How did we get here?

Last week former Federal Reserve chairman Alan Greenspan was grilled by Congress about whether the Fed's policies, while he was chairman, played a part in the current financial crisis. While at the Fed, Mr. Greenspan guided monetary policy taht allowed the United States to enjoy tremendous prosperity, without inflation, during his tenure. Anyone who is familiar with even a little economic history knows how dangerous inflation is to any economy. With regard to the economic crisis we find ourselves in now, to his credit, Mr. Greenspan did warn that Fannie Mae and Freddie Mac were going to have problems. He admits, though, that his faith in the free markets' ability to regulate itself, was misplaced. While at the Fed, he opposed government regulations of derivatives, believing that the investment houses would keep the best interests of their clients and stock holders in mind, and regulate themselves. As is true with so many of us, he underestimated human nature.

But, there is plenty of blame to go around. Mr. Greenspan's naivity was a minor act compared to others. First and foremost, there are the investment houses such as Bear Sterns and Lehman Brothers. They turned a blind eye to the risks of the derivatives they invested in, and simply focused on the returns. There was no way they could sustain those returns, knowing the investments that were generating them would eventually fail. We should not believe that they did not realize the risk. The subprime mortage market was booming for years, cheap credit and nonexistent underwriting standards. The loans are called subprime for a reason. It is because they are below the standards of what is considered a loan with acceptable risk. We witnessed an era when many mortgage underwriters took the "let's throw it against the wall and see if it will stick" approach to credit approvals. Unfortunately, not much stuck.

Then, the subprime loans were bundled into investments called collateralized debt obligations (CDOs) and sold to investors. It has been reported by the USA Today and the Wall Street Journal that the three major credit-rating agencies, Standard & Poor's, Moody's, and Fitch Inc. all knowingly gave triple-A ratings to complex financial instruments backed by subprime mortgages. Exhibit-A could be an email from a Standard & Poor's analyst to a coworker in 2006. "Let's hope we are all wealthy and retired by the time this house of cards falters." Many argue the problem, as if this was not known at the time, was that the agencies were being paid to rate the investments, by the firms that were selling the investments. Christopher Shays, R-Conn, summed the situation up best saying, "When the referee is being paid by the players, no one should be surprised when the game spins out of control."

Other players in this game of financial chicken have been Congress and the President for encouraging banks and mortgage companies to take risks and freely lend to subprime borrowers. I put these two in the same category as Mr. Greenspan. Minor players. Banks and mortgage companies have the choice of approving or declining a loan request. Currently 98% of the banks in the United States are well capitalized, so clearly, the vast majority of underwriters refused to give in to the compulsion to lend to anyone who can stay alive long enough to sign the loan documents. As for the blame Mr Greenspan got last week, Congress could have passed regulations on derivatives if they wanted. Many times, especially when he called for fiscal responsibility, Capitol Hill turned a deaf ear to Mr. Greenspan. It is not fair to pick out one time that they chose to listen, and say it is his fault.

That is it, in a nutshell. I'll explore more about where we are now, and where we are headed, regarding this financial crisis, in future blogs.

Thanks for your time.

Hello Everyone

I will tell you upfront that I do not have a degree in economics. I do not have a license to sell stocks. I have a Bachelors of Science in Accounting. I am interested in economics, I read a lot, and I try and take a practical, common sense approach to things. I will try and bring these characteristics to this endeavor. My initial interest in starting this blog is two-fold. First, I have been disturbed by the government's response to the current financial crisis. I wrote four letters to the editor of the Reading Eagle in about two weeks. One was published. (hurray) They wanted to publish another one, but I do not read my emails on a regular basis, so I did not notice their request to revise my letter. The second reason I wanted to start this blog is because of all of the panic occurring in the market and in the media, as a result of this crisis. I watched a program two weeks ago where the guest, a noted columnist for a major newspaper, called for the temporary closing of the stock exchange and the banks, as well as putting a floor on stock prices, to calm the markets. What a panic those measures would cause, if implemented.

As the name Economic Clarity suggests, my goal for this blog is to take a look at the United States economy. I will do my best to sort through all the panic, hype, and anything else that needs to be eliminated, and give you my opinion, for whatever that is worth, regarding what is really happening in the economy and what, if anything should be done. I will draw heavily on my reading materials and experience and try to present an unbiased view point. There is bias in everything, but I will try and keep mine under control, to the best of my ability. I will begin with the current financial crisis and move on to other subjects when it seems appropriate.