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Blame Ourselves for the Housing Bubble

America's financial and economic woes continue to mount and multiply. With them, so too do the woes of the global economy. The US government takeover of mortgage giants Freddie Mac and Fannie Mae is followed by the bankruptcy of finance giant Lehman Brothers during which time Treasury secretary Paulson assures that the United States government is not going to bail out failing companies.

Two days later, the US government rescues insurance giant AIG with an $85 billion bridge loan which suddenly makes American taxpayers owners of AIG. What does it all mean? It means that we live in a complex economic world which grows increasingly interconnected. When one nation's economy coughs, another nation sneezes. It also speaks to the complexity of life in which neither erudite economists or self-assured bankers understand what is going on any more than the average consumer on the street. Although the tendency is to feign incredulity and point fingers at "greedy" CEOs whilst castigating governments and politicians ( Mr. Obama has this game down pat ), the truth is much simpler. When individual consumers and investors behave badly ( or make faulty choices/decisions) , bankers, brokers, and CEOs can also follow suit making their own poor decisions. And government will always behave like government which is to say that they are the last to act and do not always make good decisions either.

America and the world do not end up in this tumultuous situation overnight. It's been a long process building for many years. It derives from misguided assumptions by all sorts of parties; careless optimism by individuals, poor diligence by businesses, greed in the board rooms and executive offices of corporations, lack of sufficient oversight by governments and plain and simple arrogance by politicians who feign incredulity and meddle with affairs without providing positive assistance. No, in this instance we share responsibility for events. Unfortunately, it's the folks at the bottom who get stepped on the hardest. But wait! It does seem that some of those wealthy business elites are also getting spanked on this one. Not a cause for celebration, but certainly heartening to turn and see a suit standing astride you in the slit trench everyone has fallen into.

In America several factors lay behind the current crisis. It begins back in the 90s when banks and other financial institutions frenetically issue credit cards to folks with doubtful credit histories. Many folks see easy credit as an excuse to buy now and pay later, despite credit card interest rates of 18% to 28%. These anxious spenders gleefully take the cards and rack up mountains of credit card debt while they assuage every desire for instant gratification. The habit of spend today and pay tomorrow is burned into the brains of millions of carefree folks who ignore budgets & consequences of excessive debt or self responsibility. Of course, the banks, whose bad debt ratios rise don't mind since everyone seems to be happy. Consumer irresponsibility becomes a habit which grows exponentially along with consumer debt. This in turn fuels a salutary response amongst banks and businesses who discard discipline & caution in favor of chasing the rising wave of consumer demand. Finance banks step into the market and up the ante. The target? Home ownership. There follows a 10 to 15 year period during which home ownership becomes the mantra of bankers, finance banks, mortgage brokers, and politicians - while anxious consumers queue the housing line. Call this an age of unbridled housing optimism.

But in defense of this optimism, it should be noted that Americans are an especially optimistic people. Home ownership is one of the foundations of the American dream and a tangible measure of individual success. One can not completely blame individuals aspiring ownership or politicians who encourage home ownership for more folks, especially first-time buyers. Both presidents Clinton and Bush encourage markets to open up and allow more individuals to participate in credit; in time this becomes pursuit of home ownership. It's both an earnest gesture to individuals trying to climb the ladder of success, and wise politics to encourage home ownership. Of course when things go sour, folks naturally throw hand grenades at the last guy standing which in America, means president Bush.

But what is Mr. Bush guilty of? He simply echoes the whims and desires of individuals, financiers, builders, and politicians who all queue on behalf of the American dream. This housing circus is a consequence of individuals making poor/misinformed decisions which are then echoed and amplified by aiding and abetting home builders, banks, financial institutions, and politicians. Once unleashed, this housing juggernaut becomes a fast train speeding towards the end of the tracks. And no single brake man can stop it. In essence, individuals queue up for mortgages for which many of them in no way, shape, or form qualify for - does a babysitter really qualify for a $700K mortgage on a California house? In many cases government agencies and lenders do not require borrowers to place a down payment on their purchase - the process is broken at the earliest stages of the game. Market frenzy ( along with a touch of greed by all parties ) bolsters a false confidence amongst buyers, home-builders, banks and brokers whilst the Wall Street financial community digests all of these loans into derivatives. Housing prices soar & it seems there is no way to go but upwards.

This is one of many disconnects which occur; the first sign that something is wrong while lenders shirk due diligence & assure themselves that a qualified buyer sits before them. An individual who does not put up any of their own money to purchase their house and has no stake in the process except distorted expectations about the wisdom of purchasing a home whose payments they can't afford when interest rates are reset. Many of these folks are the same individuals who already hold tens of thousands of dollars of credit card debt which magically does not matter to lenders anymore. Banks, brokers, and government all sign off on these dubious loans. Joining the queues are hoards of speculators who grab this easy money so that they can "churn" a house in a matter of weeks and walk away with a quick profit in a market with spiraling prices ( America has scores of television shows touting this "path to success" ). Once again banks often require no down payments on these loans - it is sufficient that the individual has their own ( inflated) primary residence.

The nation is too busy singing "we're in the money" to ponder the consequences of free-for-all lending. Housing bubbles are nothing new in economic history. But the unique twist in this fiasco is how the men in suits are themselves deceived by the upwards momentum of the markets. The culprit is complex financial instruments called derivatives. These derivatives require the minds of calculus gurus who employ computer algorithms to bend, twist and meld these mountains of debts into subdivided lots, in essence atomized loans which contain toxic mortgages. This presumably spreads the risk around and thus minimizes the dangers to all - at least this is how it appears in theory to folks who sell the idea of derivatives to CEOs. In retrospect, derivatives are the computer age's version of a perpetual motion machine. Suffice it to say that if finance bankers and CEO's are clueless as to how these derivatives actually work, how should one expect bureaucrats and individuals to fathom them. As we all now know, derivatives did not work as promised.

The problem is that every bank, every lender, every broker, every business and yes, even the government and the Federal Reserve all assume that things are covered. Yes today, there is an urge to "blame" and to signal out the responsible parties (cue the politicians again). But the responsibility falls upon all of us. It begins with spendthrift consumers who delude themselves into believing that instant gratification is a constitutional right which excuses them from constraining their spending habits in accordance with their income ( if Lenin were alive to do a MasterCard commercial he might say, "from each according to his ability, to each according to his bank balance & credit rating"). It continues with overly optimistic builders and buyers whose greed for quick returns clouds their judgment. They close their eyes and click their heels like Dorothy in the Wizard of Oz hoping that they will be magically transported to a place where housing prices never fall.

Admittedly, consumer and market momentum is a powerful force, difficult for all parties to resist. But neither financers, banks, nor government is prepared for magnitude of the bubble which bursts beneath their feet. Markets never grasp what derivatives were. Analysts fail to gage their impact upon the balance sheet. Wall Street and the Feds look at balance sheets which appear sound but are in fact over-mortgaged Potemkin villages. Government, which is always slow to react and tends instead to address tomorrow's problems with yesterday's solutions plays its usual clueless part. No small wonder then that America's Treasury and Federal Reserve sends mixed signals as this economic crisis shifts and undulates daily. Storm clouds had been long on Freddie Mac's and Fannie Mae's horizons.

The Treasury acts. America's finance banks take their bitter medicine. AIG gets a government respite, but sells it's soul to taxpayers. No surprise that the Treasury is writing the book case by case during this unprecedented finance catastrophe. Ripples spread around the globe creating a tidal wave effect on housing in Ireland, the UK, and Spain. Folks there are learning the same lesson that Americans learn. What does the future hold? You'll have to get up each day and find out. In the mean time, we all need to get back to the basics of the individual. Presently, Adam Smith's invisible hand is stuck up our back side. But we all asked for it. Time to fess up, get our own finances and spending in order, and to learn from our mistakes. As to government? They sure didn't help on this one, and none of us should be surprised. Let's see how America votes, not that it will really make a difference. Then again, politicians need only make promises while individuals live with the direct consequences of their decisions.

Article By Contrary Barry

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