Louisiana Voice

By John Sachs
Guest Columnist

In his book Too Big To Fail, Andrew Sorkin provides the reader a blow-by-blow account of the words, actions, and intrigue surrounding the financial crisis in the fall of 2008. The book does not delve into the financial products and practices that led to the crisis. Sorkin has left that task to others, including me, as you will see in the text below. He deals extensively with the personalities of the participants who managed the crisis by providing details as to what each one said and did in the heat of battle. This particular battle, like all battles, revealed the real measure of each man or woman.

Keeping up with the characters, the institutions they represented, and their responsibilities was confusing, or at least it was to me. Nevertheless, I found that if I kept reading and “listening” to each character, the real story unfolded. And it is a story that reveals a truth about all of us: among us, there are good and intelligent folks — and then there are those who are not so good or intelligent.

The following is my brief sketch of the origins of the financial crisis.

The crisis had been festering for a number of years. For more details, I recommend that you read Wikipedia’s account of FNMA and FHLMC, or Fannie Mae and Freddie Mac, as they are more commonly known.

Unlike GNMA (Ginnie Mae) which provides a secondary market financing source only for federally insured mortgages, Fannie and Freddie were free to provide mortgage financing funds to mortgage loan originators through the purchase of, among others, pools of risky subprime loans. And as many of you know, unscrupulous lenders were making home loans to borrowers who had little or no chance of repaying those loans unless their homes appreciated — and/or the rates on their adjustable rate mortgages stayed at or lower than the rate at origination.

Those subprime loans were combined (pooled) to form what is known as securitized loan packages. Then those securities were sold in the financial marketplace to the public: folks like you and me and our 401(k) retirement accounts, banks, mutual funds, etc.

Then along came 2006 and 2007 when many adjustable rate mortgages repriced at significantly higher rates than the borrowers could afford. That led to foreclosures. A significant number of foreclosures created a glut of available housing, and the laws of supply and demand came into play. Housing values fell. When values fell, those homeowners who needed or wanted to sell their homes found that the value of those homes had fallen below the amount they still owed on their mortgages.

Being “under water” led to more foreclosures, more of a housing glut, and then even lower home values. The line of dominos began to fall.

The collapse in the housing market then led to a collapse in the value of those securities that had as their basis the value of the pools of mortgages. Matters continued from bad to worse not only in actual home values, but also for investors who owned the securitized mortgages on those homes — as well as those who had insured the repayment of the loans. It was huge. It was unprecedented. And it continues to this day even though the federal government has come to the rescue of nearly everyone who was affected. The government’s involvement reduced a worldwide financial crisis to simply a terrible ongoing problem with which we continue to cope.

However, not everyone involved in the crisis was destroyed. Those folks not harmed had had the good judgment to recognize the risks associated with the fallacious assumptions that housing prices would always go up and that interest rates on home mortgages would always stay low. They had prudently managed their risks by not loading-up on risky, high-yield, mortgage-backed securities.

Those firms that did not get greedy and that managed their risks wisely included Bank of America, Wells Fargo, JP Morgan, and Goldman Sachs. Those that bet the bank and lost included Bear Stearns, Lehman Brothers, Merrill Lynch, Wachovia, and AIG.

This brings us to the point I wish to make and that is that all too often the virtuous suffer because of the faults of others. How so, you may ask? In this instance, the global financial markets are dominated by only a very few institutions. As much as we wish that they themselves could police this critical marketplace, they cannot and will not — if for no other reason than they are housed in and regulated by numerous countries, and in some instances managed by greedy and/or incompetent managers who cannot be controlled by others.

Then there is the matter of associated risk and its management. We know now that some financial products are too complex and involve significant risk for even the most sophisticated investors. Such products should be placed off limits to other than avowed gamblers and even then only in manageable amounts. No regulated investment banker, broker dealer, or government entity should be allowed to involve itself in such risky product markets.

In conclusion, where “Too Big To Fail” is a consideration, regulation must exist in order to manage the risks that affect everyone. We, the prudent masses, should never again be asked to bail out the greedy and incompetent few.

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