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The Credit Crisis (part 3 of 5)
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The Credit Crisis
“What Caused the current Credit Crisis?”
The Federal Reserve, under chairman Greenspan, lowered rates to 1% causing investors to look at other types of AAA rated bonds (since US Treasuries were yielding such a low percentage) as the primary location for “safe” investments. The GSE’s (Fannie Mae, Freddie Mac and Ginnie Mae) wrap the mortgages into CMO’s and CDO’s.
Pension funds, Endowments, and many other large investment groups are required by charter to invest in AAA rated securities so they invested in the Collateralized Mortgage Obligations and Collateralized Debt Obligations that were rated AAA. These were rated AAA because these mortgage payments were grouped into boxes were the AAA were paid first at 4% rate of return then the BBB at 7% rate of return then the unrated box at 11% rate of return. This worked great until massive numbers of mortgages went bust. The cash flows dried up and no more money was being poured into the top box. AIG (among others held the Credit Default Swaps (CDS) on these huge securities (Typically 50 million per tranche). OOps! I guess they could not cover the risk. This connected cycle had the effect of decreasing the individual risk of a particular CMO failing and increasing systemic risk to the whole market until the system itself reached a tipping point or mathematically a catastrophe event.
Opinion
Here is what we should be doing but are not.
1. Reinstate Glass-Steagall Act of 1933 repealed 1999.
Reasons for the Act - Commercial Speculation
Commercial banks were accused of being too speculative in the pre-Depression era, not only because they were investing their assets but also because they were buying new issues for resale to the public. Thus, banks became greedy, taking on huge risks in the hope of even bigger rewards. Banking itself became sloppy and objectives became blurred. Unsound loans were issued to companies in which the bank had invested, and clients would be encouraged to invest in those same stocks.
Commercial banks were accused of being too speculative in the pre-Depression era, not only because they were investing their assets but also because they were buying new issues for resale to the public. Thus, banks became greedy, taking on huge risks in the hope of even bigger rewards. Banking itself became sloppy and objectives became blurred. Unsound loans were issued to companies in which the bank had invested, and clients would be encouraged to invest in those same stocks.
That sounds like what was happening with the mortgages! Don't we ever learn anything!
2. Use existing anti-monopoly laws and the FDIC to break up the big banks. No bank should be too big to fail! Separate investment banking and commercial banking - like it was before they repealed the Glass-Steagall Act!
3. Stop breaking down the barriers between governing free enterprise and operating a free market economy. Never put government in the role of trying to run anything. The role of government should be to set laws or boundaries and promote an environment where free markets can operate according to the original ideas set forth by those people wise enough to write the constitution of the United States of America.
More to follow in part 4
Don't forget to Obama Proof your Portfolio.
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