No doubt by now you have seen this video. It places blame for the current economic problems squarely at the Democrat’s feet. And while don’t know enough about economics to speak as to what the fuck is going on, we have several terrific Goons who do.

So here’s how it actually breaks down. This is going to be a gigantic wall of text, but Goon infiniteseal is working on a rebuttal video for us, to be posted here once he is done.

UPDATE: Here is the video rebuttal.

First, Goon razzledazzle lays it all out:

It’s ridiculous to blame the crisis on the or ACORN or whatever. The central thesis seems to be that the government forced lenders to give loans to risky customers, when in fact lenders chose to give loans to risky customers because there was a vast amount of profit to be made. (Reasonable people can differ on whether the CRA is good policy in principle and in practice, but that’s really besides the point here.)

It works like this:

1) The global economy was pretty good, so there’s loads of extra money sloshing around that people want to invest in something nice and safe. (It actually doubled from $36 trillion to $72 trillion between 2001 and 2007.)

2) At the same time, house prices were going up.

3) So, people decide to invest in mortgages.

4) Obviously there are lots of steps from, say, an investor in Mumbai to a homeowner in Michigan, but let’s concentrate on Wall St banks with lots of money and smaller mortgage lenders operating in communities. (Not that small necessarily, Countrywide was one, for instance.)

5) Mortgage lenders sell mortgages to wannabe homeowners. Then they sell them up the chain to Big Banks (and the investors they represent) who get the rights to the income and associated risk.

6) As things continue going nicely, Big Banks are happy to get their hands on more and more mortgages. But lenders are almost running out of people to sell houses to.

7) Fine, say the banks, who have plenty more investors who want to get in on the action. Give mortgages to more people, even those you’d usually turn down.

8 ) The lenders have a field day. Usually to get a mortgage you have to prove what money you have and what your income is. No longer! Now you can just tell the lender what you earn. Sometime later, the rules are even looser and the banks don’t even ask. (The fabled NINA, No Income No Assets loan.) And to entice people in they start giving away mortgages with very low introductory rates and all kinds of exciting offers (the fabled “predatory lending practices”) to get more and more people to sign up. Don’t forget, housing prices are still going up so lots of people are figuring they can sell the house on before the higher interest kicks in.

9) Meanwhile the banks are buying these rather dodgy mortgages by the bucketload. They mix the good and bad ones up together, whatever, who cares. Credit rating agencies reckon it’s alright, though, and give them all AAA ratings. This is partly because even if a homeowner defaults, the owners of the mortgage deal get to repossess the house and sell it at a profit. Also, who pays the credit rating agency to rate stuff? The bank with the stuff to be rated.

10) Housing bubble bursts, because that’s what bubbles do.

11) Homeowners hoping to flip their property before the higher interest rates kick in can’t sell it for what they paid for it. They’re screwed, and default. Dumber people who just magically hoped they could pay the higher interest rates coming down the line? They can’t, and default. People who didn’t read the small print in their mortgage, also screwed, and default.

12) Banks start to notice all the foreclosures. They refuse to buy the dodgiest mortgages from lenders, which is bad news for lenders as they’ve just borrowed loads of money and given out some bad mortgages and now they can’t sell them up the chain. Some lenders, therefore, go bust.

13) Obviously the fall in house prices means that the banks can’t cover their debts by selling off the property. Anyway, everyone starts to cotton on to the fact that bad stuff is going on. Investors start selling their share in the mortgages to wash their hands of them, and the price of them starts going down, so what the banks actually own in terms of capital is less and less and less.

14) Credit rating agencies start downgrading all these dodgy mixed up mortgages.

And then the rest is all Wall Street insider stuff. Banks and investment funds start writing-off assets, basically admitting that all these investments they have are worthless. Share prices go down so they can’t make as much money by potentially issuing more shares. Banks don’t know what dodgy-ass mortgages each other have and don’t want to loan each other money. But loaning each other money is what makes the whole system work, so institutions start falling over because they can’t operate without access to the loans.

For instance, Lehman Brothers ended up stuck with the crappiest mortgages (possibly because they were potentially the most profitable, possibly because they couldn’t find investors for them) and ended up losing $3 billion. Washington Mutual gave out subprime mortgages directly, and lost $8 billion. Merril Lynch lost $19.2 billion in a year. IndyMac was one of the biggest “lenders” and had $10.7bn of mortgages ready to sell up the chain, but suddenly nobody want to buy them, and they had to eat the losses when large numbers of them went into foreclosure. Countrywide had to eat losses, then their share price went down so they couldn’t raise money by issuing new shares, and then they had to admit that they were essentially including delinquent unpaid mortgage installments in their accounting as “assets” when in fact the mortgage payments would never arrive. Northern Rock, in the UK, was mostly fine but nobody would lend them money because OMG THEY DO MORTGAGES, had to get a loan from the government, which made everyone panic, triggered a run on the bank and got it nationalised. Netbank, usually a lender that would resell mortgages up the chain, tried to disguise their loans as safe, but when it was revealed they weren’t, were forced to buy them all back, and couldn’t find anyone else to buy them, driving them under.

So essentially some of the assets of some of the banks have? They’re subprime mortgages, and nobody wants to buy them or invest in them, making them worthless. If they truly are worthless, people lose confidence in the bank and the bank can’t access loans, their share prices tank, and the bank dies. (This is obviously circular in that the suspicion the bank might collapse is enough to make it collapse.) The government is planning on buying these subprime mortgages.

So there you have it.

It’s true that only a portion of bad loans had to do directly with the CRA. But you left out the part where Fannie Mae and Freddie Mac bought up all those crap mortgages largely because of political pressure.

Now Goon Blinkz0rz steps up to explain why it’s not Freddie Mac and Fannie Mae’s fault:

Basically, Fannie Mae and Freddie Mac failing are the consequences of the fallout from the subprime mortgage crisis rather than the cause. This crisis was caused by deregulation (Gramm-Leach-Bliley) that allowed banks to have investment, commercial banking, and insurance under one roof. This led to 2 separate phenomenons. First, it allowed the banking industry to create banks that were too big to fail. The sheer amount of liquid assets controlled by these huge banks makes it impossible to allow that much money in the market do be taken down by illiquid assets such as CDOs and mortgage-backed securities suddenly losing values.

Second, it allowed banks to lend money (in the form of mortgages specifically due to the rising value of homes) and then turn around and sell the mortgage-backed securities to other investment houses. The issue becomes more complicated when you have the smaller street-lenders taking out massive loans to offer mortgages and then turning around and selling these loans as MBS’s or CBOs to pay off their initial loans. When the value of houses dropped, borrowers who either couldn’t afford their mortgages* or who depended on the equity in their home to take out a home equity loan to stave off default ended up defaulting. The mortgages that were securitized dropped in value leading to financial institutions (and more specifically investment houses) losing a significant amount of money and consequently being unable to fulfill their debts. This is exactly what happened to Fannie Mae and Freddie Mac. That’s why, aside from the sheer amount of assets present in the market decreasing significantly, banks are so wary about lending other banks money.

*You have to keep in mind that the reason these people were able to take out these mortgages they couldn’t afford is because the lenders were increasingly more competitive with each other in order to make the most profit. This led to nina and ninja loans being actual services offered. For lenders, it didn’t matter whether the borrower could pay their mortgage because once the mortgage was securitized and sold, it was out of the hands of the lender.

I asked for some clarification, because I am a dunderhead. Again, Goon Blinkz0rz comes to the rescue:

The basic gist to refuting these articles is to note that both of these articles discuss a symptom of the explosion of mortgage backed securities trading. Because initially these securities were seen as a safe investment, GSEs like Fannie Mae and Freddie Mac bought and sold them without reservation. Because they represented a pretty decent amount of the actual assets the GSEs own, and the concern about them devaluing was pretty low, the GSEs treated them as almost equivalent to liquid assets even though they were, in reality, pretty shadily set up.

When the housing market went bust, the CDOs that were made up of these securities devalued like crazy. Foreclosures devalued them even further. The GSEs were left with CDOs and mortgage backed securities that were, up until recently, worth trillions of dollars, but now are worth next to nothing.

Basically the greed that caused street lenders and commercial banking institutions to push NINA and NINJA mortgages on people who couldn’t afford them and then turn around and sell them as securities while depending on an exploding housing market to keep the securities’ values pumped is what caused the failures of Fannie Mae and Freddie Mac, not the Clinton administration suggesting that Frannie and Freddie insure and issue mortgages to lower income home buyers or the CRA in 1977.

Goon Fascist Funk helps me out, too:

The NYT article distinguishes between the moderate- and low-income mortgages that Clinton and Fannie Mae stockholders advocated, and the subprime mortgages which, according to that very article, Fannie Mae itself pushed for under pressure from banks, savings & loans, and mortgage lenders, not the government.

Someone feel free to correct me if I’m wrong, but I think a failure to differentiate between low-to-moderate income mortgages and subprime mortgages is one of the chief errors of the “blame Clinton” crowd.

With us so far? Good. Goon Cav gets in to the nitty-gritty:

Mortgage defaults didn’t cause this crisis. Waves of personal bankruptcies and loan defaults aren’t anything new. The problem is that financial institutions won’t extend credit to each other, not just because some are carrying bad mortgages, but because their assets may consist principally of mortgages whose only known value was set by the company that owns the mortgage.

Every company has to have assets equal to their operating needs. A manufacturer has to have enough assets that are liquid (can be easily converted to cash) to buy materials and pay their employees. Commercial banks hold customers deposits and must have enough liquid asses to accommodate the maximum foreseeable withdrawals.

Financial banks provide working capital for business startups and expansions by underwriting stocks and bonds - they give the company the capital and then sell the stocks and bonds to recoup their investment. They’ve got to have liquid assets sufficient to cover stocks and bonds between their issuance and sale. Insurers who often insure stocks, bonds and business ventures have to have sufficient liquid assets to cover claims.

When one company can do all three types of financial business, a crisis in any of them can drain off liquid assets and cause a companywide failure. When the different types of financial institutions are intermingled, a crisis in one quickly becomes a crisis in all.

This was one of the primary causes of the bank runs that sparked the Great Depression. To insulate the different types of financial businesses, Congress passed the Glass-Steagall Act in 1933, which prohibited doing business in more then one financial arena.

In 1999, at the behest of financial institutions that wanted a piece of every pie, Phil Gramm rammed the Gramm-Leach-Bliley Act (GLBA) through a Republican controlled Congress. This repealed the Glass-Steagall firewall and opened the door to industry wide failure, again.

Now that he’d built the coffin, Gramm nailed down the lid. In late 2000, as the Clinton administration was becoming the Bush administration, Congress was rushing to pass the annual Omnibus Budget Reconciliation Act to move budget account surpluses to cover shortfalls. At the last minute, Gramm slipped in a 262 page amendment called the Commodity Futures Modernization Act of 2000 (CFMA). The dense and obtusely technical language was passed as part of the budget bill without debate.

This act almost totally deregulated derivatives, aka futures. Now each company that held derivatives, like subprime mortgages, was free to determine their value when calculating the value of their liquid assets, with little or no government verification. Any company that wanted to overextend itself could simply overvalue its derivatives and hope they didn’t get caught in a cash crunch.

They did. Companies who can’t meet their cash obligations go belly up. Normally, a company caught in a cash crunch borrows cash on short terms with its less liquid assets as collateral. But no one knows which mortgage assets are likely to fail and which ones’ value is overstated. So nobody loans and everything crashes.

The Community Reinvestment Act (CRA) of 1977 prohibited redlining, effectively saying that, if your bank or loan company’s market is Onondaga County, you can’t just loan money in Skaneateles and Manlius and decline all applications from the city. It didn’t require lenders to issue bad loans; pure greed did that.

CRA was passed in 1977. GLBA and CFMA were passed in 1999 and 2000. Things started to come apart in 2005. If CRA caused this, it took three decades to do it.

The CRA isn’t responsible for the over-inflation of house prices or banks bundling mortgages and selling them, that’s from the Gramm-Leach-Bliley Act of 1999 that basically repealed Glass Steagall.

What people who buy this shit don’t understand is that if the government was “forcing” these banks to give money to people (which doesn’t make sense but that’s what they keep saying the CRA is supposed to do) then houses would be massively UNDER-valued because banks would be fighting to give the least amount of money they could.

Instead, the repeal of Glass-Steagall allowed banks to basically sell a mortgage to whomever, bundle it up with a bunch of other mortgages, then sell that bundle as an investment that would “mature” and be worth more than what the buyer paid for it. For example, if the bank bundled up 5 $200,000 mortgages and sold it for $750,000, the buyer of the bundle would basically be assuming to make $250,000 on it when the homeowners finished paying up, which they failed to do, devaluing all those pieces of paper they’d been trading back and forth for the last decade. The bank doesn’t care, though, because they make their money back and a tidy profit off the short-term sale, it was the long-term owners of those mortgage bundles that got fucked.

The guy who made the video figures if he just throws enough shit at the audience with a “GRRRRR DEMOCRATS!” message that people will get confused and just assume it’s the Democrats’ fault. Information overload. But it’s pretty simple: Phil Gramm, McCain’s chief economic advisor, also behind the Savings & Loans scandal of the 80’s (which resulted in the biggest bank failure in history up until WaMu last week), repealed Glass-Steagall in 1999 which allowed banks to consolidate commercial and investment holdings and go wild on short-term profit by selling mortgages as investments. They overvalued every thing they had, sold it all, and then when people couldn’t pay up, every one freaked out because no one knew what anything was worth anymore, every body wrote off their investments as losses, stopped lending to each other, and then the institutions collapsed.

So you want sources, you say? Here is the best possible explanation as to the whole mess, an hour long episode of This American Life from NPR. Take the time and listen to it, and educate yourself.

This entry was posted on Wednesday, October 1st, 2008 at 11:38 pm and is filed under Domestic Policy, Money. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.