economic crisis wikipedia
economic crisis wikipedia
Origins of the Subprime Scandal
If there’s a word that is universally invoked in the world of finance, it’s “transparency.” The word comes to us from the 16th century with the connotation of “shining through,” The idea is simple. Transparency is about being able to see what is going on and to have key practices disclosed. Without that, it is believed, financial markets can’t function because of a lack of trust and clear rules that all the players adhere to. It is a market fundamental, a primary rule of principle.
Or so you would think.
When it began, subprime lending was even not a term that most people outside the financial markets understood. (By 2007, the American Dialect Society would call it the most used term of the year.) The Wikipedia would describe it this way:
Subprime lending, also called B-paper, near-prime, or second chance lending, is the practice of making loans to borrowers who do not qualify for the best market interest rates because of their deficient credit history. The phrase also refers to paper taken on property that cannot be sold on the primary market, including loans on certain types of investment properties and certain types of self-employed individuals. Subprime lending is risky for both lenders and borrowers due to the combination of high interest rates, poor credit history, and adverse financial situations usually associated with subprime applicants.
In early February 2008, almost a decade after the birth of what would become the subprime industry, the Securities and Exchange Commission, the nominal regulators of financial markets, found the courage to admit that they didn’t really know what was going on in their multi-billion-dollar securities market.
They announced an investigation.
One of their “enforcers” explained: “The big question is, who knew what when, and what did they disclose to the marketplace?” These were the words of Cheryl Scarboro, an associate director in the SEC’s enforcement division in charge of the subprime working group. This working group, composed of one hundred lawyers, which seems to have only begun working after the scandal erupted, is investigating how banks, credit rating firms, and lenders valued and disclosed complex mortgage-backed securities.
Reuters reported they were looking into three areas: “the securitization process, the origination process nd the retail area. Insider trading, which is one of the SEC’s highest priorities, is also a key area.”
Bear in mind that they are not operating in the interests of borrowers who were victimized by deceptive loans, but inquiring whether shareholders – i.e., investors – were kept in the dark through inadequate disclosures.
Their scope is narrow: “We do have to work very hard at bringing the right cases,” says SEC enforcement division chief Linda Chatman Thomsen. “We work on the most ‘impactful’ cases. … At the end of the day we have to be about deterrence.”
Deterrence? That was a concept born in the nuclear age to prevent/deter war. How it’s relevant after the collapse of the industry itself was not addressed. What is there now to deter?
This SEC group was reportedly “talking with” but not coordinating with oversight bodies like the Federal Reserve, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, and Office of Thrift Supervision. Is it significant that the FBI, which also announced its own investigation into criminal conduct by mortgage firms, is not on this list!
If the regulators who should be in the know about these practices are not, it’s not surprising that most of the media and the public share this plight.
The whole area is murky. Even George Miller, the Executive Director of the industry’s own trade association and lobby group the American Securitization Forum, told CNBC as this investigation was announced that one of the reforms his organization was advocating was “taking steps to enhance where necessary the transparency in the marketplace.” Note the qualifying phrase “where necessary.”
While reporting from the Forum’s meeting in Las Vegas, CNBC’s correspondent joked they had “gambled away our economy.” Ha, ha. The Forum has not always been a joke. When the Treasury Department announced, with great fanfare, a program to help distressed homeowners in December 2007, it was widely reported that this industry group had actually written it. The plan offered no help to
families facing foreclosure.
They also played a very powerful role in holding off government scrutiny. They were the influential behind-the-scenes player rationalizing the industry and its exotic derivative financial instruments. Their website, which lists their impressive membership list of big banks and funds, describes its work this way: “The American Securitization Forum (ASF) is a broadly-based professional forum through which participants in the U.S. securitization market can advocate their common interests on important legal, regulatory and market practice issues.”
According to the New York Times, the Forum’s Las Vegas Meeting could be considered a “predator’s ball.” The newspaper did not remind readers that 16 years earlier this same phraseology was used widely about an earlier scandal on Wall Street. This account was published on August 15, 1991:
They call it the Creditors’ Ball: a hundred or so bankruptcy lawyers, bankers and investors, sipping cocktails and feasting on shrimp in the Hamptons in an unabashed celebration of the impoverished 1990′s.
This party of the well-paid, the well-connected, and the well-coiffed is quickly becoming the social event of the bankruptcy set, just as the Predators’ Ball was a highlight of Wall Street’s social calendar. That Beverly Hills extravaganza, sponsored by Drexel Burnham Lambert Inc., ended with the brokerage’s downfall in 1990.
So much for lessons being learned.
THE IMPORTANCE OF DISCLOSURE
At least now, the industry’s public face and the regulators have come around to agreeing with a growing army of critics that inadequate disclosure was at the root of the problem, i.e., a lack of transparency.
And not only in the housing industry!
Well-known banks had also been admitting a little, while hiding a lot. When the finance ministers from the Group of the 7 top industrialized countries met in Tokyo on February 9, 2008, they issued a call to banks to fully disclose their losses from the subprime meltdown. The German Minister Peer Steinbruck said that these write-offs could reach a whopping $400 billion, four times previous estimates.
It must be noted that just a month earlier, in late December, Wall Street firms paid out more record bonuses to the bankers who had made them a vast fortune.
Why the secrecy, why the lack of disclosure?
A top-level corporate reputation consultant, who asked to remain anonymous but who has worked on the issue, summed it up for me in one word: greed. “They were making so much money that they didn’t have time for due diligence or transparency. It was just pouring in.”
Yet, oddly enough, one of the industry’s big traders was still not remorseful. “We need to step back and take a breather,” John Devaney told the New York Times. “I don’t think there is anything fundamentally wrong.”
No one asked him about the findings of the Senate’s Joint Economic Committee:
Approximately $71 billion in housing wealth will be directly destroyed through the process of foreclosures.
More than $32 billion in housing wealth will be indirectly destroyed by the spillover effect of foreclosures, which reduce the value of neighboring properties.
States and local governments will lose more than $917 million in property tax revenue as a result of the destruction of housing wealth caused by subprime foreclosures.
No one thought about that at the beginning of the subprime boom either.
About the Author
Danny Schechter edits
Mediachannel
. He was an Emmy Award winning producer for ABC News, director of the film In Debt We Trust and author of the new book: PLUNDER: Investigating Our Economic Calamity.
Could somebody please give me a summary of the economic crisis?
Hello,
I’m not actually doing this for an assignment or project, but more out of plain curiosity. For the past who knows how long, I’ve been hearing so many things about how the economy is deteriorating so much in America, and though I’ve tried to ask people about it, I always get different answers from people. Some people said it had something to do with a mortgaging problem (?) and others said it was because nobody is spending money anymore (?), etc.
I’d really appreciate it if someone could give me a summary (or even better, something more detailed than a summary) of what is actually happening. Even just a link to a website that explains this fully (not wikipedia, please), I’m willing to read it even if it’s incredibly long.
Thanks!
The people who tell you that the crisis is caused by mortgages are correct. However, the people who tell you that the crisis is caused by a drop in spending are also correct. Right now, we are in what is called a liquidity trap-actually more like a liquidity tar pit. Consumers are not spending and are finding it difficult to obtain credit to spend. Businesses are losing revenues and also having a difficult time obtaining credit. And several major banks are in trouble. As people stop spending, businesses lay off people, which increases the number of people who can not pay their debts and buy things, which deteriorates the assets held by banks, so banks won’t lend, and with less money to available to borrow, businesses lay off more people and so on. It is a vicious cycle and not the easiest problem to fix.
It might make sense to divide this crisis into three or four separate shocks that have come together to create a problem. The number is probably closer to 20, but I don’t have all night. This is a global problem right now, so events globally make a difference. You should look at this as a crisis in the financial system, a crisis in consumer credit, a commodity price shock. That should help sort this out.
1) Consumer credit crisis: At the heart of this issue is the mortgage problem, but it also involves credit cards, student loans, car loans, etc. For many years, interest rates were very low, and for a variety of reasons, credit became very easy to obtain. The money available to lend to consumers seemed endless. Financial companies were able to bundle these loans together into securities and sell those securities to other people very easily, obtaining more money back to lend to consumers. (This is called a virtuous cycle, the opposite of our current vicious cycle).
Unfortunately, because interest rates were low, it was more profitable for for companies to lend to people whose ability to pay was doubtful, but with loans that had higher interest rates. Also, the prices of homes were rising rapidly, so people took out much bigger loans than they did in the past, thinking that home values would continue to rise and if they got into financial trouble, they could easily sell their houses at a profit. Also (see, all these alsos), since investors were willing to buy bundled packages of loans from lenders and take on the risk of default of bad loans, lenders relaxed their lending standards. As prices of houses continued to rise, many people bought houses and condos on speculation (flip this house!) and many people found that the only way they would qualify for a loan for a house was to take out a non-traditional mortgage (aka sub-prime loan). Incomes did not keep pace with home prices, and rather than saving until house prices came down, people bought houses with little or no down payment. Also, people thought that their incomes would increase, and they thought that they could easily refinance, so they bought houses that were more expensive than they could afford to pay for at the time thinking that that problem could be solved in the future.
Starting in late 2006/2007, this cycle began to unravel. Some of the people who took out sub-prime mortgages found themselves unable to pay. Because people defaulted on their loans, the investors in the bundles of loans started to realize that the bundles of sub-prime loans that they thought were relatively safe were in fact not very safe. So investors stopped buying securities backed by sub-prime loans. However, lenders kept making loans, thinking that the situation was temporary. The investment banks that bought the loans to sell to investors continued to buy loans for awhile, but suddenly, they found few customers and ended up holding the loans themselves. If the banks had ONLY been doing that, things would have been better.
Anyway, people are not spending for many reasons. One reason is that they are struggling to pay off mortgages. Another reason is that they no longer have access to easy credit to buy things. They are trying to pay down debt and/or save in case they are laid off.
In May last year, the government sent many people a check for $300 if you were single or $600 for a family, thinking that this would make people start spending. The government did this after September 11, and it seemed to work then. The government did this in 1970s, but it did not work so well. The rebate did not work this time.
Now, Congress is trying to figure out how to get consumers to spend again…or whether that is desirable to boost consumer demand in the short run.
Republicans want to stimulate consumer demand through tax cuts and incentives. For instance, they want to incentivize people to buy houses by offering a $15,000 tax break and 4% mortgages and incentivize people to buy cars by making interest on car loans deductible.
The administration does not believe in the short run tax cuts will have any more effect this time than the $300 rebate did last summe
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