October 2, 2008
There’s a meltdown in our credit markets. Headlines scream with news about banks, insurance companies and investment firms crumbling under financial pressure. We worry about rollercoastering values in our retirement accounts and annuities, and we fear for the safety of our bank deposits.
Meanwhile, in Washington, D.C., our government runs in frantic circles, proposing plan after plan to “fix” the problems and “solve” the crisis. But let’s stop for a moment and take a deep breath. What’s really going on here? What, if anything, should the government be doing about it? And what about the rest of us? What should we be doing?
In addition to practicing law, I’m blessed to serve on the faculty in the department of management and business at Messiah College, teaching courses on contemporary economics, the economics of social issues, and personal finance. I’ve been fascinated with the mysterious workings of our economy since my undergraduate days at Penn State, where I earned my degree in agricultural economics and rural sociology, with a resource economics option. As a Christian believer who views our economic environment through the dual lenses of academic interest and real life business experience, I’d like to offer some helpful perspectives and insights.
First, it’s important for us to understand where this whole credit crisis came from. Some are blaming Main Street; some are blaming Wall Street; and some are blaming those inside the Washington Beltway, but actually the blame belongs squarely with all three.
Yes, those of us on Main Street had a role in causing the problem. It was regular folks who bit off more than they could chew, buying homes on shaky credit and extracting every last penny of equity through endless refinancing. And too many who borrowed against their homes knew very well that the mortgages would be difficult to repay, but they borrowed anyway. And many of the lawyers, title companies, appraisers, inspectors, real estate agents and loan officers involved with these toxic transactions knew very well that something wasn’t right, but they held their noses and accepted their fees and commissions and did the deals anyway. So yes, some blame belongs on Main Street.
And certainly, Wall Street played a huge role in taking a modest problem and transforming it into a global nightmare, by buying and then leveraging many of those questionable Main Street mortgages into bizarre new financial instruments that ultimately put the entire financial industry at risk.
In short, the players on Wall Street, in their sophisticated human wisdom, figured out they could very profitably sell investors not only bundled interests in the mortgages themselves (“collateralized debt obligations”), but also hedges against the failure of these same mortgages (“credit default swaps”). And, in their greed, they sold so many of these credit default swaps that they exceeded the values of the underlying mortgages by factors of up to 60 or 70 times.
To use a simple analogy, it would be like an insurance company selling fire insurance on my house not only to me, but also to 60 or 70 of my neighbors! When my house burns down (now much to the delight of the whole neighborhood), every neighbor collects a claim for the full value of my home from the insurance company, and the insurance company faces financial disaster. And this is exactly what happened to the big Wall Street firms when the mortgages they had sold and “insured” started going bad. Now they owe everyone in the neighborhood (because of all the credit default swaps), and they simply don’t have the money to pay! So they are falling like dominoes.
And, last but not least, we have the Washington Beltway. While the greed on Main Street and the greed on Wall Street both contributed to the mess, it was the misguided policies of our federal government that made it all possible. Because it was Washington, starting in the 1970’s, but accelerating especially in the 1990’s, that literally forced banks to start making home mortgage loans to people who would ordinarily never qualify for such credit.
First enacted under President Carter, and later modified by aggressive new regulations under President Clinton, the Community Reinvestment Act was used, in the name of equality and fairness, to lawfully require banks to lend to folks with bad or no credit history. This effort was enhanced and encouraged by government sponsored entities Fannie Mae and Freddie Mac, which served as middlemen in the lucrative pipeline pumping a steady flow of these risky mortgages from Main Street to Wall Street. So, essentially, the Beltway crowd decided that economic reality could be ignored and the ability of a borrower to repay was no longer a relevant factor in deciding whether that borrower should receive a home mortgage loan!
Well, the reality is you can’t ignore economic reality! You can’t repeal the law of supply and demand any more than you can repeal the law of gravity! Now, economic reality has arrived. Many of the mortgage loans on Main Street are not being repaid. The borrowers have defaulted and their homes are in foreclosure, as real estate prices fizzle. And, on Wall Street, that fizzle has become an explosive storm, thanks to the overleveraged credit default swaps, as financial institutions around the world find themselves hopelessly short of liquid assets. And, inside the Washington Beltway, the politicians seem once again convinced they can suspend economic reality by passing laws. Bail-outs or rescues or whatever titles they use, the government is attempting to change the basic economics of the situation through legislation. But more laws are not the answer and cannot solve the problem!
We are blessed to live in the wealthiest country in the history of the world during its wealthiest era. It is no coincidence that our prosperity has arisen in the context of our abiding commitment to free market capitalism. Other countries have tried other economic systems, everything from communism to socialism to fascism, and none have measured up. The human toll of these alternative economic systems has been tragic and horrific. While the free market is not a perfect system, history has shown it to be the best way to bring about the most good for the greatest number of people. And to operate correctly, the free market must embrace both risk and reward.
In the Great Credit Panic of 2008, it appears that Washington is now trying to pass laws to protect the very people who made the most unwise decisions from the downside risk of their irresponsible actions. If the government requires the rest of us to insulate the greedy players on Main Street and Wall Street (and inside the Washington Beltway) from the consequences of their own failures, it will only encourage more of the same morally hazardous behavior and we will all suffer. The problems will fester and grow worse over a longer period. The government cannot permanently fix an economic problem by passing laws that say we must ignore economics.
The free market has the power to work the problem out, as it always does. There may be short term pain for many of us, but there will be long term health. We may need to tighten our belts and increase our faith. It might be a rough ride. But the alternatives are unthinkable. And, in my humble opinion, the last thing we need are any more laws!
Stephen L. Bloom is a Christian lawyer serving clients throughout Pennsylvania. He wrote “The Believer's Guide to Legal Issues” (Living Ink Books) and frequently speaks on Christianity and law. For information, visit his website www.IsThereALawyerInTheChurch.com.
Article reprinted from Stephen Bloom's Good News Daily column titled "Good News on the Law." Visit Good News Daily's website at http://www.goodnewsdaily.net/