BACK TO THE SAUSAGE FACTORY, with MR. DONALD TRUMP?

Among the various financial woes that led America to the edge of the Financial Abyss, nothing hits home more directly than the Housing Crisis.  If not your home, then your neighbor’s!   To better understand that, let’s take a trip to the Sausage Factory.  The raw meat goes in one end, and reengineered sausages come out the other.

Interest rates had been declining since 2006; however, the Fed lowered them to barely above zero in 2008.  Consumers took advantage of low loan rates, especially for home mortgages.  Banks began to hire commissioned salesmen to pump-up profits during the housing boom.  Also,  by packaging mortgages, regardless of credit quality, the risk would be sold-off in what are called mortgage “pools”.

Banks sold huge pools of mortgages (up to hundreds of millions of dollars worth) to Fannie Mae and Freddie Mac, the government-sponsored agencies, and received their money back.  Fannie and Freddie, while caring little about credit quality themselves, just slapped their guarantees on the pools, and sold them to investment banks.  The banks, in turn, sold Mortgage-Backed Securities—bonds really—using the underlying stream of mortgage payments as collateral.

At this point in the sausage-making process, the secret ingredient was needed, “credit ratings”.  Moody’s, S & P and Fitch are the major rating services, and their ratings assure marketability, with the coveted “AAA” enabling the highest prices.  Since the rating fees are paid by the investment banks, the profit motive, no doubt, influenced the ratings.  The top rating was almost automatic, lest the banks shop the competition for the highest credit rating.

The last step along the sausage factory production process was the banks’ slicing and dicing area.   Most investors didn’t want to invest over a 30 year term, and to be paid from a fluctuating cash flow.  So, the banks grouped the first year’s cash flow from the entire mortgage pool, and used that to collateralize one-year mortgage-backed securities.  That process was repeated for each of the successive one-year cash flows

Everything was humming along smoothly:  interest rates remained low; home buyers were signing their names to anything; housing “flippers” were even boosting the home prices higher; mortgage originators were hauling-in the huge profits; Fannie and Freddie collected their fees; ditto for the rating agencies; investment bank stock prices spiked; and the investors were pleased with their returns.  And then, suddenly, the gravy train stopped!

Housing prices started falling; homeowners defaulted; the excessive supply of bonds outpaced the demand, and everyone along the way had no one to pass the mortgages on to.  The originating banks, Fannie and Freddie, and the investment banks all had trouble financing the mortgages that were in their possession when the bubble broke!  Remember that this was not the only toxic asset effecting our economy, and most specifically, the lack of liquidity was systemic throughout the banking system.

That meant that the banks could neither extend credit to each other, nor to businesses or individuals.  Consumer spending nose-dived, lay-offs increased and foreclosures continued to surge.  Fannie and Freddie had to be taken-over by the Treasury, AIG Insurance Co. was a basket case, GM and Chrysler had to be bailed-out, and so on…

President Obama signed the Dodd-Frank Act into law in July of 2010.  That legislation was designed to rein-in the banks, and to ensure that a similar systemic banking crisis doesn’t occur again.  Donald Trump, however, wants to repeal Dodd-Frank, which might take us back to those days, of not just a housing bubble, but a systemic Banking Crisis, as well.  So tell me, now that we’ve seen what might potentially lurk, in and around, Donald Trump’s Sausage Factory, do we really want to go back there again?

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  1. #1 by cheekos on December 29, 2016 - 1:29 AM

    NOTE: A related post, “Why did the Government bail-out the Banks, and not the Homeowners?”, is linked as follows: https://thetruthoncommonsense.com/2016/11/01/why-did-the-government-bail-out-the-banks-and-not-homeowners/.

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