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Why the Economy Crashed in 2007-

Why the Economy Crashed in 2007:   My studied Opinion

If the Free Market normally works to self-maintain itself and if the government regulators and federal bankers are doing their job, why did the financial markets almost collapse completely in 2007,  causing our on-going economic slump, the worst since the Great Depression. The current liberal administration and the Democratic Congress in 2009 blamed capitalism and moved for greater control, a position echoed by the elite media. Despite their loud voice and bold action, the truth is still coming out. Government over-involvement in the mortgage finance markets, encouraged by liberal politicians, with over-assured regulators allowing the bubble to expand unchecked, deserves the main blame.

Several recent economic studies from both sides seem to agree on these points:

As early as the Carter administration, and more boldly during the Clinton times, the Democratic policies have stressed the goal of more housing for everyone, a worthy ideal if it does not compromise sound financial practice.

The anti-discrimination directives of post-segregation mortgage lending have been increasingly mandated to allow non-qualifiers to get home loans. Under pressure the pendulum swung from “red-lining” to “green lighting.” A worthy objective but pressed beyond caution.

The GSE’s (Government Sponsored Entities) Fannie Mae and Freddie Mac, set up years ago to moderate the market for “conforming loans” have expanded to over half of all loans with increasingly relaxed standards. The GSMs were not subject to the restrictions and taxes that Banks and S & L’s have, and the GSM appointees lobbied and donated heavily to the administration and the Congressional banking chairs(Dodd and Frank). The Fannie Mae President (himself a big Obama contributor) even moved numbers back to a prior year for his executives to qualify for millions more in bonuses.

Investor’s Business Daily reported in 2008 that President Clint rewrote Fannie’s and Freddie’s rules. In doing so, he turned the two quasi-private, mortgage-funding firms into a semi-nationalized monopoly that dispensed cash to markets, made loans to large Democratic voting blocs and handed favors, jobs and money to political allies. This potent mix led inevitably to corruption and the Fannie-Freddie collapse.

Competing with the GSMs for non-conforming loans the banks and Savings & Loans also relaxed standards, which were increasingly computerized. Can you say “sub-prime”? With credit rates still low from previous Fed actions, the housing market for new and used homes continued to expand more and more. The resulting rising home prices would feed the expectation of lenders that the values could only continue to rise. Buyers also saw this opportunity as a way to “flip” houses for greater and greater profits. The expansion of credit extended to other areas, autos, appliances, and home-equity loans as the economy ballooned.

With the GSMs came the “bundling” of good with poor(sub-prime) mortgages into mortgage-backed securities(securitization) which brought more money into the market from pensions and individuals. Seeking for ways to protect against any mortgage defaults, the Banks created new investment products for buyers from individuals, pension funds and even foreign investors to participate in the boom: Mortgage-Backed Securities, Credit Default Swaps and Collateralized Debt Obligations. Increasingly, loans to bad credit risks were bundled with other perhaps better risks and sold to a public eager for some “guaranteed good returns” beyond stocks and bonds. During this time Congress repealed the Glass-Stegall Banking Act allowing Banks to get into investment sales again. From 2003 to 2007 the assets of these institutions doubled, much of it representing short-term loans that are vulnerable to a loss of confidence.  If these securities proved to be “toxic” the whole house of cards could come tumbling down.

How big did the housing finance bubble get? According to the American Enterprise Institute, by 2008 half of all mortgages were made to low credit borrowers: 12 million worth $1.8 trillion to the GSE’s, 7.2 million with FHA/VA worth $900 billion and the other 7.8 million risky loans worth $1.9 trillion to private lenders. The leverage ratio the investment banks like Lehman Brothers enjoyed has expanded in 4 years from 23 to 31 times collateral in hand. Once the short term money dried up and the losses were exposed, the whole bubble would collapse, bringing down the economy with it.

Meanwhile, the Federal Reserve Bank responsible for tightening credit to restrain bubbles saw no reason to believe that this boom could not continue, until it was too late. The public does really not know how close the nation came to a total melt-down of our financial system, or how important the Bush administration and the Congressional Troubled Asset Relief Program(TARP) saved us all from a total collapse. Unfortunately, the huge stimulus spending of the new administration and Congress did not do much more than expand the national debt and reward favorite projects and districts.

As much as the media wants to blame the greed of the bankers or the past administration, it does not hide the fact that it was the “unintended consequences” of liberal government policies and the compromised standards of the lenders and regulators that precipitated the housing and banking crash.

The past four years have not brought about substantial recovery and there are fears in serious economists that there is worse to come when the National Deficit and currency bubbles pop. Can you say “fiscal cliff?” The Fed’s “monetizing the national debt” with “Quantitative Easing” by printing limitless new dollars is keeping the stock markets and currency up only because the European socialist economies are further down the same road to national bankruptcy. We still can turn back.

My research Sources and details available upon request

Dorsey M. Deaton, Ph.D., Emory University

33 years as History Professor, University System of Georgia

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