The Crash: The beginning of the end…

The response to the post on complexity theory and the financial crises has been very positive. Been recieving lots of positive feedback, thank you to any who have written or commented.

Several people, including Steven Johnson, the author of Emergence, posted a link to this great piece “The Economy Does not Compute” that I encourage everyone to read.

Dave D. emailed me with this fascinating story from the New York Times that arguably pinpoints the moment the incentives in the market were shifted that started us down the road to the present crises. Entitled Fannie Mae Eases Credit To Aid Mortgage Lending the piece is dated September 30th, 1999. This excerpt below really summarizes the underlying logic and benefits for initiating the change as well as predicts the ultimate catastrophe that it would unleash (remember, written in 1999):

”Fannie Mae has expanded home ownership for millions of families in the 1990’s by reducing down payment requirements,” said Franklin D. Raines, Fannie Mae’s chairman and chief executive officer. ”Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.”

Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.

”From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. ”If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”

The article shows us the challenges around blaming any one individual – except possibly Blll Clinton – as once the incentives for embracing a higher risk group were altered it vastly increased the chance that more and more people would cater to them and expose themselves to that risk.

The other fascinating thing about this piece is how the web is now getting to be old enough that it is becoming a fantastic tool for historians. Think of how much richer our history is going to be when critical documents like this one are both more accessible and easier to locate.

8 thoughts on “The Crash: The beginning of the end…

  1. Joseph

    I think it is a great leap to say no one specifically is to blame – except “possibly” Bill Clinton. It is just as valid to say that the warnings were there, in which case why wasn't more done by – um, the present administration – to ensure those risks were managed?Why not just blame the first President who presided over the creation of Fannie Mae, if you're going to be speculating on the one person who “might” be blamed?Otherwise, I like the post.

    Reply
  2. Michael Molson

    I flip flop on this. Warren Buffet commented that it was simply greed – everyone keeping up with the Jones', buying bigger and better houses and second homes. Were the banks going to say 'no' to potential customers?And I shouldn't use the past tense either. We are looking at a couple more years of this. The economic fallout has not hit yet.

    Reply
  3. Patrice Collin

    I agree that the surprised reaction of the masses is a bit surprising…remember any conversation you probably have had in the last 5 years with folks at parties or social events about how real-estate is great and how much more their house is worth! I know a bit of a simplistic approach, but honestly I can remember tons of conversation with folks along these lines….Wow I stand to make 70K on the value of my house, the only problem is that there is nothing in my price range after that so I might as well buy the next up ….hey I made 70K on the value of the home…so what’s another 150K on a mortgage.Granted the banks in my opinion should have the lionshare of the blame…..buffett is right : who turns away potential clients?….however banks are supposed to be masters at due dilligence and calculating ROI….and in most of these mortgages they knew that ROI wasn't feasible nor profitable.On another ote David, I am glad you brought up the Net and what it means for historians…..the main thing we need to get a handle on is the validity of the information and having a means to validate the original document or source…in the era of digitization: a lot of the books publications, periodicals etc.. are being destroyed without first confirming that they are available electronically……Ottawa University is actually in the midst of a big problem with some of their periodicals because of digitization! But I think you could write a whole other blog on that subject ;-)

    Reply
  4. Joseph

    I think it is a great leap to say no one specifically is to blame – except “possibly” Bill Clinton. It is just as valid to say that the warnings were there, in which case why wasn't more done by – um, the present administration – to ensure those risks were managed?Why not just blame the first President who presided over the creation of Fannie Mae, if you're going to be speculating on the one person who “might” be blamed?Otherwise, I like the post.

    Reply
  5. Michael Molson

    I flip flop on this. Warren Buffet commented that it was simply greed – everyone keeping up with the Jones', buying bigger and better houses and second homes. Were the banks going to say 'no' to potential customers?And I shouldn't use the past tense either. We are looking at a couple more years of this. The economic fallout has not hit yet.

    Reply
  6. Patrice Collin

    I agree that the surprised reaction of the masses is a bit surprising…remember any conversation you probably have had in the last 5 years with folks at parties or social events about how real-estate is great and how much more their house is worth! I know a bit of a simplistic approach, but honestly I can remember tons of conversation with folks along these lines….Wow I stand to make 70K on the value of my house, the only problem is that there is nothing in my price range after that so I might as well buy the next up ….hey I made 70K on the value of the home…so what’s another 150K on a mortgage.Granted the banks in my opinion should have the lionshare of the blame…..buffett is right : who turns away potential clients?….however banks are supposed to be masters at due dilligence and calculating ROI….and in most of these mortgages they knew that ROI wasn't feasible nor profitable.On another ote David, I am glad you brought up the Net and what it means for historians…..the main thing we need to get a handle on is the validity of the information and having a means to validate the original document or source…in the era of digitization: a lot of the books publications, periodicals etc.. are being destroyed without first confirming that they are available electronically……Ottawa University is actually in the midst of a big problem with some of their periodicals because of digitization! But I think you could write a whole other blog on that subject ;-)

    Reply
  7. loan modification advocate

    Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market. —– good post

    Reply

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