This past couple weeks in the market have been highly volatile and have placed our economy in a very unstable condition. Fannie Mae and Freddie Mac have been bailed out by the government, Lehman Brothers was forced to declare bankruptcy, Merrill Lynch was acquired by Bank of America at a fire sale rate, AIG was bailed out by the government at a tune of 85 billion, and previously the government backed the acquisition of Bear Stearns by JP Morgan. Why is this happening? We all are aware the current state of the housing market is a direct reflection of the relaxed lending guidelines over the previous eight years in the subprime market. In order to fully understand how we reached this point it is important to understand the decisions made which placed us in this current state of affairs.
Back in 2000 Texas Senator Phil Gramm introduced the Commodity Futures Modernization Act into the budget bill. Originally, commodities were typically agricultural products and raw materials. Things like pork bellies, corn, wheat, and oil are common commodities. Once the Commodity Futures Modernization Act was passed into law, the shape and feel of ordinary commodities was able to become very different. Before this piece of legislation, a commodity was a tangible good which could be produced and traded in the market place. This bill allowed stocks and other securities traded on Wall Street to be treated as commodities. This greatly affected the real estate industry by allowing bundled up subprime mortgages to be sold as securities which were then treated as a commodity. The hidden truth behind this legislation is the fact neither the SEC nor the Commodities Futures Trading Commission (CFTC) were allowed to examine financial institutions to guarantee they had the assets necessary to cover the losses they were guaranteeing. By not allowing financial institutions like hedge funds and investment banks to be thoroughly examined in an effort to ensure they had reserves needed to support all the subprime mortgages they were guaranteeing, basically allowed major financial institutions to gamble the idea these mortgages would not default and homeowners would be able to continually make their monthly payment. As we have seen over the last handful of years, a great amount of subprime mortgages have defaulted causing the foreclosure crisis in America which led to plummeting values of homes throughout the country. Since the investment banks guaranteeing these mortgages did not originally have the assets required to cover these losses, we now have our current liquidity crisis where it is more difficult to insure and guarantee loans for qualified homebuyers.
The current events taking place in the market have led investors to look for safer and more secure investments, which are typically found in the bond market. The greater amount of investment in the bond market generally leads to better interest rates for mortgage backed securities. This means, qualified homebuyers will currently be able to purchase homes at lower interest rates. We are in no way shape or form out of the woods yet. As the next months unfold it will be important to see what other financial institutions are close to becoming insolvent. Follow the Implode-O-Meter website to see how many lending institutions have been forced to close their doors since 2006, and which lenders are on the watch list of possibly closing their doors as well.
As I write this on Friday morning, Treasury Secretary Henry Paulson just announced he will be working with Congress over the weekend to create a program that will cost “hundreds of billions” of dollars in an effort to shore up the housing market and stabilize the economy. Unfortunately the biggest loser in this debacle will be the taxpayers. All relief granted by the government will be paid for by taxpayers over the following countless years. Immediate action is needed and it appears the government is attempting to take all necessary steps to fix the problems created by relaxed lending guidelines for the past eight years. It is hard to forecast what will happen in the coming months as America takes action to repair the damaged economy. Stay tuned as further information presents itself…
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