Lowenstein; The makings of the next financial crisis
In a happier world, we would be celebrating the bank bailouts of 10 years ago. They stopped a scary downward spiral, averted a longer-lasting depression and quickly led to a recovery that endures today.
Instead, the bailouts poisoned American politics, specifically by destroying the then-moderate center of the Democratic Party and shifting the base of the Republican Party into the netherworld of conspiracist paranoia.
Stephen Bannon, the spiritual author of Donald Trump's toxic populism, said of the financial crisis, “the fuse that was lit then … eventually brought the Trump revolution.” For marginalized voters right and left, the bailouts epitomized what was rotten with Washington. Once you believed that the Federal Reserve had sold out the country to rescue bankers, there was not much you could not believe.
I recall the precise moment. Ben Bernanke and Hank Paulson asked for legislation to save the banking system - what became TARP, the Troubled Asset Relief Program. This was September 2008, days after the failure of Lehman Brothers. No one knew who was next. Virtually no one - not GE, not Goldman, no financial firm - was assured of its survival.
The country was deep in recession. Jobs had been vanishing all year. Millions of homes were in foreclosure. Banks were not making loans.
The popular reaction to TARP was outrage. Sen. Jon Kyl, R-Arizona, noted prophetically that his mail was split - 50 percent “No” and 50 percent “Hell, no!” The House voted it down; the market fell 700 points. The House reconsidered.
A decade on, the painful recession and the bailouts have been fused in popular memory into a single cause for smoldering resentment. They tainted the image of capitalism, perhaps fatally for a generation that does not recall the exhaustion of statist models from pre-Thatcherite England to the Soviet Union.
Taking its cue from public anger, post-crash legislation went to great pains to preclude the possibility of another bailout. That effort, and that focus, was misplaced. Our focus should be on minimizing the likelihood of another crash.
The term “minimize” is used advisedly. Now and then, market capitalism lays an egg. The old saw is that if we didn't have speculation, we wouldn't have railroads, nor would we have the internet or a thousand successful start-ups that began as an unlikely gamble. The downside is that speculation occasionally goes awry. The economist Hyman Minsky said markets are programmed to go awry. Each time someone takes a risk and comes out whole, the next person takes a little more risk. This was no less true for lending to Argentina than it was for subprime in San Bernardino, California.
Not even regulatory scrutiny can keep speculation healthy forever. Consider the housing industry - which, since it melted down in 2008, has been the object of intense scrutiny by overlapping regulators. In obvious ways, the industry has improved. Credit scores are higher, suggesting that lenders have tightened credit. Americans have more equity in their homes, and they are not withdrawing equity ATM-style, as they did previously, to pay for groceries and sailboats. Largely gone are “Alt-A” loans, which contained some of the worst abuses and eventually the highest default rates.
There also has been some improvement in the financial superstructure. True, Wall Street is unreformed - short-term oriented and speculative as ever - but banks are better capitalized. And households, for now, also are less leveraged. On balance, housing is safer than it was in 2008. That does not mean it is safe.
Home prices have been on a tear for most of the past decade. Lately, they have risen at 5 to 6 percent a year - double the rate of personal income growth. The gap between housing and income cannot widen indefinitely. The Minsky bubble psychology has infected government agencies who insure about 80 percent of home-purchase mortgages. Fannie Mae and Freddie Mac, the biggest of these, have loosened standards. With encouragement of their regulator, the Federal Housing Finance Agency, half of first-time home buyers getting mortgages guaranteed by Fannie and Freddie are making down payments of 5 percent or less. Such easy credit is aimed at broadening access for young people, who often lack capital. However, a lesson from 2008 is that if a person cannot afford a home under prudent lending standards, imprudent lending will not help them.
The riskiest loans are insured by the Federal Housing Administration, an agency whose mission is to broaden homeownership. (These loans are securitized with a guarantee from a different government sponsor, Ginnie Mae). Somewhat akin to subprime in the 2000s, the FHA sector, by definition the most marginal, has widened. It is now approximately 20 percent of the mortgage market. According to Edward Pinto, co-director of the American Enterprise Institute Center on Housing Markets and Finance, the average market price of FHA-enabled purchases has risen 25 percent in the past five years, yet the dollar amount of the average down payment has fallen.
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