The Beginnings of the Financial Crisis

With all the talk of economic depression, stimulus, sub-prime mortgages — and of course all the political grandstanding, finger pointing, and attempts to use the situation to further political agendas, most people have a simple question:

How did the country get in this mess?

A good question, and one the media doesn’t cover much so we’ll try and put the pieces together. But be warned while it’s not hard to understand, it does take several pieces appearing unrelated until put together. So stay with us, it’s going to be a wild ride, and plenty of blame exists to go around — neither political party has clean hands.

The Beginning - Community Reinvestment Act

In 1977 under the Carter Administration, the Community Reinvestment Act passed congress and became law. While it contained good intentions, it lays the foundation for the current disaster. Certainly not by itself, but as you’ll see, combined with reasonably foreseeable events, anyone studying the law could understand how we arrived in this position (it is not, as many politicians claim, completely unforeseeable and a shocking revelation).

Basically, the CRA mandates banks loan money by the needs of the community — it’s essentially a quota act designed to enable “easy credit” for people who otherwise would not qualify for loans. From 1977 until about 1989, the act by itself did little damage (as long as the housing market climbs, anyone losing their home owes less than the mortgage, but we’re ahead of ourselves), but under President Bush and Clinton, changes to the CRA set the stage for certain doom, guaranteeing failure when combined with other factors.

ACORN and the 1990’s

From 1977 until the 1990’s, the CRA didn’t cause too much damage — as long as the market climbs and not too many sub-prime loans were available.

However, in the 90’s and early 2000’s groups like ACORN discovered the law could be used to force banks to make more sub-prime loans, for example NINJA loans (NO income, NO job, NO assets). In short, loans were made simply by signing for them — those making the loans knew the loans could not be repaid, and the groups lobbying for more sub-prime loans also knew those loans could not be repaid. Why do such a thing? Two reasons:

  1. Community organizers and other groups (Congress) forced banks to make sub-prime loans for political and social reasons.
  2. Greed of the banks.

How can greed of the banks factor in? How can they profit from loans they knew were bad? That’s the next key of the puzzle, coming right after the dot-bomb era.

Stock Market Bubble

During the stock market bubble (dot-bomb), money flowed and everyone was happy. Until the crash, that is. Then (like now), cries for the government to “fix it” arrived from every corner. Never one to miss the opportunity of a crisis, the government lept into action. To stimulate the economy, interest rates became low to encourage investing.

One problem with their “fix” — combine low interest rates with NINJA loans, and what do you get? An exploding housing market! This of course was what government wanted — economic recovery.

And life was good again, as everyone made piles of money, government and community organizers got their housing to people who couldn’t pay the loans, and all was good … until the housing market went down.

But by then (when the adjustable rates begin to change) interest rates became more historically normal and many people couldn’t pay their mortgage anymore. So all those sub-prime mortgages began to fail. And if that’s all that happened, we still wouldn’t be in the mess today. So we’ll diverge a bit, and then you’ll see how the pieces fit together.

Politics

Republicans used to be known as the party of fiscal responsibility, while the Democrats were tax-and-spend — Democrats haven’t changed, but the Republicans sure have. They’re called “neo-cons” by some, and if you’ve been involved in Republican politics you’ll know they’ve thrown Conservatives off the cliff, while asking for donations on the way down.

The two parties now share a common fiscal irresponsibility, and both now believe in massive deficit spending (with no viable means to pay it back). Nobody in Washington believes in fiscal responsibility anymore, and the hugely increasing deficit will at some point have to be paid.

President Obama already announced he’ll run trillion-dollar deficits for his entire administration, and combine that with all the “stimulus” floating around (already by some estimates at over 7 trillion), and in 4 years Obama’s administration could add 10-15 trillion to the deficit.

Leveraging

While all this went on, investment banks used something called “leveraging” to make piles of money, basically meaning borrow money to invest. For example, if you have $1 to invest and you think you’ll make 10%, after one year you’ll make $.10 profit. But if you borrow $9, and promise to return it at 5%, you’ll have $10 to invest, you’ll have $1 gross profit of which you’ll pay $.45 to the person you borrowed from, and you’ll have $.35 more profit!

Sounds great, huh? And it is … as long as your investments pan out. It doesn’t take a rocket scientist to figure out the risk involved if what you invest in goes down. And it turns out some banks leveraged 40-1, so when the investments went south, so did the banks.

But still, the mess would be contained to the mortgage market, except for one more piece to the puzzle.

Securitization

Banks knew those sub-prime loans were bad, so a brilliant idea appeared — package them together with “good” loans, and sell them to investors, thus spreading the risk. Another great plan … except nobody really knew how good those loans were (in spite of grade “A” ratings). They sold little bags of doggie poo-poo, which worked as long as nobody looked in the bags.

But once they did, they realized all they held was doggie poo-poo.

Additionally, those banks still didn’t want the bad loans around, so the government came up with an idea — sell them to Fannie and Freddie! And those on the government oversight committees thought it was a great idea — banks continue to sub-prime loan, but they won’t complain because they’ll sell the loans to Fannie and Freddie!

And their scheme worked great … right up until Fannie and Freddie collapsed.

But Democrats like sub-prime mortgages (people who by definition can’t pay back the loan), and Republicans enjoyed the banks profit, so nobody in Washington cared and all bought into the scam. More regulation can’t solve the problem, because all the bureaucrats in charge of oversight were well aware of what was going on (either they deliberately lied to the public or they simply lack understanding. Either way they allowed the disaster to unfold right under their nose). Many of those in charge of committees were among the largest recipients of Fannie and Freddie lobbying money — so it’s no wonder they did nothing as they fed at the trough as well, profiting from sub-prime loans.

The Problem in Brief

Combine Securitization, leveraging and sub-prime mortgages, and you’ve got the makings for the perfect economic storm. Banks were now only too happy to sub-prime loan, knowing they would sell the loans to Fannie and Freddie. Fannie and Freddie took the bad paper, securitized it, and sold it to investment banks like Lehman and so on.

Lather-rinse-repeat. Life is good!

In short, Congress (through the CRA and other legislation) mandated and required sub-prime loans, but Congress had the bright idea of passing them off to Fannie and Freddie. Since banks no longer had to keep the loans, they had no incentive to require people to afford the loans. They profited from points and fees, and passed the debt off to Fannine and Freedie. After the stock market bubble, when interest rates went way down, this enabled many people who couldn’t afford mortgages to get them (interest only, negative amortization, NINJA loans, etc). BOOM! Housing bubble born, prices skyrocketed.

But when the economy turned around a bit, interest rates rose to more normal levels. In 2006 and 2007, when those adjustable rate mortgages came due to adjust, many people discovered they could no longer afford their home. But as the overheated market cooled a bit, they found their home wasn’t worth what they paid for it, and began to default on their loans. Fannie/Freddie were left holding bags of doggie poo-poo and collapsed.

But through securitization and leveraging, the toxic mess spread through the banking system — Lehman and so on. Those banks became insolvent and collapsed, as when the bags of securities were opened, everyone found out they held nothing but doggie poo-poo — and the banks collapsed.

So this mess ultimately arose from two issues:

  1. Deficit spending.
  2. Credit expansion.

Both political parties were complicit in this disaster, though Democrats controlling Congress the last few years were the most recent to refuse to reform the system in order to advance their own political agenda, while taking political contributions from the very people their committees should have been overseeing.

The issue contains many more details we’ve left out, if you’re interested the wikipedia article of sub-prime crisis has more information, and lots of links for further study. The economic situation is one area you must investigate for yourself, as the media rarely yields comprehensive information, and politicians won’t ever give the complete story.

Solution

What do the fearless leaders propose to solve this mess? Deficit spending and credit expansion — Washington never learns the lesson from history — many of the proposals have been attempted before, and none worked as you can’t get out of a disaster caused by deficit spending and credit expansion by spending more and expanding credit.

That sounds bad (and it is), but reality is even worse than that. Examine the following graph provided from the St. Louis Fed regarding the Money Supply.

Money supply graph

Notice the vertical line at the end? That’s how much money the government has been pumping into the economy in an attempt to reduce the crisis they created. What will be the end of all the spending? Inflation. How do you end that? Raise interest rates. That makes a recession, and then more “Stimulus”, then … lather-rinse-repeat.

Notice each “bubble” is worse than the previous? The housing bubble exceeded the stock market bubble, and so on. The next bubble caused by current government stimulus/bailout will be worse than the housing bubble the country is in now.

The $800 billion spending bill & TARP can’t solve the problem, because it’s more of the same — deficit spending and credit expansion.

The Looming Crisis

Anyone studying even casually knows the money doesn’t exist for any of the so-called “stimulus” (much of which is pork, and not even stimulus), so where are they going to get it? They’ll borrow it, of course (and tax later for it, to be sure). Combine that with the fact we’re using more oil than produced (and Obama and Congress refuse to seek out new sources) and soon the energy crisis will be roaring back. Mix in the tension with Israel and Iran. Stir in Social Security being broke in 2017.

Where does that leave us? In big trouble.

No quick and easy fix exists. The recession caused by years of federal mismanagement — ultimately deficit spending and credit expansion — has now arrived. Yet the new administration desires to fix it be deficit spending and credit expansion?

Don’t make the mistake current events are temporary and life will return to normal again when the crisis ends. It can’t. The massive deficit, coupled with those using the situation for political reasons shall alter the landscape permanently.

Conclusion

So is all hope lost? Are we doomed? Of course not. God is in control.

Don’t be afraid, as God still reigns and His will shall be done — read the back of the book for answers as the end events are already known. How the world goes from point “A” to point “B” isn’t known, but obviously a major shift has begun.

Yet in any crisis, you can make two mistakes:

  1. Failing to prepare.
  2. Trusting in your preparations.

First, being a good steward requires preparation. It’s foolish to put trust in government, even if they could solve the problem; you need to be prepared for events which can be reasonably foreseen (do you have a spare tire in your car?). But second, don’t trust in your preparations, as it’s ultimately the Lord who provides. It’s quite easy to vear off to one side or the other, but as with other areas of your life a balanced approach is required. Yes, you must prepare, but don’t overly trust in your preparations to the exclusion of the Lord.

Read through 2 Kings chapters 6–7 to see one example of how the Lord works in spite of doomsday scenarios. During the siege, Israel has been reduced to cannibalism as their food supply was cut off. Finally, a few lepers decide to venture out side the city, as they’re going to die anyway.

But the Lord drives off the Syrian army ahead of them, and they find supplies and empty tents. Running back to the city, they inform the King, and just as Elisha said previously, by the end of the day food would be abundant again — and it was.

But the point remains, during the siege, if you were in the city, would you have believed Elisha’s prophecy? No matter how dark events appear to be, it’s never a lost cause as you and God are a majority every time.

Be prepared as times change, but don’t trust in your preparations.

The horse is prepared against the day of battle, but safety is of the Lord. (Proverbs 21:31 KJV)

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