October 23, 2008
Financial crisis like a game of musical chairs that became painfully expensive
The world financial crisis has been a painful game of musical chairs, but now governments and financial managers are scrambling to bring players back to the table, said a panel of financial experts Monday evening at the UW.
Those managers are also analyzing how standards dropped so low that the game became agonizingly expensive.
The panel discussion, held in 130 Kane, was the first in a two-part UW series sponsored by several units on campus. The second evening is scheduled for 7 to 9 p.m. Monday, Nov 3, in the same location.
You can watch the Webcast of Monday’s meeting, moderated by KUOW host Steve Scher, at http://www.uwtv.org/programs/displayevent.aspx?rID=27363.
Several times during the two-hour discussion, the experts said bad government moves coupled with too-easy credit and a drop in housing prices made the game music roll to a halt.
Panel members were Alan Hess, a finance professor at the Foster School of Business; Lew Mandell, senior fellow at the Aspen Institute and a visiting professor of finance at the Foster School; Richard Zerbe, a public affairs professor at the Evans School of public affairs; and Rich Bennion, executive vice president and residential lending director at HomeStreet Bank in Seattle.
The current economic trouble began at the beginning of this decade, when Congress pressured Fannie Mae and Freddie Mac to lower home lending standards, said Zerbe.
Looser standards made home ownership possible for more Americans. As government-sponsored enterprises, Fannie Mae and Freddie Mac buy mortgages, thus ensuring funds for banks to lend for home purchases.
In 2004, big investment banks pressured the Securities and Exchange Commission let them to take on more debt than previously allowed. They’d then have more cash for such things as mortgage-backed securities. The bankers argued that it would be good for business, but the decision was short-sighted, Zerbe said, because it lowered standards too far.
Lowered standards and financial tools such as subprime mortgages are causing severe financial pain, acknowledged Mandell. However, he said, subprime mortgages “in and of themselves have been terrific innovations developed to compensate lenders for the additional risk of financing families with less-than-pristine credit ratings.” Subprime mortgages carry higher risk and higher interest rates, he added, but are alternatives to no mortgage at all.
But after the 9/11 terrorist attacks, Mandell said, the Federal Reserve “flooded the U.S. economy with liquidity,” making money easier to come by, and investors looked for places to put that money — stocks, bonds, real goods such as appliances — and of course, houses, because many people assumed houses would appreciate.
But the U.S. has had repeated cycles when housing appreciation slows and prices don’t rise as expected, Hess said.
At the same time credit loosened in the U.S., foreign investors were looking for safe, sure-bet places to invest their money so they bought an array of financial instruments, including mortgage-backed securities from Fannie Mae and Freddie Mac.
At the same time, standards for credit slipped further and further. More and more poorly qualified buyers took out home mortgages — many of them speculators, said Bennion.
Then, when houses either failed to appreciate or actually dropped in value, many people, particularly speculators who hadn’t invested much money or didn’t fully understand their actions, simply walked away — defaulted, Bennion said.
In 2007, he added, 50 percent of mortgages were written with adjustable rates, often with a low, teaser rate to get borrowers in the door, and when the rates reset, too many borrowers couldn’t cope with their new mortgage payments.
“The music stopped because the default rate went up. People reached their limits,” Bennion said.
Meanwhile, brokers who had originated those dicey mortgages continued passing them on to investment bankers who bundled them into securities — some with questionable triple-A ratings — and passed them on to investors around the world.
“Passed the trash,” Mandell said.
The pattern continued, said Hess, as political pressure for home ownership caused Fannie Mae and Freddie Mac to drastically increase their purchases of mortgages.
In 2003, Hess said, the percentage of subprime mortgages was 8 percent; by 2007, it had almost tripled, to 22 percent. Also, he said 55 percent of all subprime mortgage loans have been cash outs, that is, mortgages that also provide cash for other purposes.
“The housing price decrease, coupled with the huge increase in subprime loans of increasingly dubious quality, got us where we are now,” Hess said, referring to the crisis.
Zerbe said the recent consolidation of banks raises antitrust concerns, and that there may be collusion in large, syndicated loans.
Asked how long it might be before government money infused into banks might make its way to consumers, members of the panel disagreed.
Mandell said, however, the maximum amount allowed for FHA loans, $567,500, is close enough to the median price of Seattle houses that people seeking jumbo loans are finding banks fearful to lend larger amounts — and that’s slowing house sales.
Also, he said, the financial crisis could cause banks to hang on to cash instead of disbursing it in student loans. “The whole higher education industry may suddenly be in a lot of trouble,” particularly small, private schools that heavily depend on student loans for tuition, room and board.
Sponsors of the panel discussions are the College of Arts & Sciences, the Office of External Affairs, the Evans School of Public Affairs, the Foster School of Business and the UW Alumni Association.