23 September 2008

The love of money

I was asked by a friend over the weekend if I would be blogging on the present financial crisis, especially the subprime mortgage aspect of it.

I have been thinking about it, but whatever I would have written has already been written. I can blog on what I’ve been reading, however.

Kevin A. Hassett, of the American Enterprise Institute, writes on “How The Democrats Created the Financial Crisis”. Hassett’s article is worth reading not as an instance of more finger-pointing, but as an explanation which avoids tired, meaningless abstractions like “predatory lenders”, “‘failed’ economic policies”, and so forth.

Of particular interest is Senate Bill 190 (2005), an element of the President’s “failed” economic policies, which would have averted this mess:

For the first time in history, a serious Fannie and Freddie reform bill was passed by the Senate Banking Committee. The bill gave a regulator power to crack down, and would have required the companies to eliminate their investments in risky assets.
Different World

If that bill had become law, then the world today would be different. In 2005, 2006 and 2007, a blizzard of terrible mortgage paper fluttered out of the Fannie and Freddie clouds, burying many of our oldest and most venerable institutions. Without their checkbooks keeping the market liquid and buying up excess supply, the market would likely have not existed.

But the bill didn't become law, for a simple reason: Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter. (See also this related May 2005 article by Peter J. Wallison, also of American Enterprise Institute.)
But why would Democrats do such a thing? Obviously there must be something of value in all this for Democrats to do, and be responsible for. But what?

Here’s another interesting element from Hassett’s article. We are rather consistently informed about various Republican ties to “big oil” and “big pharmacy” and other “special interests,” unlike Democrats who, we are to believe, have no such ties. But as it turns out, for some reason Fannie Mae and Freddie Mac had a penchant for giving money to politicians who protected them from regulation, including Christ Dodd and Hillary Clinton. Oddly enough, another Democrat makes that list: Barak Obama.

This article at Cyber Cast News Service explains yet another element of the whole story, the role of the federal government:

[According to Sheldon Richman]…government policy laid the foundation of this crisis more than 30 years ago when Congress passed the Community Reinvestment Act of 1977. This law forced banks to loan money to low-income borrowers as a way to ensure that financial institutions would “meet the credit needs of the local community.”

Under the Clinton administration, federal regulators began using the act to combat “red-lining,” a practice by which banks loaned money to some communities but not to others, based on economic status. “No loan is exempt, no bank is immune,” warned then-Attorney General Janet Reno. “For those who thumb their nose at us, I promise vigorous enforcement.”

The Clinton-Reno threat of “vigorous enforcement” pushed banks to make the now infamous loans that many blame for the current meltdown, Richman said. “Banks, in order to not get in trouble with the regulators, had to make loans to people who shouldn’t have been getting mortgage loans.”

This threat combined with the government backing of Fannie and Freddie set the stage for the current uncertainty, because the “banks could just sell the loans off to Fannie or Freddie,” who could buy them with little regard for negative financial outcomes, Richman said. (See also Stan Liebowitz, The Real Scandal; How the Feds Invited the Mortgage Mess [February 2008].)

On the other hand, against the idea that the Community Reinvestment Act (CRA) is the cause of these problems, Robert Gordon offers this April 2008 opposing view. He holds that the lending institutions involved weren’t governed by the Community Reinvestment Act. “Most analysts,” he says, “see the sub-prime crisis as a market failure. Believing the bubble would never pop, lenders approved risky adjustable-rate mortgages, often without considering whether borrowers could afford them; families took on those loans; investors bought them in securitized form; and, all the while, regulators sat on their hands.” (One might think to ask just how Gordon knows that all these lenders believed the housing bubble would never pop. Anything’s possible, but most people in business seem to know that it is the nature of bubbles to pop. Frankly I prefer to think of it not in terms of bubbles, but rather musical chairs; it’s always just a matter of when and who’s going be left without a chair when the music stops. But I digress.) Gordon goes on to cite various sources to substantiate the claim that most of the institutions involved here were not under CRA law and any that were engaged in these loans during a period when CRA was being weakened. He concludes by saying, “Law didn't make them lend. The profit motive did.”

It sounds good. And it’s tricky to reason through. For example, one wants to say that if these lenders were motivated by the profit motive, then they would not have approved risky adjustable-rate mortgages, without considering whether borrowers could afford them. After all, if you want to make a profit lending money then you would consider whether a borrower can afford the loan. What profit is there in making such a risky loan? If one is going to lend money without consideration of the borrower’s ability to pay, one must think one is going to get that money from someplace.

Enter the investors, who purchased these mortgages in “securitized” form. Apparently, we are to believe that investors, people who want to make money, purchased mortgages without ever considering the borrowers’ ability to pay. A mortgage is an investment only if there is some reason it can be paid. One can easily blame the profit motive, as Gordon does, but the profit motive is usually what keeps people from making unreasonably risky investments. Here, I’m employing the term ‘unreasonable’ to refer to the probability of return on investment. A reasonable risk is one in which one has some reason for believing he shall see a return on his investment. A man who buys a mortgage with no idea of how he shall see a return on his investments, no idea about the borrowers’ ability to pay isn’t greedy; he’s bloody well stupid.

Why buy these mortgages? Someone had, or thought he had, some reason for believing he could make money buying a mortgages. This money can be made in one of two ways. He can receive the loan payments or he can turn round and sell the mortgage himself. If he bought the mortgage, as Gordon says, with no consideration of the borrowers’ ability to pay, then he must have thought he’d made his money selling it.

And at the top of the mortgage-buying food chain are Freddie Mac and Fannie Mae, who hold eighty percent of all mortgages and who could buy these with little regard for negative financial outcomes because of implicit government backing. Of course, Freddie and Fannie, though government sponsored entities, are still private corporations. And that government backing was never spelled out in the law which created Freddie and Fannie. So we don’t know why they purchased all these mortgages. Or do we?

I agree with Gordon in part. Obviously, these loans were made by people who thought they could make money. But that same motive should really have kept these loans from being made. So while he may be right that CRA didn’t cause the crisis. He hasn’t told us anything by telling that the profit motive did.

I’m motivated by profit. And if I wanted to make money by lending money you can bet I’d not loan money to people I thought had little chance of paying it back. So we are still left with the question: Given the relevance of the profit motive, and given that it should really have induced no one to make such loans, why did people make such loans?

Think about the recipients of these loans. We are told that they are minorities who were preyed upon by “unscrupulous” lenders. Perhaps. But given that lenders need to make money and that they do so by receiving loan payments. This isn’t telling us anything either. However, if I were a lender, I can tell you one thing that would make me loan money to someone I wasn’t sure could pay it, especially if that person were a minority: the fear that my refusal to grant the loan would get me accused of racism. That would do it.

And that is where CRA may come in. The question is, How, if at all, could CRA have induced people to make these obscenely risky loans? According to Richman, the Clinton administration used CRA to go after banks who engaged in redlining in their lending practices. Most of those who were redlined were minorities. In the end I’ve heard and read the case for CRA’s connection, but so far I haven’t traced it out.

In related pieces, Glenn Beck lists the SEVENTEEN TIMES the present administration warned about the problems with Fannie and Freddie, explains who he thinks is responsible for the bank bust, and explains the back mess using a very imaginative analogy (hint: it involves Paris Hilton).

Finally, Cal Thomas gets at the spiritual roots of the entire mess, which demonstrates how everyone involved (borrowers, lenders, securitized mortgage purchasers) are all to blame. Like me, he’s Purtian-friendly.

Modern Western culture has been built on the success ethic, which says the acquisition of material wealth produces happiness and contentment and that the value of a life is to be measured not by one’s character, but the size of his bank account, the square footage of his home, the cost of his clothes and the cars in his garage. The Puritan Thomas Watson addressed this notion when he said, “Blessedness ... does not lie in the acquisition of worldly things. Happiness cannot by any art of chemistry be extracted here.”

Christianity Today magazine noted in a 1988 article, “The Puritan Critique of Modern Attitudes Toward Money”: “American culture has been strangely enamored of the image of ‘the self-made person’ — the person who becomes rich and famous through his or her own efforts. The idea of having status handed over as a gift does not appeal to such an outlook. Yet the Puritans denied that there can even be such a thing as a self-made person. Based on an ethic of grace, Puritanism viewed prosperity solely as God’s gift.”

The writer might have added that prosperity should not be seen as an end, but a means. Throughout Scripture, people are warned that money is a false god that leads to destruction. Wealth is best used when it becomes a river, not a reservoir; when it blesses and encourages others and does not solely feed one’s personal empire.

The modern business ethic seems to be to make as much money as possible, but with little purpose for making that money other than to enhance the wealth and status of those who make it. No wonder Paul the Apostle wrote that “the love of money is the root of all kinds of evil” (1 Timothy 6:10). It isn’t money itself that is evil. Money, like fire or firearms, can be used for good or ill, depending on the character of the person who possesses it. But money can be worshipped with as much fervency as that golden calf in Moses’ time. In Dow we trust!

Part of our problem is a failure to distinguish between needs and wants. Until the last century, most people were familiar with the Puritan ethic of living within one’s means. The Gilded Age in the late 19th century demonstrated the folly of rapacious living, yet the Roaring Twenties generation had to learn the lesson anew from the Great Depression.

Discontent, coupled with a profit motive, is a disaster just waiting to happen. It’s always just a matter of time.

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James Frank SolĂ­s
Former soldier (USA). Graduate-level educated. Married 26 years. Texas ex-patriate. Ruling elder in the Presbyterian Church in America.
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