$700 Billion Bailout: What It Means
A clear, plain English explanation of the $700 billion bailout, and what it means to you.
Nobody in their right mind would agree to a $700 billion financial bailout. If it actually were a bailout, each of those people would be correct. But it is not.
To understand the current economic situation, it’s necessary to examine how it happened. Then – and only then – can we make an informed decision as to whether this is actually a bailout, and whether it is a good idea.
Throughout its history, the mortgage business ran on a couple of principles. They were based in the underwriting standards upon which they relied in order to make lending decisions. First, the borrower was expected to put 20% down on the house. This 20% was to be in the form of cash – not an additional loan. Sometimes young people received help from their parents, but that fact was not disclosed on their mortgage application.
In addition, total housings costs were to be no more than 30% of gross (pre-tax) income, or 25% of net (after-tax) income. Housing costs included mortgage payments, insurance and property taxes. So, the mortgage business went on, largely in the form of “savings and loan associations” until the 1980’s, when their deposits were slowly siphoned away by “money market funds” at brokerage firms and commercial banks.
In order to remain competitive with these new instruments to which they were losing their depositors, Congress deregulated the rates that savings and loans could pay to their depositors, but did not deregulate the rates they could charge their borrowers. The result? They paid more for money than they could charge to lend it out, and began to go out of business. Thus, the savings and loan crisis began, and in order to save themselves, savings and loans designed “adjustable rate loans” to keep themselves afloat. After many failures, and deregulation of the rates that they could charge their borrowers, the industry was saved.
Fast forward to the 1990’s, when President Clinton approved repeal of the “Glass-Steagall Act,” which was enacted after the Great Depression to separate the activities of investment bankers (brokerage firms) and commercial bankers (and savings and loans). This opened the door for your local bank to offer brokerage services, as well as brokerage firms to offer banking services – including mortgages. In the early 2000’s some Wall St. whiz kids presented research that showed a remarkable fact: at no time in history had housing prices fallen in the entire country at the same time.
6 Comments
in michigan we have sphagnum bogs, with moss you can walk on floating over a pond. whoever rated those bonds AAA did that to the economy. i hope those crooks go to jail.
I think this is a pretty good outline of the problem as I understand it. There is one point that is missed which is the “credit default swaps” which allowed for the “insurance” of these securities that was passed late 2000, rushed through Congress by Phil Gramm (former Republican Senator and McCain’s previous economic advisor)in a 11,000 page bill just before Christmas when the Republican’s were in majority in Congress and there was no debate. Not to say the the Democratic’s did not have their dirty fingerprints on this bill but I guess everyone has their price and can be bought. See http://en.wikipedia.org/wiki/Commodity_Futures_Modernization_Act_of_2000 if you are interested and following where we went wrong.
I am not sure this will turn out good for the taxpayers but doing nothing does not seem to be an option.
Hi Teresa,
Credit default swaps, while technically private insurance contracts, are generally considered to be part of the derivative problem that included monetizing these mortgage loans. In total, the problem is based in securitizing and selling, rather than holding the mortgages, thereby having no vested interest in the quality of underwriting for the loans.
Thanks for your comment. I would agree that doing nothing is not an option.
Thank you for your article. Round table discussions involving “true” mortgage holders question, “what will happen to my interest rate, and my home value” if the bill allows for devaluing for only those who are in jeopardy of defaulting? At that point, the holders are considering a revolt – not a good response, but has the industry considered the equity (no pun intended) for all mortgage holders.
Hi Sherry,
Yours is an excellent point, and is at the heart of those who are believers in the free market system. Mortgage holders, some of whom sacrificed dearly to pay their debt as agreed, have every right to be very angry about the current circumstance. Sadly, the alternative to this huge injection of liquidity is a financial meltdown; nevertheless, this “fix” is severely flawed, as you so eloquently state.
Thanks, Kitty, for helping to demystify the current complicated economic picture. In the late 80s I was convinced that I could afford a home that cost roughly 4.5 times my annual income. The realtor involved offered a “bridge loan” which beefed up my bank account and told me it was a completely legal, common practice. I put roughly 10% down and signed up for an ARM. After 10 years I sold the home at a profit just before I was about to lose it, and I purchased a far less expensive home with a fixed mortgage I could afford. I was one of the lucky ones. This same realtor was the subject of a class-action suit for fraud and his company had to settle. He never paid a penny. To my knowledge he is still selling very expensive homes to people (mostly older, single women) who can’t afford them and qualifying them through his bridge loan scheme. In this economy, do you think he’ll still be able to operate in the same way? Or will more realistic qualifications for him and others like him force to operate more honestly (and receive lower commissions)? Thanks, as always, for your keen insight.
Maurine