taxpayer’s liability.
“Freddie Mac and Fannie Mae combined own or guarantee $5.4 trillion in outstanding mortgage debt. The government’s decision to place both agencies into a conservatorship — in essence, taking on responsibility for that debt by wresting control from the corporations — is an historic move.”
Despite government contributions to the housing crash, former HUD Director Henry Cisneros is still pushing for “affordable homes.” Homes are defiantly more affordable than they were just a few years ago, however today one actually needs to QUALIFY for a loan. Stated income, a heartbeat and a signature are just not enough to get a loan these days.
[10] The Fistful of Dollars report also didn’t seem to cover HUD’s lack of any risk management policies for 75 years. It took a near collapse of the banks, the U.S. economy and millions of jobs before HUD decided to add a risk manager to its credit policies.
[11] The FED also has a history of making wrong monetary policy calls in the Fed Funds Rate since at least 1998, which I argue influenced the .com bust of 2000-2002 and the real estate bust quietly beginning in 2006.
[12] Finally, we can’t forget the speculators. No, not the traders on Wall Street – they were just trading off the events that were already happening. We need to look at the consumers who bought homes they knew, or should have rationally known they really could not afford.
Sure, there were arguably unscrupulous mortgage lenders who share in the blame.
The way I saw it was that people were buying homes with low “teaser interest rates” (short definition) with stated income (liar loans) when in reality, they really could not afford to repay such loans back. Instead, I argue people had this mantra in mind:
‘When the low teaser rate is over and the new higher interest rate hits, I can just sell my house because it will double or triple by then.’
The only problem with this kind of thinking is it is based on pure speculative fantasy. I argued professionally back then that banks and individuals were making two fatal risk management mistakes.
(1) That interest rates could never go up.
(2) That home prices could never go down.Any sharp increase in rates or lower home prices and a recipe for disaster was in the making.
— Net Advisor™ (2006)
Impact on Housing Market by the FED
What occurred is rates went up 17 times in two years (2004-2006); and that was the financial death rattle that killed the real estate market and subsequently “#2” happened – No, not that, I mean #(2) above, where as a result of #(1) above, home prices did come down – a lot.
We saw a 425% increase in the FED Funds Rate in just two years – from 1.00% to 5.25%. As the FED increased interest rates to banks on overnight loans.
Banks (as they always do) followed the FED rate increases by passing on the higher FED borrowing costs to consumers, and watch the cost of adjustable rates soar.
So as my thinking began in 2004 and continued to 2006 after the sharp rise in interest rates:
“Anyone who thought that a 425% increase in short-term rates was not going to impact adjustable rate mortgages, watch out!”
— Net Advisor™ (2006)
Seeing these events unfold from 2004-2006, helped me and my clients who followed my recommendations avoid getting whacked during the downturn.
As we can all now see the results, certainly the Fistful of Dollars report needs to check the cash register to note who else hand their hand in the till.
It hardly can be drawn that “bank bailouts” were the result of “lobbying” over the previous 7 years, when in fact government played a key role in creating the legal environment for such rapid speculation to occur.
I’m not here to defend the banks, or anyone else; just want to see a fair and broader scope of the facts.
images: public domain. original images owner unknown.
Copyright © 2011 Net Advisor™
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