A brief note on this credit crisis

Everybody is trying to capsulize what caused this credit crisis, and both political sides are trying to minimize their role. Here are some simple facts.

In the 1990's some congresscritters, mostly Democrats, noticed that many inner city people could not qualify for mortgages because they could not provide a record of income sufficient to justify a mortgage. So they passed a law with some Republican votes requiring banks to provide so called "no document" mortgages without checking the borrowers income. Furthermore the law required Fannie Mae and Freddie Mac to buy those mortgages from the banks. A former law had established Fannie and Freddie as quasi arms of the government, which allowed them, in turn to borrow money from the Treasury and from others at lower interest rates than usually required for such things as mortgages. The Federal Government thus became sort of responsible for the debts of Fannie and Freddie.

If congress had just restricted such "no doc" mortgages to cheap housing in the inner cities all would have stayed manageable. But noooooooooo! The congresscritters, Democrats and Republicans, quickly figured that it would be unfair to only let poor people take advantage of the system like that - so they quickly raised the limit on such mortgages to middle class and even wealthy people. After that it became all the rage for banks to offer everybody who couldn't or didn't want to prove their income "no doc" mortgages.

As a result pretty soon banks were writing big mortgages on first homes and even on second and third, fourth and fifth home mortgages on a "no doc" basis. This all resulted in a very enjoyable party wherein folks were buying and selling homes like sausages, especially in Florida and California. If you doubt this you can turn on the TV and find a show called Flip That House which is all about how everybody can get rich by buying houses, fixing them up a bit and then selling them for big profits. Naturally all this game playing drove the price of housing up to the sky in the hot markets.

It all worked quite nicely while home prices continued to go up fast because people could take out a new mortgage to pay their old mortgage. But then in the early part of this decade the nasty old Grinches, like Warren Buffet, tried to spoil Christmas by pointing out the old Chinese proverb that "No tree grows to the sky."

So, in 2005, some congresscritters (mostly spoil sport Republicans this time, including John McCain) noticed that Fannie and Freddie were writing an awful lot of bad mortgages, and they were also fostering a market in blindingly complex bonds and betting pools called "derivatives" which were being sold and kept in bank and insurance company vaults as assets just as though they were real money. The Republicans were shouted down in 2005 because they were gutless wimps and because nobody wanted to leave off drinking the champagne and eating the caviar that came of writing and trading and betting on all these interesting new "derivatives" even though nobody could really understand them.

So there you have it. High finance in a few paragraphs. That is what brought us to where we are now, when even the smartest financial wizards don't know what those "derivatives" are worth, and when if the government doesn't bail out all the dumb banks and insurance companies the whole shebang will come apart.

As an aside, practically every well known congressman and senator except John McCain was on the Fannie and Freddie payroll to keep the party running as long as possible. And even McCain is not blameless because he should have shouted his concerns from the rooftops in 2005 instead of letting the Democrats kill the bill which would have at least moderated the crisis. But, of course, if he had done that he wouldn't have been able to run for president because nobody likes a Grinch. His opponent, Barack Obama, is trying his darndest to wriggle out of his share of responsibility for all of this, but that's pretty hard when it's a simple fact that he took the third biggest money envelope Fannie and Freddie handed out last year.