Thursday, January 14, 2010

Causes and Solutions to the Financial Crisis

Greed and irresponsibility were factors in the housing and banking crisis. Politicians did things for their benefit to stay in office. Bankers and homebuilders were making money by engaging in bad business practices, and borrowers were getting that “Great Deal”. Other factors that contributed to the housing and banking crises this country is now facing are as follows: the Government/politicians through the Community Reinvestment Act (CRA), the Gramm-Leach-Bliley Act which repealed the Glass-Steagall Act, Community activists groups, predatory lending, Fannie Mae and Freddie Mac, Banks that set up loans which would lead to foreclosures, Homebuilders who overbuilt, na├»ve borrowers and people who game the system.

Under the Community Reinvestment Act bureaucrats pushed for more homeownership among minorities and low-income consumers and encouraged lenders to make questionable loans. Fannie Mae and Freddie Mac expanded homeownership by reducing down payment requirements, and changed the underwriting in order to loan to borrowers with poor credit ratings. Also banks, thrifts, and mortgage companies pressed Fannie Mae to help make more loans to so-called sub prime borrowers. 100% loans are not the problem; the loans need to be structured in a way for the borrower to be able to pay back the debt.

Community activists groups under the guise of the Community Reinvestment Act were pressuring the banks to give out questionable loans to people who may have not normally qualified for the loan. Some of these banks were not verifying income, employment etc. in order to put through the loan because they were making money processing, packaging, and selling these loans.

The Gramm-Leach-Bliley Act that repealed the Glass-Steagall Act enabled commercial lenders to underwrite and trade instruments such as mortgage-backed securities and collateralized debt and established structured investment vehicles ( SIVs) that bought those securities. This conflict of interest could lead to abuses by these institutions.

Government/Bureaucrats in Congress (Democrats and Republicans) passed laws that brought about this financial crisis and were aware of the problems at Fannie Mae and Freddie Mac but did nothing to solve the problem. In 2004 there were Congressional hearings on the questionable lending practices by Fannie Mae and Freddie Mac under the guise of CRA. The Democrats (Representatives Barney Frank, Maxine Waters, Gregory Meeks, Arthur Davis, and Lacy Clay) wanted to continue the practice that was being done saying that there was not a problem. The Republicans (Representatives Christopher Shays, Richard Baker, Ed Royce, and Don Manzullo) saw the potential problem with Fannie Mae and Freddie Mac but did not take decisive action on it even though they were in control of congress at the time.

John McCain while campaigning for President stated he was aware of the problem at Fannie Mae and Freddie Mac in 2005. He was a US Senator at that time and the Republicans controlled Congress so where is the legislation to try to correct the problem. President Barack Obama states he inherited this economy with these deficits. He was a US Senator and the Democrats took control of Congress in 2006 so where is the legislation from him to correct the problem.

Politicians receive campaign contributions from these lending institutions, which may influence how and what type of legislation is passed. The bankruptcy law that was recently passed heavily favors the lending institutions wherein it is more difficult to write off credit card debt in the bankruptcy but the interest rate that is being charged was not reduced.

These banks set up o% or low interest rate teaser loans knowing that some of these loans would go to foreclosure. These loans were basically a 5-year balloon note with the interest accumulating over the five years after which the interest payment and payments would adjust to higher payments unless the borrower is able to refinance at a lower rate. An onerous term “toxic assets” is used to make the situation seem direr. However these properties/ mortgage paper do have a value. If the loan had been modified the mortgage paper would not be “toxic”, or if the housing values had not depreciated and the homeowner would have been able to refinance at a lower rate, the mortgage paper would not be “toxic”. Also some of these properties have been sold in a foreclosure sale so why would the original mortgage paper still be on the banks books?

Some people are upset with the governments proposal to modify mortgage loans, stating they do not want to subsidize people for buying a house they could not afford calling them losers. However, it depends on how the loan is structured, because if it is spread out over a longer period of time one could afford it. Let’s say you want to get a loan for $100,000, if you have to pay it back in a week most people would not be able to pay it back but if spread out over time 10 years, 30 years, 100 years the person would be able to pay it back. The banks should have been modifying some of these loans on their own.

Some people are concerned with contract law that these people entered into a contract and they should abide by it. I say contracts are written in legalize in order to break the contract. When it comes to a mortgage the rate and terms are based on the persons credit report and now more importantly the credit score. Credit Bureaus and Banks in cooperation with each other are selling credit-monitoring services, which is clearly a conflict of interest because it is in the interest of the banks for the borrower to have a lower credit score so the bank can charge higher interest rates.

In my situation I bought a house, with a mortgage and made my payments. I then got another loan and bought a home to rehab and eventually move in it as my primary residence. Then came the housing collapse and I was unable to sell either house. I depleted my savings and began getting cash advances on my credit cards to make the payments in the hopes that I would be able to sell one of the homes in order to maintain my good credit. I tried to refinance the loan but the lenders would not refinance it if it were on the market for sale, stating per government regulations it needs to be off the market for 90 days before you can refinance. (I think that is a ridiculous guideline; it should make no difference whether the house is for sale in order to refinance the debt.) Now because of all of the foreclosures the appraised value of my home has deteriorated wherein the lenders will not refinance it. I could not sell either house therefore I contacted my lender to modify my loan. Would I be considered a speculator or a loser?

Bank robbers steal at the point of a gun. Bankers steal at the point of a pen. Not only did they set up risky loans in the mortgage business but also they have clauses in the credit cards to get more money from the consumer.

Banks use a universal default clause to charge people more interest on their credit cards. If you are late with another card, or if you are having a dispute with another creditor, or if your credit score drops, the banks can raise the interest rate even on charges that are already on the card. The banks also circumvent the usury laws by incorporating in states that have lax or no usury laws. There also is a binding arbitration clause where people are signing their rights away to the judicial process where you cannot join in a class action lawsuit against the bank.

The credit bureaus on the other hand lower your score if you shop for a loan. I do not believe you should be penalized for trying to get a better deal for yourself. The creditors use the credit bureaus as a club, or collection tool over people. The consumer’s word or documentation does not mean a thing; the credit bureaus take the words or documentation from the creditors, even though sometimes that information is inaccurate. Almost everything you do now is based on your credit rating/ score, if you are seeking employment, a loan, or insurance your credit report is ran.

Congress recently passed a law where people can get a free copy of their credit report once a year. However, you have to pay for your credit score and most loans these days are score driven. The credit bureaus will not reveal how they obtain your score or what criteria are used, because they claim it is proprietary. In math your taught that 2 + 2 = 4, but in credit scoring 2+2 = whatever the bureaus want it to be. This is not right and needs to be changed.

What should be reported is if you do not pay your bills. If you incur the debt you need to pay it back. However you should be able to make alternate arrangements to pay off the debt because of extenuating circumstances such as a loss of job, or illness.

The banks and credit bureaus use the scare tactic of Identity Theft to get more money out of the consumers by having them sign up for credit monitoring services. As previously stated the bureaus have even formed partnerships with some banks to offer credit-monitoring services for a fee, which is a conflict of interest. It’s the credit bureaus grave responsibility mandated by law to maintain accurate credit reports on individuals. So why are they charging a fee for monitoring it?

Banks and credit bureaus are in the business to make money by loaning money and maintaining credit reports for a fee. However, I do not believe these companies should be taking advantage of the consumers by use of the default clause, binding arbitration, credit monitoring or how the bureaus score the credit report.

Both sides are using class envy, which is not right or productive. The liberals/socialists use class envy against the rich and the achievers pitting the haves from the have-nots. The conservatives/right are calling some of these people losers saying they are gaming the system getting something for nothing.

Barrack Obama uses the term speculator in a derogatory way stating that in his housing plan he would not reward speculators. What is his definition of speculator? Is a speculator someone who buys a property, fixes it up, and sells it for a profit? What is the difference between a speculator and a homebuilder? A speculator and homebuilder both help the economy by purchasing materials and hire contractors to build and fix up the property. The retailers make money and the contractors make money wherein people are employed and their debts are paid. The homebuilders continued to build causing an oversupply of housing on the market causing the values of the houses to decline because of supply and demand.

Another consequence regarding the housing crisis is with the housing prices falling so will the tax revenue. In Missouri we have reassessments on property every two years. Properties are being foreclosed on which brings down the value of homes and with reassessment the homes will be valued less, therefore there will be less tax revenue. What will the government do with less tax revenue?

A solution to the housing problem is to do a loan modification on the property. Make it available to anyone that would want to do it. There would need to be exceptions made to the lending rules, by using the original appraisal of the property and renegotiate the rate and term of the loan. Reducing the interest rate and spreading the loan over a longer period of time wherein the homeowner is able to make the payment would help to stabilize the housing market. My solution would hold everyone involved in the transaction responsible and everyone would win. The costs are added into the renegotiated loan, and the payments are paid out over a longer period of time. The homeowner is held responsible by paying off his debt, and the banks and lender receive their money albeit over a longer period of time. . This would help the housing crisis, because the homeowner keeps the home; the banks and investors receive the money albeit over a longer period of time. Home values would stabilize and the government would receive the tax revenue. It would be a win-win for everyone including the states that receive tax revenue.

Another solution suggested by Jim Cramer is to modify everyone’s loan and give 40 year mortgages at 4 to 4 1/2% interest rate, write down the principal if need be and issue a certificate to go to the banks if the property wherein if the property is sold at a higher price from the principal being reduced the banks would receive the difference between the two and any excess over that would go to the homeowner.

The housing market needs to be stabilized which would stabilize the banking system.
More importantly to solving problems facing this country is to elect officials that are going to do the right thing and pass legislation that is fair to everyone.

Greg Zotta

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