Archive

November, 2010

The Great Recession: what is the root cause and is there a way out?

(Updated 12/05/2010)

Subprime Mortgage: a mortgage given to an individual who is likely to default on payments and the mortgage as a whole.

The narrative promoted by Obama and the Democrats and passed along to the public by the lame-stream media, is that eight years of Bush administration policies, cronyism with big corporations and Wall Street, and war-mongering with loss of U.S. treasure on contrived foreign wars led to the collapse of the housing sector and U.S. financial markets, which has caused our current Great Recession with volatility in financial markets affecting the retirement savings of millions of Americans, the loss of U.S. manufacturing industry, high unemployment and business stagnation.

The story goes on to claim that because of Obama policies, bailing-out and taking-over private companies, and the high level of government spending under the Obama administration working in concert with a Democrat majority in Congress, significantly deeper and more painful economic disaster has been averted by stimulating the economy and saving or creating millions of jobs.

Further Democrat narrative claims that the new Obama financial law brings much needed regulatory control of financial markets that prevents Wall Street from taking the kind of risks that they took with subprime mortgage derivatives that led to the financial collapse. The narrative also claims that the new financial law frees the taxpayer from ever having to pay for anymore bail-outs of companies “too-big-to-fail”.

While this grand Democrat myth seems plausible on the surface and has a certain appeal to a public that has been much abused by the excesses of Wall Street and the loss of gainful employment by businesses moving offshore and deserting everyday Americans, there is the minor annoyance that the facts just don’t support the story.

In fact, the collapse of housing and financial markets, the loss of U.S. industry and jobs, and our current Great Recession were brought about and then worsened by failed Democrat policies that persist in supporting unacceptably high-risk Wall Street ventures based on taxpayer-guaranteed, subprime mortgages that Democrats continue to encourage, and future government-mandated, tax-payer-funded bail-outs of failing “too-big-to-fail” companies that was written into the new financial law.

The new Obama Financial Law canonizes for select, large financial companies that profits are privatized while losses are socialized (i.e. if these big firms undertake high-risk ventures and make huge profits, they will pocket the gains; however, if in taking on high-risk ventures they lose big, their losses will be absorbed by the government with taxpayer funds). Some call this close relationship between government and large corporations State Capitalism, but a more appropriate term would be National Socialism (from which the German National Socialist or Nazi Party name was taken and whose precepts Hitler and the Nazi Party embraced).

It is also the inconvenient truth that Democrat policies have produced the loss of U.S. industry and jobs, and Obamacare, the new financial law, the promise of higher taxes and Democrat anti-business rhetoric has dramatically increased the costs of doing business and created such uncertainty that American businesses are virtually paralyzed. While large, government-favored financial institutions have been showered in taxpayer funds to keep them strong, small banks and businesses on Main Street have been abandoned by the federal government and hung out to dry.

Beginning with the Clinton administration, Fannie, Freddie and other mortgage banks were coerced by the Democrats to give mortgages to low-income families so these families could participate in home ownership and enjoy some of the economic benefits of the middle-class, a seemingly noble humanitarian goal.

While it’s a worthy goal to want to help as many low-income citizens as possible join middle-class America through home ownership, what may have seemed initially like a blessing has now become a curse. In the medical profession’s Hippocratic Oath it encourages physicians to do all they can in the interests of the patient, with this final caveat: But above all, DO NO HARM.

Since the mid-1990’s almost all lenders have been making subprime and creative mortgages. These loans are called subprime because the homebuyer is at significant risk of not making payments and of defaulting on the mortgage at some time in the near future. In the originating lenders’ rush to collect the inflated fees and points that were producing huge profits for themselves, lenders often overlooked or failed to verify creditworthiness, employment status, citizenship, or ability to repay the loan.

Since originating lenders quickly bundle and sell the mortgages they write to Fannie, Freddie, other large financial institutions, and Wall Street firms like Goldman-Sachs, what should they care if the homebuyer should default some time in the future? The originating lender has made its profits by charging low-income homebuyers more to make a subprime loan than it charges for other homebuyers.

While the low-income homebuyer gets hit with a huge bill from the lender for advancing the loan, these loan costs are usually hidden in the loan amount to be advanced and taken off the top by the lender, so the homebuyer doesn’t feel it until later on in the loan repayment schedule. After signing loan documents, and before the ink is dry, the originating lender immediately sells the mortgage. The subprime hot potato has been passed to someone else, who will pass it along to again another or multiple other investors (i.e. Fannie, Freddie, Bank of America, Citibank, JPMorganChase, and Wall Street firms such as Goldman Sachs).

Subprime homebuyers take another hit when the loan terms are written. Typically, an Adjustable Rate Mortgage (ARM) is set up providing for an initial low monthly, low interest, interest-only house payment. Then over the subsequent 3-5 years, the homeowner sees his interest rate increase and also begins paying back principle along with the interest payments which often doubles or triples the initial monthly payment to a level that the homeowner had not anticipated, a level of payment that the homeowner cannot sustain for long without exhausting all resources. Many of these subprime loans have a large balloon payment due at 3-5 years. Also, virtually all subprime borrowers are required to purchase mortgage insurance which adds a significant sum to the monthly payment.

The lender predicts while making subprime loans that the homebuyers are likely to default within the first 3-5 years. Even if the originating bank holds the subprime mortgage it makes, the bank makes money from making the loan, collects monthly payments for the duration of home ownership, and forecloses on and takes possession of the home for resale when homeowners default. As long as home values continued to rise, if the bank had to foreclose on the home, the bank stands to make a profit on this too. In addition, since all subprime mortages require mortgage insurance, if the homeowner defaults, the bank can turn to the mortgage insurance company (AIG ring any bells?) to pay off the defaulted mortgage.

Many subprime lenders utilize predatory loan practices that benefit the lender at the expense of the homebuyer. Such as lending to low-income, would-be homebuyers, where the lender knows in advance there is high risk of default, higher loan costs are charged the homebuyer but hidden in the loan amount, ARMs are set up as described above where over several years a reasonable payment becomes two to three times it’s original amount, there may be an unrealistic balloon payment required, and the cost of mortgage insurance is added to the monthly payment.

If not too many homeowners default on their mortgages at once, this is not an unmanageable or unprofitable situation for banks. So, while lenders making subprime mortgages clearly reap huge profits from these predatory practices, the low-income homebuyer takes another hit with foreclosure, eviction, and financial and psychosocial-emotional loss. Rather than being a benefit to low-income families, hundreds of thousands of subprime mortgages have defaulted and are in foreclosure; many more such loans are due to default over the next several years. Massive subprime mortgage defaults resulting in collapse of the housing, financial and insurance markets, and the ensuing Great Recession has brought about untold misery for these families and for most Americans.

The fact that most mortgages are federally guaranteed (using taxpayer money), explicitly or implicitly, encourages the financial sector to consider these high-risk, subprime mortgage bundles and the Wall Street securities and derivatives based on them as low-risk investments.

The government mortgage guarantee converted a known high-risk investment into a low-risk one, being secured by mortgage insurance companies and also by the good faith and credit of the United States. These mortgages were securitized and sold by Wall Street as prime investments, not based on the usual anticipated high homeowner debt repayment level, but based solely on the insured value and the government mortgage guarantee.

When millions of these homeowners began to default on their subprime mortgages as predicted, a glut of troubled or foreclosed upon homes on the market produced a fall in home values, making most American homeowners upside-down in their mortgages (the mortgage balance owed is greater than the current appraised home value). Securitized subprime mortgages were leveraged as derivatives at 100:1 and greater, and when the housing market collapsed and mortgages were defaulted, the value of the derivatives evaporated as well leaving the Wall Street investment banks owing 100:1 on their products which now no one was buying.

In 2006, the Bush administration tried to rein in Fannie, Freddie and the other mortgage banks and halt any new subprime mortgages with government guarantees to people who could not afford them. Democrats in Congress resisted all efforts to provide judicious oversight or regulation of this high-risk activity. As late as 2008, Democrat leadership in Congress assured the American public that Fannie, Freddie, and the U.S. housing and financial markets were in good shape and as strong as ever.

When the subprime mortgage housing crisis began to grow and spread, Wall Street firms and other large financial institutions filed insurance claims based on the defaulted subprime mortgages, that led to the failure and federal bailout of large insurance companies like AIG, that were insolvent and unable to satisfy claims. The financial sector next went to the federal government for the guarantee and the government gave the financial and insurance companies taxpayer money to bail them out.

The bubble of subprime mortgages was contrived and executed and Wall Street and other financial company excesses were subsidized by Democrat policies that led directly to the current Recession. While the Bush administration was admittedly far from perfect, Bush is not responsible for the current recession—this blame is more appropriately laid at the feet of the Democrats.

While the Bush administration did little to hold down government spending and deficits, Obama has raised spending and deficits more than twice as high as levels under Bush. Most of the Bush deficit expenditures were for a prescription drug program for seniors, and providing justifiable action for national security defense against Islamic Jihadist terrorists.

On the other hand, most of the Obama expenditures have been political payback to Democrat cronies, like Wall Street, the unions, environmentalists, ACORN and other subversive groups, and increasing the size of government and the number of government employees, along with ensuring that federal employee salaries and benefits were more than twice those of comparable workers in the private sector.

The fact that Bush did a limited amount of damage to America through deficit spending on widely desired and other essential, constitutional government functions, does not justify Obama’s multiplying Bush’s deficit many times over with frivolous and wasteful, pork-barrel, political payback while aggressively acting to destroy American free market capitalism, abridge American freedoms, stifle the voice of opposition and critical analysis, weaken American and allied national security defenses, increase American subservience to international interests and secure long-term power to himself and the Democrat Party.

Big Labor, and high corporate taxes, both strongly supported by Democrats, have forced companies to leave the United States and take their businesses elsewhere to remain competitive. If we could have stopped the unions in the 1980’s, and maintained a more reasonable business and investment tax policy we might still have a private auto industry, other manufacturing, and a stronger business sector with higher employment in our economy. Even now, we have the opportunity to dramatically reduce corporate and investment taxes and see business and industry return and boom in the U.S.

However, in order to hire employees, expand the business and increase production, business needs capital. Despite a massive infusion of taxpayer dollars, money is still tight. The banks still are not lending to the economy what the economy needs to grow. When the banks get back into the business of providing the needed capital to the economy instead of just investing overcautiously in Treasury Bills, the economy will have a chance to start growing again.

In the United States we don’t have a typical parliamentary system, but we do have a fairly strong two party system. Many times in the past, third parties have been formed, and while they may temporarily sway American thought and the direction of the two major parties, none have been successful in being any real, long-term influence on American politics. The plan of the Tea Party from the start was to take over, from the inside, the Republican Party, taking it from the establishment which had lost its way and return the party to its roots in fiscal responsibility, smaller government, lower taxes and free markets within the framework and freedoms of a Constitutional Republic. The Tea Party did not want and refused to go down that pointless, third-party road.

Large numbers of individual, average Americans, most for the first time in their lives, moved beyond their comfort level, took a stand against the fiscally irresponsible policies of both major political parties, and worked long and hard hours to get good people with Tea Party views to win in the Republican primaries. Many progressive incumbent Republicans were replaced in these primaries with a Tea Party-supported Republican candidate. In the general elections, many progressive Democrats and earmark and spend establishment Republicans were roundly defeated and replaced with Tea Party Republicans committed to sound fiscal policies.

Over time, the goal is to replace progressives of all party affiliations with Tea Party Republicans such that the Republican Party will be the party of Tea Party principles and values, and the majority party in federal, state and local government. The “Tea Party” is not an actual political party, but a loose organization of Republicans, Independents, Constitutionalists, Libertarians, Unaffiliated and even some Democrats fed up with politics as usual forming thousands of small patriot groups that together make up a rather disjointed but broad-based and committed, grass-roots political movement.

There is nothing illegal, immoral or unethical in being a Tea Party Republican. Rather than serve to prop up the corrupt Republican or Democrat establishment in Washington, Tea Party Republicans have been charged with the special mission of restoring the Republican Party and the nation to correct, constitutional principles of government that promote freedom and prosperity.

There is less than zero basis for any type of legal or ethical challenge to these newly elected lawmakers for not being “real” Republicans. The Tea Party movement believes that real Republicans ascribe to Tea Party principles and values, and that establishment Republicans have strayed far too long from their true conservative roots. The Tea Party movement may, in fact, be a part of another “Great Awakening” spreading across America and even well beyond her shores, presenting the possibly of a second chance for other great nations as well.

With an influx of Tea Party Republicans into governments across the land and a Republican majority in the House, slowing down if not actually stopping altogether and reversing the relentless and destructive Obama socialist/anti-colonialist juggernaut is a real possibility. If the average American continues to stand against what is wrong with America, and fights for what is right for America, in the next several election cycles there will be Tea Party Republicans in power across the country, in the House, the Senate and in the Oval Office.

If the millions of Americans who relate to the Tea Party movement continue to stand up for the God-given, inalienable rights guaranteed by the Constitution, corruption and destruction will fail, freedom will prevail, and America will be back on the road to honest industry and real, non-bubble prosperity, building a better life for our children and grandchildren, instead of selling them into future slavery to foreign powers.

Earmarks are a perversion of the normal congressional funding process

Funding of government activities begins with the passage of an appropriations bill specifying the gross sums of money that will be spent during the fiscal year. The executive branch proposes to Congress exactly how the allocated money will be spent. Congress, representing the interests of the people, then holds hearings, writes, debates and votes on bills funding specific projects or programs, or agreeing to the President’s proposed expenditures. Spending bills passed in both chambers of Congress then go to the President’s desk for signature or veto.

Where contracts are to be made with private companies to perform any such funded project, the contract is properly put to competitive bid, and the bid with the highest cost-to-benefit value wins the contract. This process is wholly transparent, is subject to public scrutiny and serves to involve rank-and-file congressional members in the process of deciding how much will be spent on which projects.

Earmarks (Em) are a perversion of the constitutional provisions for funding government. Earmarks are requests by individual congresspersons to congressional leadership that portions of the year’s total appropriated money be directed to specific entities for specific projects, bypassing the open bidding process. While the constitutional appropriations process is based on merit and cost-benefit value, Em are not merit-based, but based on seniority, state or locality, congressional district, committee assignments, party power, political connections, and perceived need for reelection campaign support

These earmark requests are often funding projects, companies, universities, organizations and individuals that are located in the congressperson’s district (bringing home the bacon), or benefit those that provide generous campaign contributions for the congressperson’s reelection and preservation in office, whether or not these entities are located in the particular district.

Proponents of congressional earmarks argue that it is the only way for Congress to specify how the allocated dollars will be spent each year, that earmarks allow Congress to fund local projects and industry, providing jobs in their districts, and that earmarks only provide for congressional dollar allocation while not increasing total spending levels.

Ems are made anonymously without public hearing, transparency or accountability, are granted by congressional leadership on a seniority/majority/party/political connections basis, are placed inside other bills at the discretion of the leadership, are not vetted, debated or voted on for their merits, and the congressperson who submits the earmark request is obligated to vote for whatever bill the leadership attaches the Em to, even if that bill entails bloated budgets or wasteful spending. In this manner, congressional leadership, controlling the very structure of Congress and every step in the process of passing bills, exerts an undue dominant influence on what Congress does each year. This Em interplay between leadership and rank-and-file members, serves to continually raise levels of government spending.

As explained above, the Constitution provides an open process for funding government activities including specific projects or programs desired by Congress; the Em process is not required for Congress to exercise its prerogative of designating how taxpayer funds will be spent. In the self-serving rush to assure each congressperson’s share of the federal pie, and to assure that the executive branch doesn’t get to spend all the money by itself, the option of not spending all the appropriated, hard-earned taxpayer money is rarely considered.

Ems to fund projects in the congressperson’s district (to garner local support for reelection) or to specific entities in exchange for campaign contributions are a corrupt mechanism to promote an individual congressperson’s interests over the interests of the American people. Bypassing the open bid process leads to government paying more than the actual value and getting lesser quality of the service or product provided, and fosters corruption behind closed doors.

The fact that earmarks are granted by congressional leadership at their discretion allows leadership to carry out their top-down agenda and control rank-and-file members, often at odds with fiscal responsibility and the goals of the people and their representatives. Leadership, seeking support for unpopular legislation, will insert many Ems into such a bill, guaranteeing the votes of those who requested the Ems, even where the individual representative may be opposed to the bill in question because of its excessive spending or other significant objections.

Government agencies estimate the direct cost of Ems at less than 2% of federal spending, and many have suggested that due to the relatively small amount of money spent on Ems, the practice should not be condemned. However, indirect and hidden costs are considerably greater and are truly significant. When major appropriations bills go through Congress, lawmakers pad each bill with excess dollars in anticipation of taking Ems further on down the line. Data showing a direct correlation between the annual costs of Ems with total annual federal spending suggests that the practice of earmarking contributes significantly to excessive government spending.

Many Ems are simply add-on expenses to bills that, without question, directly increase total spending. In other instances, involving only redirection of previously appropriated funds, projects unvetted for merit are funded by defunding other programs that had been justified on a merit basis. With the Em redirection of funding away from merit-based programs, a greater portion of taxpayer dollars is spent on non-meritorious and often frivolous and wasteful projects.

Many Ems are not even included in a bill, but in the conference reports on the bill. In this case, the Ems are given the full effect of U.S. law, despite the fact that they are not an actual part of the bill that was given public hearing, debated and voted on by Congress, and signed into law by the President. A convincing argument can be made that such Ems are illegal and unconstitutional and should be publically declared as such.

The entire system of congressional rules and structure greatly favors leadership agendas, which are often contrary to fiscal discipline and the best interests of the American people. Eliminating Ems would greatly diminish leadership power and influence; a bitter battle is likely to ensue with Washington powerbrokers desperately resisting any reduction in their influence and power despite this being a necessary component of government reform to further the interests of the American people.

The Heritage Foundation and others have called for complete elimination of Ems and total reform of the majority/seniority system congressional rules and structure with the goal of real power-sharing with rank-and-file members, full disclosure of interested party/lobbyist/lawmaker relationships, and full reporting of campaign or favored cause support by those making and receiving contributions.

Other sound proposals for government reform include the institution of term limits, moving congressional members and their retirement funds into Social Security, moving congressional members from congressional health plans to those that are available to the public, eliminating members voting on their own salary increases, and assuring that lawmakers are subject to every law they pass. The prime motivating factor for lawmakers must be the best interests of their constituents and the American people, not what’s best for self or party.