Financial Crisis and Inveitability

I feel that is high time that I commented on the biggest debacle of my life - the financial crisis. To date, we have seen the massive failure of Fannie Mae, Freddy Mac, Lehman Brothers, and AIG - with possibly more to come. We are in the midst of determining whether or not to bailout AIG and their financial brethren. Through all of this most people seem genuinely surprised at this outcome. I, for one, am not. The tailspin of the US - and therefore the worldwide - financial markets began in a frighteningly familiar way. Corporations, under intense pressure to continually grow their businesses at a level far above inflation, are continually searching for new markets and opportunities. In the lending sector, the typical business model more or less follows a simple description: Financial institutions lend money to home buyers, and then sell securities on the market that are backed by the expected future income stream generated by the mortgage payments from the home buyers. Implicit in this system is as assumed rate of default, usually (and hopefully) a fairly small percentage of the loans given. This business model has been very successful, but certain lenders wanted more. They realized that there were many potential home buyers that had not taken out mortgages due to various "risk factors", or due to the fact that their current financial situation did not warrant a large loan. These lenders knew that approving loans to these higher risk borrowers would result in a much higher projected income stream, which would mean more securities to sell. Everyone with a mailbox or an e-mail account knows what happened next: hundreds of thousands of people were "pre-approved" to borrow huge sums of money for homes that they could not possibly afford. I personally remember being "pre-approved" for a loan that was almost 6 times my annual salary. Fortunately, I knew enough math to reasonably understand that I could never afford such a loan, and did not take the bait. For many others, however, the offer was not to be ignored. They saddled themselves with massive mortgage debt, secure in the fact that it was OK because they were "pre-approved". Mortgage and re-financing sales sky-rocketed, and the revenues of the lenders grew by leaps and bounds. Meanwhile, in the securities market, fund managers began to take notice of the massive increase in the potential income of the mortgage lenders. They started filling their mutual funds with mortgage-back securities, and sat back to watch their funds grow at 4-5 times inflation. The housing market was booming, and executives at places like AIG and Lehman Brothers were making millions in executive compensation. The mutual fund and hedge fund executives were making millions as well in executive compensation. The massive market potential and the need to show massive growth lead to perverse accounting practices at places like Fannie Mae, but since there was enough money to go around, nobody seemed to mind. Like all things that are too good to be true, however, this financial paradise could not last. The massive and ever-widening gap between the projected income stream of mortgage-backed securities and the actual income stream became impossible to hide. Excessive default from the high-risk mortgages made the income projections on which the securities sales were based highly suspect. As consumer confidence eroded, the value of mortgage-backed securities began to plummet. Due to the high value of the mortgage industry, and the penetration of mortgage-backed securities in the mutual fund market, the entire financial sector began to feel the pain. Many lenders followed their loanees into bankruptcy. The entire system teeters on the brink of collapse. A fairly amusing, yet dangerously accurate portrayal of the whole event is here. How could this have been allowed? The fact is that this happens all the time in the US "free market economy", but usually to a lesser degree of severity. In the 1980's, the S&L disaster followed suspiciously similar lines. The S&L companies had been offering small loans to private consumers, and doing a fairly good business. However, as their growth began to slow, they started looking elsewhere for new markets. The "answer" presented itself in the form of commercial real estate. the S&L's began dealing in commercial real estate in the same way they had previously dealt with residential properties, resulting in a huge increase in expected income. Fund managers latched onto this growth in the same way as described above, and similar securities backed by equally dubious income streams found their way into most American portfolios. Then, as now, the difference between expected cash and actual cash eventually broke the S&L industry, and many average investors lost lots of money. The S&L executives and fund managers, however, got rich quickly. As if this weren't enough, the same basic story can be found in the .com bust of 2000. The future value of most of the new-fangled ".com" companies was ridiculously over-stated, creating a massive gap between perceived value and actual value. Financially savvy leaders exploited this perceived value to sell huge amounts of stock at enormously inflated prices. Needless to say, another small group of people in corporate leadership and investment management got rich. Regular investors, meanwhile, lost billions when the bubble finally burst. The fact that this same basic mechanism could have manifested itself in the financial markets so many times should provide some insight as to the mechanics of the "free market" economy and "capitalist" institutions. Executive leaders are expected to show massive gains year over year. If they do, they will be rewarded with huge compensation packages. Fund managers are similarly expected to create huge returns, and are rewarded richly as well. This necessitates risk-taking on the part of the executives in order to achieve the needed growth. Fortunately for these executives, the risk of failure is nearly non-existent. If the risks taken prove to be disastrous (as they have recently), the executive has already received the massive compensation package for the earlier perceived growth. He is under no obligation to give it back. By the time the mistake is fully manifested, the risk has been diluted in the securities market and spread across all those who hold the securities backed by the now-defunct income stream. If it gets really bad, we can always declare bankruptcy or appeal to the government for a bailout. So it is all reward, and no risk, for the executives - assuming they are willing to paint their "risks" in the best possible light; treading the line of legality, and certainly intentionally deceiving the investing public. All reward, and no risk, if only we tell a little white lie... how can an executive resist? We have seen the executive compensation debate before, but this Fannie Mae compensation paper bears review... Chomsky, of course, offers the best insight: The unprecedented intervention of the Fed may be justified or not in narrow terms, but it reveals, once again, the profoundly undemocratic character of state capitalist institutions, designed in large measure to socialise cost and risk and privatize profit, without a public voice. This "socialize cost and privatize profit" mentality is the common thread that connects the S&L crisis of the 1980's, the ".com" bubble of the 1990's, and the financial crisis of 2008. This is our system. This is how it works - always has. So, will this crisis change it? Not likely. As the American public, we are now going to pay for the unpunished mistakes of the financial elite - whether through a tax-funded bailout or through a catastrophic collapse in the investment market, this crisis will hit us all in the wallet. We are asking for an explanation, a recovery plan, and reform. We will get none of them. The "why?" has been asked many times. As always, the survey result is in the eyes of the question-asker. The average person has no idea what has even transpired, let alone what should be done about it. No doubt that, bailout or no bailout, we will be told that the decision has the support of the American people, and we will be shown surveys that seem to prove it. So, no explanation. As for the recovery plan: We are being asked for $700 billion dollars. If you are like me, you are no doubt wondering how it is possible that the financial folks could have arrived at that number so darn quickly. Are they really that smart? Nope: We just wanted to choose a really large number... Wow. I feel much better now. Is oversight/regulation in our future? Really, what's the point? The system will still work to "socialize cost and privatize profit" - oops, I mean Capitalism. And, a terrible thing is regulation.. or "Socialism", as the Republicans - and to only a slightly lesser extent the Democrats as well - will cry... and the average citizen will believe them, because we have been taught to fear and abhor the dreaded Socialists so much that merely invoking the dreaded name is enough to send many Americans into convulsions of irrational fear - perfect for suggestion. So, the financial markets are broken, the regulatory bodies are dysfunctional, the leaders of the recovery plan are pulling "really large numbers" out of thin air.. and we are told - "Trust Us". So, let's find the $700B, eh? Ironically, we already have it - really, it's true. On September 24, the House passed a $612B defense authorixzation bill. That's right... $612B for "defense": The whole bill passed by a vote of 392-39 and will fly through the Senate, where a similar bill has already been approved. And no one will even think to mention it in the same breath with the discussion of bailout funds for dying investment banks and the like. I'm converting what little money I have left into gold and sewing it into my mattress tonight.