The Credit Crunch
Boulder Tomorrow Breakfast Seminar September 25, 2008 The Credit Crunch (NOTE: The details to the credit bailout have continued to evolve and some comments below may not encompass those changes.)
Boulder Tomorrow's monthly breakfast meeting on September 25 was highly relevant as two expert local economists discussed the national credit crunch and bailout discussions and how the Boulder area business community could be affected. Nearly 100 attendees heard from Rich Wobbekind, Associate Dean at the CU Leeds School of Business and Lou Barnes, owner of Boulder West Financial Services about the root causes of the current financial crisis and they suggested ways for the local business community to prepare for the fallout.
Lou provided a brief history lesson on the regulations that applied to banking and financial companies over the last 80 years, and the changes that contributed to the current situation. As an example of the shifting mindset away from the need to guard against unsafe and unsound financial policies, he described his grandfather's post-Depression era pride in having bank examiners review his Savings and Loan's books, whereas his father, who worked on Wall Street, "despised" the inquiries and restrictions federal examiners required.
According to Lou the Securities and Exchange Commission, which regulates securities firms, never had a charge to determine "safety and soundness" as banking regulations did; rather the SEC mandates disclosure and investigates fraudulent and illegal activity. "The SEC never had the role to say to a firm 'Stop that. That's stupid. It may be innovation, but not now'", he said. "In the 1990s as the line between securities firms operations and bank operations became blurred, we repealed another depression-era regulation, Glass-Steagall. Very large banks began to engage in securities operations that were not within the realm of safety and soundness. The regulation of really large banks began to break down."
From that point, in what Lou called an "extraordinarily quiet migration", credit creation departed heavily regulated banks to the less regulated structured finance firms on Wall Street. In the early 2000s, increased trade resulted in our Asian trading partners seeking to buy dollar-denominated securities, of which there were not enough. "It is Wall Street's job, given a shortage of securities, to make more securities," said Lou. Then starting in 2004, the rise in petroleum prices led to even more demand for US dollar-denominated securities. "Those dollars have to come back into the United States, or the dollar becomes wallpaper, " he continued. These forces increased the creation of additional unregulated credit securities of various kinds. These securities were often backed by risky and/or subprime mortgages.
For a while, all of this manufactured credit hid any blatant signs of the rising problem. "A funny thing about credit is if you have too much of it, loan defaults go down," said Lou. "You don't know how much trouble you're in, because you're loaning so much money that nothing looks wrong." During the last several years, Lou explained, between $1.5 and $2 trillion in mortgage credit was extended to households beneath the minimum underwriting standards of the Federal Housing Administration. Low credit scores, high consumer debt, inherently unstable jobs - these characteristics were not impediments to getting mortgages.
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