Unless you've had your head in the sand or been under a rock for the last year, you know our economy has been in a downward spiral. The release of the official word on December 1 by the National Bureau of Economic Research confirmed what we've all known--we're in a recession.
So, how did we get here? Listening to all of the talk of securitized loans and collatoralized debt obligations (CDOs), it may be easy to think that the repeal of the Glass-Steagall Act of 1933 and subsequent beginning of deregulation of the banks by Clinton with the Gramm-Leach-Bliley Act is to blame. Maybe partially so. Allowing investment banks to act as commercial banks (and vice-versa) definitely opened the door to these "complex financial instruments," as they've been called.
Some of these "complex financial instruments" include the securitizing of mortgages. What that means is mortgagors divide up their mortgages into tradeable securities and then sell them on the market. The idea is supposed to be that they're less risky because slices of so many different mortgages go into each security. Maybe they are--as long as the mortgagees are paying.
If you're a pro-business kind of person, then you'll probably see the hobbling of businesses (particularly auto makers) by unions as the cause. Yes, American car makers sell vehicles that cost more to produce, acquire, and maintain, and which also suffer quicker depreciation than their foreign counterparts. Union officials claim that they only account for about 10% of the cost of a vehicle; other sources say that number is as high as 25-30%. The truth is probably somewhere in the middle.
If you're more populist, you might think that the relaxed lending guidlelines from banks and the high-pressure tactics employed by mortgagors is to blame. Traditional guidelines said that you shouldn't buy a house that cost more than three times your annual income. With the takeoff of the CDOs, we quickly reached a point where everyone who wanted a home and qualified for a conforming loan had a mortgage.
To feed the beast, banks started offering "no verification" loans of all sorts, including "no document" and "stated income." These "creative" financing options allowed borrowers to merely tell the mortgagor how much money they made and the mortgagor would take it at face value. The inevitable happened--banks started lending money to people who had no way to pay the debt.
Adding insult to injury, a whole host of new loan options became popular, including interest-only and ARMs with ridiculous terms, designed to draw borrowers in on the promise of a low rate. The idea is that with a housing market rising at double-digit rates every year, you could continue to bank on your "investment" and just refinance (with cash out, of course) every so often to make sure you took advantage of your home's fake equity.
For example, a friend of mine recently related a story of when he was purchasing a home about 18 months ago. He makes a pretty good salary--about $70,0000 a year. He filled out the loan paperwork, and his mortgage broker told him that he qualified for a $600,000 mortgage. That's $3,000 a month for only the interest. Not to mention the taxes (most places in Michigan, that would be about $8-12,000 yearly) and insurnace (around $1,000 yearly). All of the sudden, you end up with a $4,000 per month commitment to your house; not too good when your take home is only about $4,100 after taxes and health care. Fortunately, he heeded Dirty Harry's advice, and knew his limitations.
But, for someone who wasn't as aware of what that would do to their finances (aka, no business getting a mortgage) or who was overpowered by the allure of an envy-causing house, it's the path to financial ruin.
People watching this happening from the outside would have called this "abso-f'ing ridiculous."
While all of these are definitely contributors, I'm going throw in the last piece of the perfect storm. Folks teetering on the edge of their financial demise were OK until the incredible rise in oil prices. All of the sudden, something that used to cost $2.00 per gallon doubled in the space of a few months.
The oil industry holds some blame, I think--they claim that percentage-wise, their margins never changed. That may be true, but it was obvious what the effect on the consumer was. 7% of $4bn per month is a lot different that 7% of $1bn per month or whatever it was. While they were recording month-over-month record profits, they were also setting the stage for the collapse of the entire world economy.
Suddenly, people had to choose between paying on their massive credit card bills, paying on their overpriced mortgage, paying on their gas-guzzling SUV, putting gas in their gas-guzzing SUV, or putting food on the table. Most people chose food. Food prices rose somewhat (mainly due to fuel surcharges), but stayed relatively flat when compared to the precipitous fall of home and car prices.
As people spent more that the pump, they started defaulting on their mortgages. People defaulting on their mortgages led to companies like AIG collapsing, due to having to pay unprecedented insurance claims to banks (AIG was one of the biggest players in the mortgage private insurance market--the folks you pay your PMI to when your house is at more than 80% LTV). With defaults and foreclosures flooding the housing market, prices plummeted. With all of the collatoralized debt obligations based on the fact that people pay their mortgages, securities started falling apart, leading to financial institution bailouts (Bear-Stearns, AIG), takeovers (Wachovia) or collapses (Lehman Brothers).
Demand for oil plummeted as well--since you no longer have a job or a house, you certainly can't afford to be driving anywhere. While oil is still almost double the 2004 OPEC target price of $29/barrel, pump prices are the lowest they've been in almost a decade.
With the impending passage of the bailout for the Big 3 and subsequent appointment of a Car Czar, one can't help but wonder if it's going to do any good. After all, we have also had government oversight in banking (Senate Banking Committee) and financial trading (Security and Exchange Commission), and that hasn't helped out a whole lot.
All I can really say is that there's no time like the present to analyze your spending and debts and figure out how to live within your means instead of leveraging assets with declining values (such as your home) to fund your future.
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