It feels like it’s 1990 all over again.
Remember 1990? The Savings and Loan Crisis? It’s arguably what cost George H.W. Bush the 1992 election. It’s what caused the recession of the 90’s that brought Bill Clinton to power. It cost U.S. taxpayers $500 billion to bail out nearly 300 failed savings and loan institutions. It was the financial crisis that was supposed to have taught us that yes, a strong capitalist economy does, in fact, require clear regulations and strong regulators in order to work smoothly.
Remember? I do. But apparently, no one on Wall Street or in Washington D.C. does.
“Those who cannot learn from history are doomed to repeat it”, George Santayana said. We all know that saying. People say it all the time. But very few people seem to pay attention to what it means.
Financial crises, I believe, clearly point out the actual governing differences of Republicans vs. Democrats. It is not, as so many people think, a “conservative” vs. “liberal” thing. That may have been true in 1968. It may even still have been a little bit true in 1980, perhaps. But it hasn’t been true for a long time now.
In fact, I’d argue that Democrats are actually far more “conservative” than Republicans are. When it comes to regulating finance, Republicans are all about lack of enforcement. They want to remove all regulation, and what little regulation remains, they don’t want to enforce it. Democrats, on the other hand, truly believe in laws and regulations as fundamental tasks that government must do.
I saw this current financial crisis unfold right in front of me. For four years, starting in late 2000, I worked for a major financial and real estate firm, one that had a large and very public presence on the Internet. Often, as part of my job, I had to work with the company’s legal counsel, presenting evidence about our compliance with the (then) new Gramm-Leach-Bliley Act . In addition, the main function of our web site was to sell mortgages, home equity loans, and real estate transactions.
I saw the sales tactics that were used to encourage anyone and everyone who was even remotely qualified to get the highest mortgage they could. I met with banks, mortgage brokers, and real estate agencies, and got an inside view as to how all of these transactions were put together and sold. I witnessed the formation of the Real Estate Investment Trusts (REITs) which had not existed before.
Therefore, I egotistically feel that I have a better than average understanding of what happened, what went wrong, and what we need to not do again. And if you’ve read this post this far, you must think I at least have some chance of explaining something, right? So here we go…
What, exactly, are we bailing out for our $700 billion? Basically, bad mortgages. Specifically, mortgage-backed securities. Mortgage-backed securities did not exist 10 years ago.
A “security” is a bond issue or paper collection of various financial instruments. An investor can then buy these securities in shares, just like stocks, and trade them around. A mortgage-backed security is basically a collection of, say, a thousand mortgages, packaged and sold together as security. By packing them together like this, investors can buy and trade home mortgages on the open market.
Prior to 2000, this was not possible. There used to be strict laws isolating real estate firms from mortgage firms from insurance firms. The Gramm-Leach-Bliley Act (or “GLB”, as it was called by those of us in the business), did away with all of that. Now, the same firm that sold you your real estate could also issue your mortgage – as well as your mortgage insurance!
Regulation for all of this was also made, ah… “voluntary”. Can you guess what happened? Oh, sorry, you don’t have to guess, it’s kinda been all over the news the past few weeks. That’s right. Shockingly, none of these institutions chose to “voluntarily” regulate themselves.
And now the house of cards is collapsing, because this whole circular, incestuous approach to financing worked only if home values always increased, steadily and constantly, every year. Every quarter, in fact. Once they started to fall, well then… these mortgage-backed securities, which contained many new and unusual types of mortgages such as Interest Only, 1-Year ARMs, etc. all started to be worth less and less as more and more people couldn’t pay them.
But while that’s bad, that’s not what actually caused the current crisis.
Prior to 2003, it also used to be a requirement that any financing institution had to have 30% of its assets in cash or cash-convertable form (such as treasury or other bonds), in case of failure of its securities. This 3-to-1 ratio of cash to securities had been finessed over the years as the best balance between profit and security. But in 2003, the Bush administration eliminated this requirement, and let each institution decide for itself how much cash to keep around.
How well did that work? Well, most of the failing institutions have security-to-cash ratios of about… 35 to 1. Whoops. So, by failing to regulate – in fact, by removing the regulations entirely – we were asking for catastrophic failure.
There are places on this earth that do not have any financial regulations at all. To name two examples: Haiti and Somalia. Anybody want to invest money there? No regulations to worry about!
This time, let’s learn the damn lesson. You cannot take an “anything goes, whatever you like” approach to finance. The government needs to have offices full of steely-eyed regulators who pour over every deal, and say things like “you can’t do that”. We need to have strict, enforced laws that put up firewalls between different types of businesses, like we used to.
You want safe investments? You want a strong stock market? You want a high-performing economy? Then you need to have strong and strict regulators, enforcing hard and fast rules backed by the full force of the law.
Now we’ll have to spend the next two to three years rebuilding our whole financial system, just like we did from 1990 to 1993.
I’d like to remind everyone that once we got over that, we had 7 golden years with a great economy, lots of investment, a rolling stock market, and very low unemployment. Then we screwed it all up, starting in 2001.
So I don’t want to hear anybody, anywhere, ever again say that Republicans are the “fiscally conservative” political party. They are not. Democrats are fiscally conservative. Republicans are radical anarchists who want to let greed rule and take laissez faire economics to their illogical extreme. They don’t want to have to pay any attention to laws, regulations, or common financial sense. They hate the concept of government so much that they are willing to destroy our entire economy rather than play by some simple rules.
In 1981, I was spending the summer in Korea, living on an Army base. There was a small movie theater on base, and every Saturday they’d show a kid’s movie at the matinee. One weekend, the movie was some cheesy Disney film called Billion Dollar Hobo. Except, whoever had put up the marquee for the movie had misspelled it, Billion Dollar Yobo. This was, it turns out, a hilarious mistake.
“Yobo”, you see, is Korean for “sweetie”… and common slang for “whore”. Everyone always knew about the “Yobos” who hung around the front gate of the Army base, willing to do whatever a horny soldier wanted for the right price. As you can imagine, the marquee got a hell of a lot of laughs before someone finally changed it.
This week, every time I see that “$700 Billion” figure, in my head I see a movie marquee: “Seven Hundred Billion Dollar Yobo”. I sure hope the American taxpayer enjoys the screwing that we’re gonna get from this one, it’d really be helpful for everyone to educate themselves in the financial field a little bit more. For those who are interested, I suggest visiting SoFi.