Gals and Guys,
Just got this from a friend in the states. I can't believe that it is strictly the Democratic's fault. Perhaps others would like to comment on the collapse of the Ayr Bank in Scotland.
Best
Dom
Social engineers are bad bankers
John Montgomery | October 01, 2008
IN 1772, the collapse of the Ayr Bank led to the Edinburgh banking crisis of
that year. Only three of Edinburgh's 30 private banks survived. Adam Smith
commented that "the operations of this bank seem to have produced effects
quite opposite from what was intended". The Ayr Bank had been established in
1770 to provide long-term loans and provide credit to people who otherwise
found it difficult to borrow, financing a speculative boom in housing,
turnpikes and canals, the transport infrastructure of the time.
It borrowed from other banks in London and Edinburgh and, as borrowers began
to default, it had to pay off its debts by securing greater loans. Smith's
final verdict on its collapse was that it only enabled borrowers "to get
much deeper into debt, so that when ruin came, it fell so much the heavier".
The British economy struggled to recover until the 1780s.
The collapse of the Ayr Bank tells us much about the present crisis.
In 1999, then president Bill Clinton instructed the Fannie Mae Corporation
to ease credit requirements on loans to ethnic minorities and low-income
earners. In this nationwide scheme, the pilot program alone involved 24
banks. This was to include what became known as the sub-prime sector. Fannie
Mae's chairman and chief executive in 1999 said that in addition to
"reducing down payment requirements" the corporation would underwrite loans
in the sub-prime market. Fannie Mae's board is largely made up of prominent
Democrats.
Fannie Mae and its sister corporation Freddie Mac are government-sponsored
enterprises, exempted from taxation and with any losses guaranteed by public
monies, although shares of profits go overwhelmingly to investors,
executives and board members with shares. This is a hangover from its
foundation in 1938 as a means to provide liquidity in the mortgage market
that had collapsed following the Wall Street crash of 1929. The idea was to
provide federal money to local banks, which would then finance home loans at
below market interest rates. Fannie Mae held a virtual monopoly of what
became known as the US secondary mortgage market until 1968, when Lyndon B.
Johnson converted it into a private corporation or, rather, a
government-supported enterprise. A second GSE, Freddie Mac (the Federal Home
Mortgage Corporation) was established in 1970.
It is important to note that Fannie Mae does not lend money directly to
consumers, it purchases loans that banks make on the secondary market. This
was made possible by Fannie Mae being allowed, uniquely, to borrow money
from overseas at low interest rates backed by the US government. It passed
this on to borrowers in low down payments and fixed rate mortgages. The
parallels with the Ayr Bank are startling.
However, the strategy announced in 1999 was to spur the banks to make more
loans to people with poor credit rating, and especially to blacks and
Hispanics. This was done by offering mortgages at 1 per cent above the
standard variable rate. Home ownership rates among these groups had in fact
been growing rapidly during the period 1993-98, 87 per cent for Hispanics
and 72 per cent for blacks, but this was considered insufficient to close
the gap between these and other groups. As early as 1998, Fannie Mae was
already making 44 per cent of its purchases from loans to these groups.
Not everyone was convinced this was a good idea. Peter Wallison of the
American Enterprise Institute warned: "If they fail, the government will
have to step up and bail them out." The US Senate finance committee in 2005
considered a bill to increase scrutiny of Fannie Mae and its accountancy
mechanisms. In 2003 it had been revealed that Freddie Mac's accounting
practices contained $4.5 billion worth of errors brought about by the
removal of three of the company's top executives. By this time, combined
debt at Freddie Mac and Fannie Mae was equal to 46 per cent of then national
debt. The then US Federal Reserve chairman, Alan Greenspan, warned of
forthcoming financial collapse if Fannie Mae's activities were not reined
in.
The bill was opposed by the Democrats, and lost.
The trigger that caused the bubble to burst was the raising of interest
rates by the Federal Reserve in 2006 and 2007, to ward off a perceived risk
of inflation. This sent mortgage payments through the roof and hundreds of
thousands of Fannie Mae's customers defaulted on their payments. To make
matters much worse, the banks had been buying and selling loans from each
other before selling them to Fannie Mae. With the collapse in the housing
market came the collapse of Fannie Mae and the loans it had purchased from
the banks. Before long, the banks were collapsing too, not all of them but
those that had bought and sold sub-prime loans. Defaults are now running at
almost 3per cent of all mortgages in the US, representing hundreds of
thousands of loans.
The culprits in all of this are the executives and board members of Fannie
Mae for buying unsecured and risky loans, the Federal Reserve for putting up
interest rates too far and too quickly, and the banks for what almost
amounts to pyramid selling of bad debt based on fools' mortgages. Fannie
Mae's structural flaws were an accident waiting tohappen.
But there is another culprit. The Clinton administration, in pressuring
Fannie Mae, created the policy of lending initially good and then bad money
to people who were themselves bad credit risks. This was done for good
political - not to say politically correct - reasons: the targeted extension
of home ownership to minority groups. But this social engineering has been
achieved at a heavy cost, not least to those who have lost their houses and
taxpayers who may now have to pick up the cost of an emergency package.
People awarded such loans may well be forgiven for thinking they are now
worse off than they were in 1999.
The lesson of all of this is not that Wall Street is greedy, nor even that
banks should be limited in onselling debt, although periodically this is
true. The main lesson is that banking and credit should be run on sound
banking principles rather than as a political project. For where politicians
become involved in banking, as in the case of the Democrats and Fannie Mae,
only incompetence, pork-barrelling and corruption will follow.
As Smith put it: "I have never known much good done by those who affected to
trade for the public good. The sober and frugal debtors of private persons
would be more likely to employ the money borrowed in sober undertakings
which, though they might have less of the grand and marvellous, would have
more of the solid and the profitable." The sooner we get back to this the
better.
Bailing out bankrupt banks will only prolong the pain. It is likely markets
will, left to their own devices, recover as growth in the real economy
starts coming back. It is equally likely panic measures will be taken, just
as they were in 1938, when the worst was over.
John Montgomery's latest book is The New Wealth of Cities.
Just got this from a friend in the states. I can't believe that it is strictly the Democratic's fault. Perhaps others would like to comment on the collapse of the Ayr Bank in Scotland.
Best
Dom
Social engineers are bad bankers
John Montgomery | October 01, 2008
IN 1772, the collapse of the Ayr Bank led to the Edinburgh banking crisis of
that year. Only three of Edinburgh's 30 private banks survived. Adam Smith
commented that "the operations of this bank seem to have produced effects
quite opposite from what was intended". The Ayr Bank had been established in
1770 to provide long-term loans and provide credit to people who otherwise
found it difficult to borrow, financing a speculative boom in housing,
turnpikes and canals, the transport infrastructure of the time.
It borrowed from other banks in London and Edinburgh and, as borrowers began
to default, it had to pay off its debts by securing greater loans. Smith's
final verdict on its collapse was that it only enabled borrowers "to get
much deeper into debt, so that when ruin came, it fell so much the heavier".
The British economy struggled to recover until the 1780s.
The collapse of the Ayr Bank tells us much about the present crisis.
In 1999, then president Bill Clinton instructed the Fannie Mae Corporation
to ease credit requirements on loans to ethnic minorities and low-income
earners. In this nationwide scheme, the pilot program alone involved 24
banks. This was to include what became known as the sub-prime sector. Fannie
Mae's chairman and chief executive in 1999 said that in addition to
"reducing down payment requirements" the corporation would underwrite loans
in the sub-prime market. Fannie Mae's board is largely made up of prominent
Democrats.
Fannie Mae and its sister corporation Freddie Mac are government-sponsored
enterprises, exempted from taxation and with any losses guaranteed by public
monies, although shares of profits go overwhelmingly to investors,
executives and board members with shares. This is a hangover from its
foundation in 1938 as a means to provide liquidity in the mortgage market
that had collapsed following the Wall Street crash of 1929. The idea was to
provide federal money to local banks, which would then finance home loans at
below market interest rates. Fannie Mae held a virtual monopoly of what
became known as the US secondary mortgage market until 1968, when Lyndon B.
Johnson converted it into a private corporation or, rather, a
government-supported enterprise. A second GSE, Freddie Mac (the Federal Home
Mortgage Corporation) was established in 1970.
It is important to note that Fannie Mae does not lend money directly to
consumers, it purchases loans that banks make on the secondary market. This
was made possible by Fannie Mae being allowed, uniquely, to borrow money
from overseas at low interest rates backed by the US government. It passed
this on to borrowers in low down payments and fixed rate mortgages. The
parallels with the Ayr Bank are startling.
However, the strategy announced in 1999 was to spur the banks to make more
loans to people with poor credit rating, and especially to blacks and
Hispanics. This was done by offering mortgages at 1 per cent above the
standard variable rate. Home ownership rates among these groups had in fact
been growing rapidly during the period 1993-98, 87 per cent for Hispanics
and 72 per cent for blacks, but this was considered insufficient to close
the gap between these and other groups. As early as 1998, Fannie Mae was
already making 44 per cent of its purchases from loans to these groups.
Not everyone was convinced this was a good idea. Peter Wallison of the
American Enterprise Institute warned: "If they fail, the government will
have to step up and bail them out." The US Senate finance committee in 2005
considered a bill to increase scrutiny of Fannie Mae and its accountancy
mechanisms. In 2003 it had been revealed that Freddie Mac's accounting
practices contained $4.5 billion worth of errors brought about by the
removal of three of the company's top executives. By this time, combined
debt at Freddie Mac and Fannie Mae was equal to 46 per cent of then national
debt. The then US Federal Reserve chairman, Alan Greenspan, warned of
forthcoming financial collapse if Fannie Mae's activities were not reined
in.
The bill was opposed by the Democrats, and lost.
The trigger that caused the bubble to burst was the raising of interest
rates by the Federal Reserve in 2006 and 2007, to ward off a perceived risk
of inflation. This sent mortgage payments through the roof and hundreds of
thousands of Fannie Mae's customers defaulted on their payments. To make
matters much worse, the banks had been buying and selling loans from each
other before selling them to Fannie Mae. With the collapse in the housing
market came the collapse of Fannie Mae and the loans it had purchased from
the banks. Before long, the banks were collapsing too, not all of them but
those that had bought and sold sub-prime loans. Defaults are now running at
almost 3per cent of all mortgages in the US, representing hundreds of
thousands of loans.
The culprits in all of this are the executives and board members of Fannie
Mae for buying unsecured and risky loans, the Federal Reserve for putting up
interest rates too far and too quickly, and the banks for what almost
amounts to pyramid selling of bad debt based on fools' mortgages. Fannie
Mae's structural flaws were an accident waiting tohappen.
But there is another culprit. The Clinton administration, in pressuring
Fannie Mae, created the policy of lending initially good and then bad money
to people who were themselves bad credit risks. This was done for good
political - not to say politically correct - reasons: the targeted extension
of home ownership to minority groups. But this social engineering has been
achieved at a heavy cost, not least to those who have lost their houses and
taxpayers who may now have to pick up the cost of an emergency package.
People awarded such loans may well be forgiven for thinking they are now
worse off than they were in 1999.
The lesson of all of this is not that Wall Street is greedy, nor even that
banks should be limited in onselling debt, although periodically this is
true. The main lesson is that banking and credit should be run on sound
banking principles rather than as a political project. For where politicians
become involved in banking, as in the case of the Democrats and Fannie Mae,
only incompetence, pork-barrelling and corruption will follow.
As Smith put it: "I have never known much good done by those who affected to
trade for the public good. The sober and frugal debtors of private persons
would be more likely to employ the money borrowed in sober undertakings
which, though they might have less of the grand and marvellous, would have
more of the solid and the profitable." The sooner we get back to this the
better.
Bailing out bankrupt banks will only prolong the pain. It is likely markets
will, left to their own devices, recover as growth in the real economy
starts coming back. It is equally likely panic measures will be taken, just
as they were in 1938, when the worst was over.
John Montgomery's latest book is The New Wealth of Cities.
