Today's Article
One Congressional
report provides an
excellent primer for
non-specialists who
wish to know precisely
what factors have
created the current
economic meltdown.
report provides an
excellent primer for
non-specialists who
wish to know precisely
what factors have
created the current
economic meltdown.
The American Spark
 |
 |
 |
 |
 |
A Clear-Cut Explanation For Global Financial Mess
By Cliff Montgomery - Dec. 5th, 2008
A Congressional Research Service report issued on Oct 31st provides an excellent primer for non-specialists
who wish to know precisely what factors have created the current economic meltdown.
The American Spark provides some key quotes from the study, below. We've also decided to emphasize an
essential factor: This crisis began because people at or near the bottom of the economic scale could no
longer afford their mortgage payments.
This ship cracked at the bottom, not at the top. However one tries to spin it, this truth confirms that we are
affected as much by the needs of the poor and middle classes as we are of the wealthy. Thus as long as we
chiefly spend taxpayers' time and money to prop up the rich, we will never fix the real problem--and are doing
little more than re-arranging the chairs on the Titanic.
"Starting in the 1980s, non-bank lenders [have created programs which increase] shares of U.S. mortgages.
These non-bank lenders obtained their own funds through the conversion of mortgages into marketable
securities (securitization), rather than by accepting consumer deposits as in the traditional banking model.
"In most cases, once a mortgage was made, the entity that originated the loan sold it to another institution,
which then pooled a large number of these loans together. From this pool of loans, the institution then issued
securities whose returns were based on the payments made on the underlying mortgages in the pool.
"For a variety of market and regulatory reasons, these mortgage-backed securities (MBS) became widely held
by most financial institutions in the United States and by many institutions worldwide.
"In addition to the securities directly backed by mortgages, financial institutions created numerous other
complex securities and derivatives based on the initial MBS. These secondary products, such as collateralized
debt obligations (CDO) and credit default swaps (CDS) were also very widely held.
"In 2006 and 2007, the rates of default and non-payment by mortgage holders increased significantly
[Emphasis added]. This, in turn, ultimately caused the securities and derivatives based on these mortgages to
lose value. In some cases, securities thought to be low risk were completely wiped out.
"These losses have rippled through the financial system, causing problems for institutions in a number of
unexpected ways as well as stress to the general financial system. The failures of large financial institutions,
including Bear Stearns, IndyMac, Fannie Mae, Freddie Mac, Lehman Brothers, and AIG, were part of this
turmoil.
"Due largely to the uncertainty about what future mortgage default rates will be, what institutions are exposed
to mortgage-related assets, and whether more institutions may fail unexpectedly, financial markets have nearly
frozen at various points in time since August 2007.
"Difficulties for individual financial institutions, and for financial systems as a whole, can often usefully be
distinguished as problems of liquidity or of capital adequacy.
"A firm suffering from liquidity problems has assets whose values significantly outweigh liabilities, but is unable
to liquidate these assets fast enough to meet short-term obligations.
"A firm suffering from capital adequacy problems has an inadequate buffer between its assets and its
liabilities; if its asset values fall or liability values rise unexpectedly, the firm may be unable to meet its liabilities
even if its assets can be liquidated quickly. Insolvency could result.
"The classical prescription for addressing liquidity problems is for a lender of last resort (such as
the Federal Reserve) to lend freely, but at high enough interest rates so that institutions do not take too many
risks.
"[But] Capital adequacy problems, particularly when widespread, can be more difficult to address. In past
crises, steps have included directly bolstering firms’ capital and sweeping insolvent, or near insolvent, firms out
of the system. [...]
"Beginning in early 2008, multiple failures in large financial institutions prompted case-by-case government
interventions to address these failures. Dissatisfaction with these ad hoc responses was cited by the Treasury
in proposing a broader response focusing on government purchase of troubled mortgage-related assets,
hoping to stem uncertainty and fear by removing these assets from the financial system.
"In early October 2008, Congress passed, and the President signed, the Emergency Economic Stabilization
Act of 2008, creating the Troubled Assets Relief Program (TARP).
"TARP includes two primary programs: a troubled asset purchase program and a troubled asset insurance
program. Troubled assets under the program are first defined as mortgages and mortgage-related assets, but
the Treasury is also authorized to purchase any assets if so doing promotes financial stability.
"The total amount of assets to be purchased or insured is limited to $700 billion, with a possible congressional
resolution of disapproval when the amount exceeds $350 billion. Taxpayers are to be at least partially
protected from losses through the provision of equity or debt considerations and through insurance premiums
from the financial institutions participating in TARP.
"Participating institutions are also required to abide by certain limits on executive compensation. In addition to
aiding financial institutions, TARP aims to aid homeowners directly through provisions promoting mortgage
restructuring and extending tax relief for homeowners who have mortgage debt forgiven.
"On October 14, following enactment of EESA, Treasury announced the creation of a voluntary Capital
Purchase Program. Under this program, up to $250 billion will be injected into financial institutions through
government purchases of preferred shares.
"This program is substantially different from the original Treasury proposal, which focused on removing
mortgage-related assets from the financial system rather than directly bolstering financial institutions’ capital
reserves. It is being undertaken under the broad authority provided in the law to make any asset purchases
that promote financial stability."
Like what you're reading so far? Then why not order a full year (52 issues) of the The American Spark e-
newsletter for only $15? A major article covering an story not being told in the Corporate Press will be
delivered to your email every Monday morning for a full year, for less than 30 cents an issue. Order Now!
By Cliff Montgomery - Dec. 5th, 2008
A Congressional Research Service report issued on Oct 31st provides an excellent primer for non-specialists
who wish to know precisely what factors have created the current economic meltdown.
The American Spark provides some key quotes from the study, below. We've also decided to emphasize an
essential factor: This crisis began because people at or near the bottom of the economic scale could no
longer afford their mortgage payments.
This ship cracked at the bottom, not at the top. However one tries to spin it, this truth confirms that we are
affected as much by the needs of the poor and middle classes as we are of the wealthy. Thus as long as we
chiefly spend taxpayers' time and money to prop up the rich, we will never fix the real problem--and are doing
little more than re-arranging the chairs on the Titanic.
"Starting in the 1980s, non-bank lenders [have created programs which increase] shares of U.S. mortgages.
These non-bank lenders obtained their own funds through the conversion of mortgages into marketable
securities (securitization), rather than by accepting consumer deposits as in the traditional banking model.
"In most cases, once a mortgage was made, the entity that originated the loan sold it to another institution,
which then pooled a large number of these loans together. From this pool of loans, the institution then issued
securities whose returns were based on the payments made on the underlying mortgages in the pool.
"For a variety of market and regulatory reasons, these mortgage-backed securities (MBS) became widely held
by most financial institutions in the United States and by many institutions worldwide.
"In addition to the securities directly backed by mortgages, financial institutions created numerous other
complex securities and derivatives based on the initial MBS. These secondary products, such as collateralized
debt obligations (CDO) and credit default swaps (CDS) were also very widely held.
"In 2006 and 2007, the rates of default and non-payment by mortgage holders increased significantly
[Emphasis added]. This, in turn, ultimately caused the securities and derivatives based on these mortgages to
lose value. In some cases, securities thought to be low risk were completely wiped out.
"These losses have rippled through the financial system, causing problems for institutions in a number of
unexpected ways as well as stress to the general financial system. The failures of large financial institutions,
including Bear Stearns, IndyMac, Fannie Mae, Freddie Mac, Lehman Brothers, and AIG, were part of this
turmoil.
"Due largely to the uncertainty about what future mortgage default rates will be, what institutions are exposed
to mortgage-related assets, and whether more institutions may fail unexpectedly, financial markets have nearly
frozen at various points in time since August 2007.
"Difficulties for individual financial institutions, and for financial systems as a whole, can often usefully be
distinguished as problems of liquidity or of capital adequacy.
"A firm suffering from liquidity problems has assets whose values significantly outweigh liabilities, but is unable
to liquidate these assets fast enough to meet short-term obligations.
"A firm suffering from capital adequacy problems has an inadequate buffer between its assets and its
liabilities; if its asset values fall or liability values rise unexpectedly, the firm may be unable to meet its liabilities
even if its assets can be liquidated quickly. Insolvency could result.
"The classical prescription for addressing liquidity problems is for a lender of last resort (such as
the Federal Reserve) to lend freely, but at high enough interest rates so that institutions do not take too many
risks.
"[But] Capital adequacy problems, particularly when widespread, can be more difficult to address. In past
crises, steps have included directly bolstering firms’ capital and sweeping insolvent, or near insolvent, firms out
of the system. [...]
"Beginning in early 2008, multiple failures in large financial institutions prompted case-by-case government
interventions to address these failures. Dissatisfaction with these ad hoc responses was cited by the Treasury
in proposing a broader response focusing on government purchase of troubled mortgage-related assets,
hoping to stem uncertainty and fear by removing these assets from the financial system.
"In early October 2008, Congress passed, and the President signed, the Emergency Economic Stabilization
Act of 2008, creating the Troubled Assets Relief Program (TARP).
"TARP includes two primary programs: a troubled asset purchase program and a troubled asset insurance
program. Troubled assets under the program are first defined as mortgages and mortgage-related assets, but
the Treasury is also authorized to purchase any assets if so doing promotes financial stability.
"The total amount of assets to be purchased or insured is limited to $700 billion, with a possible congressional
resolution of disapproval when the amount exceeds $350 billion. Taxpayers are to be at least partially
protected from losses through the provision of equity or debt considerations and through insurance premiums
from the financial institutions participating in TARP.
"Participating institutions are also required to abide by certain limits on executive compensation. In addition to
aiding financial institutions, TARP aims to aid homeowners directly through provisions promoting mortgage
restructuring and extending tax relief for homeowners who have mortgage debt forgiven.
"On October 14, following enactment of EESA, Treasury announced the creation of a voluntary Capital
Purchase Program. Under this program, up to $250 billion will be injected into financial institutions through
government purchases of preferred shares.
"This program is substantially different from the original Treasury proposal, which focused on removing
mortgage-related assets from the financial system rather than directly bolstering financial institutions’ capital
reserves. It is being undertaken under the broad authority provided in the law to make any asset purchases
that promote financial stability."
Like what you're reading so far? Then why not order a full year (52 issues) of the The American Spark e-
newsletter for only $15? A major article covering an story not being told in the Corporate Press will be
delivered to your email every Monday morning for a full year, for less than 30 cents an issue. Order Now!
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