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Financial Crises Past and Present

AIR DATE: Friday, September 26th 2008
Download the mp3 for this show.
A trip down memory lane to put the latest financial troubles in historical context.

In just a matter of days the country went from coming to terms with the seriousness of the economic crisis, to Congress getting close to reaching a decision about the bail out bill. Two days ago we had, basically, Bailout 101, an hour focused on clearing up confusion about the Administration's proposal.

We?re taking a different tack tomorrow, looking through the lens of history as a way to understand the current economic crisis.

How do our country?s financial problems fit into history? Are they comparable to the 1792 panic? Or 1929? Or 1987? What can we learn from past economic crises that might inform the debate in 2008? And in what ways does the global gobble of chopped up sub-prime mortgages leave us in uncharted territory?

GUESTS:

Tagged as: bailout · history · politics

Today's program would be an appropriate time to explore and compare Neil M. Bush and his part in the USA'S bailout of the bloated, under-regulated S&L market implosion. Does anyone else find it interesting that 2 of the Bush brothers have been closely tied to THE two significant, taxpayer bailouts of wealthy investors in 90 years? Why isn't anybody talking about this from this perspective? Is this an amazing coincidence or what?
Or am I just listening in the wrong places at the wrong times?
I worked for 7-plus years in the banking industry (1978 thru 1985). Some of these regulations everybody is yelling about have been there all along: They just have not been enforced with common sense and decency. It isn't a lack of legal regulation in the financial world; it is a lack of moral intelligence and over-abundance of unbridled power and shameless greed. Bonfire of the Vanities revisited.

Here's a question you probably don't want to touch: Neil B's messed-up financial dealings with Grace Corporation. Is that related to the disappearance of W.R. Grace from your list of big sponsors? Is it the same Grace corporation? I truly do not know for certain, but I have always wondered why W.R. Grace's name was dropped after so many years of sponsorship. They aren't the only big financial entity to be dropped from your list, but this coincidental connection with Neil Bush is fascinating to me. Has OPB ceo's ever considered that you might GAIN more members and money by coming out with the straight story on something like this?? Flagging this honest question as inappropriate just makes you seem like you have something to hide. Is this so difficult to comprehend? This is not a great leap of logic here.
You won't alienate your Religious Right Listeners: you do not have any. That is why I listen to you. I suspect I'm in a majority here. My RRR (religious-right Republican) family thinks I'm brainwashed by the evil left-wing talk shows of NPR. Does anyone else want to LOL here?
Neither George W. nor brother Neil have any gift for developing profitable businesses. Quite the reverse. Such an understatement....
What seems extremely important right now is the brothers' respective talents for relentlessly running businesses (economies)into the ground, and the (coincidental) timing of Two of this country's most significant financial disasters and the saddling of taxpayers with the Bush boys' rich friends' losses.
I suppose you will flag this as inappropriate, as is usual for my questions/comments. If so, that in itself is very disturbing and speaks volumes about OPB's ethics and values.
Why doesn't it trouble YOU? I wonder how many supporters you are losing to KBOO and Pacifica.
AT least of late I seldom hear your blurbs for Kaiser Permanente. One step at a time. Healthcare is a bad place to be unable to separate church from state in administration. I could tell you scary things about KP's methods of terminating unwanted pregnancies.
Laurie Hendrickson
lauriejune —
Past finacial crises are SO relevent to today's situation. The "bail out" is absolutely necessary to prevent another 1930's style depression. The big lesson from the 30's depression was that liquidity and confidence in the financial system are absolutely necessary and essential. The goverment must provide the cash to keep the system going and to keep up the confidence.

It was a loss of confidence, followed by a run on the banks (everyone wanting their money out at the same time) which caused the collapse in the 30's. At that time, the goverment froze the financial system (closed the banks). This did not work.

Today, we have a similar situation - investors (big and little) have lost confidence and are "making a run on the bank" - moving money out of mutual funds and into treasury bonds, considered safe. (Mutual funds have replaced the 1930's bank - the place where people keep their "cash".) There has already been a collapse in the treasury bond market and some mutual fund groups are reporting a value less than $1. The collapse of the mutual funds would affect every single American and could easily lead to a depression.

The savings and loan fiasco from the 1980's is also relevent to today's situation. It is an example of a taxpayer bailout. At the time, there was the same fear that generations of taxpayers would be stuck paying off the huge amount of money spent in the bail out. As it turned out, the bail out allowed the goverment to maintain a healthy financial system and gradually deal with the assests from the failed savings and loan companies. Since the taxpayers bought the assests at a discount and were able to later resell them, the taxpayers actually made money! If handled correctly, this situation should be similar.

The anger and frustration felt by all of us (the normal people in the country - as opposed to the high rollin' investors) is total valid. However, without the bail out, the consequences would be far worse.
Yes - there should have been regulation over the housing mortgage investment schemes.
Yes - there were a lot of greedy people who made out like bandits.
Yes - the taxpayers will have to foot the bill, for now.
Yes - it seems soooo unfair!
Yes - it is essential that the bailout process be supervised and well implimented so it successful and money is not wasted.

But if the goverment does not act, and act SOON, the bail out may not work! Then we could still have a depression and we would need to inject even MORE money into the finacial system.

It is time for the politicans to get out of the way! Let the folks with the knowledge get this thing done! The Republican political dog and pony show at the White House yesterday was a farse. And the markets are going to reflect that on Friday unless the Congressional Democrates can seal a deal at at the last minute.

I agree that the Congress can make sure guidelines are set in place to help safeguard against waste and fraud. But don't screw this thing up! Our very existence as we know it is at stake.
Dr Loosedog —
"Let the folks with the knowledge get this thing done!"

these are the same people who got us into this mess, why the hell do you think they know how to get us out?
jaikenone —
Are there such "experts"? Take the complexity of CSOs (combined debt obligations rearranged to form combined sewer overflows) that no one understands. So-called experts created these mechanisms so they could retire early and watch Rome burn from the sidelines.
trurl9 —
Dr Loosedog is wrong about the 1980s bailout. The Resolution Trust Corporation LOST money. The taxpayers came out losers in that deal. Just like they will come out even bigger losers in this current bailout deal.

Luke T. —
The 1980s bailout by the RTC differs in many ways. One difference being that RTC did not acquire a bank's assets until after the bank collapsed. And then those assets were siezed and sold off for pennies on the dollar to vultures. That is why RTC lost money.

If you sell an office park for pennies on the dollar, like RTC did, then all office parks fall in value. The result of the RTC was that the real estate market stayed depressed for the entirety of its existence.

Once RTC was dissolved into the FDIC in 1995, there was a boom and bust period immediatlely following from 1996 to 1998.

This current proposed bailout differs in other ways, as well. I will outline those differences and the costs in my next post.
Luke T. —
The currnent bailout as proposed would create an enormous incentive for the government to keep real estate prices artificially inflated. Banks don't have the power to influence the price of houses, but the government does. Handing over private debt to public debt creates a near certainty that the government will prop up the real estate market artificially.

This is very complicated, but I will try to explain in simple terms.

Imagine a ladder. Each rung of that ladder is a level of risk. As you go up the ladder, the risk of default is lower. Imagine this ladder descends into a well.

The lower rungs of the ladder are the loans that are the highest risk. The most toxic loans. The top rungs of the ladder are the lowest risk. Loans to people who are good credit risks.

Each rung is known in the financial world as a tranche.

If a mortgage defaults, the bank sells the house. If the loan was for $300,000 and the house is sold for $240,000 in the current market, that is a $60,000 loss. That is a 20 percent loss, which in the financial world is known as a 20 percent "severity".

For good credit risks, the number of defaults is low. So even with a 20 percent decline in home values, the amount of gains from mortgages that don't default is much greater than the losses from homes that do default.

Of course, the lower you go on the ladder, the greater the losses because the risks are much greater.

As home prices drop, the losses from each default go up correspondingly. So the bottom rungs go underwater, meaning they lose more than they make, as home prices drop.

The more home prices drop, the more rungs go under water.

The water is rising. Because home prices are dropping.

Every time home prices drop, rating agencies have to re-evaluate the ratings of every tranche. The ones that get evaluated as "junk" are the ones that are going to lose more money than they make as long as house prices remain low and keep dropping.

The numbers for August have come in and home prices are lower than ever. So that means more tranches are under water and the top tranches all have a lower credit rating.

When a bank loses money, that is money it no longer has to loan or to otherwise use to keep the economy moving.

The banks want us taxpayers to buy all the rungs that are under water.

Yes. The ones that are losses.

There are two forces which are in dynamic tension with these lower rungs. Both are affected inversely by time. The longer you hold a bad risk loan, the more likely it will default. But the longer you hold the bad risk loan, the better your chances that real estate prices will go back up.

If you have a high risk mortgage on your hands, it is in your interest for home prices to rise.

Banks do not have the power to make home prices rise.

The government does.

Think about what that means.
Luke T. —
The last time a Republican executive presided over a constitutional crisis in the early 1970's, the U.S. paid the price in terms of wage and real estate stagnation, high fuel prices, inflation, and loss of confidence in the markets. It's a precedent that doesn't bode well, since that recession lasted for most of the 1970's.
newshound —
One need not look too far back to find examples of financial crises in our time; there is the banking crisis, the savings and loan crisis, the energy trading crisis, etc. And now the mortgage crisis, the mortgage banking crisis and the investment banking crisis.

It seems to me that one thing that all of our recent financial/commercial crises share is that they are, almost without exception, segments of our economy that were deregulated during the 1980's and 1990's.

These sorts of problems will keep occurring as long as people are willing to buy the ideology that the best way to benefit the sheep is to let the wolves do as they please without oversight or regulation.

Government is not the enemy; government is all of us banding together to achieve together the things that we cannot achieve separately. And that includes regulation of those whose ethic is 'profit uber alles'.


Earendil —
This "crises" is a good thing. People are over extended, and may not have taken the consequences of debt into consideration. Everyone on the show is talking about purchases like its an investment, using OPM. Housing is a wasting asset, just like an automobile. Its time to start saving money, growing wealth and buying what we need or want with cash. Regulation starts at a personal level. If I want something, I save and then purchase with cash. In this way I am beholden to no one. A business should raise capital by selling equity. The stock holders then take the risk... with their cash.
notnats —
There is a difference between the government addressing a bank run, where people take their money out of a bank due only to fear; versus a bailout which I think is being considered at this time.

As for "moral hazard", the U.S. Government does NOT want a moral hazard for the Chinese and other foreign govts that have been funding the US debt, they want them to continue funding US without risk. But for the individual that took out a "bad" mortgage, the govt wants that person's life ruined.
Bob88salem —
Recent financial crises have a general similarity: human emotion caused great turmoil. Warren Buffett and the best investors discuss the importance of investing in solid companies without undue emotion.

Our "free market" system is built on cycles of boom and bust and is not free. The market is manipulated by greedy players. So perhaps we should take control of the market, smooth its ups and downs, so we can have confidence that we can reach future financial goals without undo heartache.

- Replace huge single points of failure (large financial institutions that have recently collapsed.

- Replace government and corporate employees who are ethically, morally and fiscally corrupt.

- Reintroduce effective and toothsome regulations free of loopholes that enrich fat cats.

The goal is to smooth out the dramatic ups and downs in our boom-to-bust economy. What's funny is that many lay people recognized long ago that the economy is sick. Where were the so-called experts then? Maybe the experts are not as competent as we have been led to believe.

Until we have more integrity, we need to control the horizontal and vertical of the economy. Let's not pretend that free market, trickle down economics works when it obviously does not.
trurl9 —
Here's the thing about collateralized debt obligations (CDOs). What these investment banks did was take the lower tranches (highest risk) of the residential mortgage backed securities and turn them into CDOs and then divided those CDOs into new tranches. And then those new tranches were re-graded by the ratings agencies with the top rungs rated AAA. Turning manure into gold.

So the CDOs are nearly 100 percent worthless.

Perhaps this will help explain why there is panic in the air.

Every last pension plan, 401k, IRA, any investment fund you can think of, has their money in these financial instruments.

Luke T. —
Are you saying that Vanguard Energy Fund (VGENX), for example, has invested in CDOs? I assume that any company owned by a fund could invest their money in CDOs such that there is an indirect exposure to the fund.
trurl9 —
This is in response to the comments on life insurance. Your guest is wrong on how commissions are currently paid by carriers: Life insurance commissions are paid either up front or over the first year of the policy. There is a small renewal commission paid over the next several years (with some policies).
If an insured dies in the first two years of the policy, the carrier has the right to investigate and may not pay the claim if there was fraud on the application. If there is no fraud, the claim is paid to the beneficiary.

Life insurance carriers prevent fraud by doing health underwriting on the proposed insured.

Your guest's comments about greed driving the actions of many people are correct. The management of the insurance carriers are not immune, however. They and their shareholders also want new premiums to be paid so that the carrier continues to show growth.
Robert Burney
RobertBurney —
When remembering the S&L bail out, one name springs to mind. Neil Bush. The President's "other" brother.
C.
Letter C —
There is one common factor to every financial crisis America has had. That common factor is the mass delusion of investors that a high risk investment was not a high risk.

When you are making good money off an investment and you run out of good risks to invest in, you don't want the good times to end and so you beging to take bigger and bigger risks, telling yourself it will be okay.

In the current crisis, banks ran out of good mortgage risks before they ran out of money to loan.

Voila. HEre we are.
Luke T. —
Executive compensation - how to get companies to lower the amount of compensation they pay their executives... In times past, income levels over a certain threshhold (these days it could be 5million... 10 million) is taxed at a VERY high percentage, say 90%. This effectively limits the compensation to reasonable levels because anything over a certain amount goes to the government. There's no incentive to demand high incomes and golden parachutes if it will be taxed so high. Since these tax practices have been removed, executive compensation has skyrocketed.
krmick —
I find your guest's ideas regarding timing of compensation good ideas.

It is amazing that a corporation can make hundreds of millions of dollars for years in a row adding up over 10 billion dollars, then in one year lose a couple billion and go bankrupt, leaving some people that pocketed the money in the past very well off and leaving other with huge losses. Past executives that cashed out their stock options years ago do not deserve those "earnings." Had some of the past profits been put aside for cash reserves for future difficult times, they would not have gone bankrupt.

WaMu had assets over 300 billion and get bought for less than 2 billion? Anyone smell anything fishy here?

In addition, at the height of the sub prime loan lending, loan officers could make $5K immediately on closing a loan (and they would do 10 to 20 a month), the loan would get sold, and they have pocketed they money even though the loan goes belly up 5 to 10 years later.
Bob88salem —

Comments are now closed.

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