Business sense

At the behest of a friend of mine, I’ve decided to pick up a copy of the Financial Crisis Inquiry Report. Weighing in at 690 pages and 2.2 pounds, this bad boy is a behemoth of economic reporting. For those of you who prefer free, electronic copies of books, swing by FCIC website to get a full version in stunning PDF.

I’m only a few pages in, but already I’m impressed by those massively irresponsible rogue investment houses. For example,

[A]t the end of 2007, Bear Stearns had $11.8 billion in equity and $383.6 billion in liabilities and was borrowing as much as $70 billion in the overnight market. [pp. ix-xx]

Those are big numbers, and it’s hard for me to really wrap my ahead around whether $383.6 billion in liabilities is offset by the equity the company held. Being a lay person (who’s trying to learn more) in big financial matters, I’m not sure whether that sort of thing is common, sustainable, reasonable or downright foolish. So let’s do what scientists like to do with things they don’t understand: translate them into equivalent systems that they do understand. The borrowing habits of Bear Stearns were equivalent to

a small business with $50,000 in equity borrowing $1.6 million, with $296,750 of that due each and every day. [pp. xx]

Whoa. That doesn’t sound all prudent to me. How about to you?

So when Illinois congressperson Joe Walsh starts screaming at his constituents (here and follow-up here) at an Uno’s in a Chicago suburb that

it’s not the private marketplace that created this mess. What created this mess was your government, which has demanded for years that everybody be in a home…And we’ve made it easy as possible for people to be in homes

you’ve got to wonder whether he’s right. Or at least watch his rants on Youtube. But to Joe’s point, was it a misguided government conspiracy to make sure Americans have roofs over their heads that sent the economy spiraling out of control? According to the Financial Crisis Report, the answer is no.

True, for decades the Department of Housing and Urban Development (HUD) has listed affordable housing as one of its goals. Based on textual evidence and interviews, the behavior of government supported entities like the now infamous Freddie and Fannie were only marginally effected by the goals for affordable housing. In fact, a lot of the people buying up property already had homes! By the June of 2005, one out of ten home sales went to an investor, speculator, or individuals buying a second home [p. 5].

My friend’s grandparents have pointed to legislation that banned banks from black-listing whole communities from loans, a practice known as redlining, as a major cause for the collapse of the housing market. They’re talking about the Community Reinvestment Act which set expressly to combat redlining. Banks commonly denied individuals and businesses, primarily in substantially non-white neighborhoods, without regard to the creditworthiness of the applications because the entire neighborhood was deemed too risky. Chances are if you lived in a black community, the banks simply said no even if you could pay. The Community Reinvestment Act tried to make sure banks and savings and loans would lend, invest, and provide services to communities that deposited money in the banks—a sort of, you put in, we’ll put out sort of arrangement. So how much did these government policies contribute to the financial crisis?

Well, according to the report, not significantly.

Loans made by CRA-regulated lenders in the neighborhoods in which they were required to lend were half as likely to default as similar loans made in the same neighborhoods by independent mortgage originators not subject to the law. [p. xxvii]

In other words, the policies seemed to offer some protection, consistent with financial soundness! Anti-redline loans were better loans. Looks like level-headed, carefully crafted regulation can actually help stabilize markets.

I’m willing to believe Joe, but, Joe, help me out. Give me some facts I can check.

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