Washington Sleeps With Wall Street

The responsible parties to our existing economic situation are the government and its public monetary policy, private financial institutions business practices and the public (often times unsuspecting).

Opposition to any form of real financial regulation by law makers in power at the time, the Federal Reserve and it insistence on lowering Fed Fund Rates to near or below 1% allowed huge amounts of "easy" credit-based money to be injected into the financial system and thus create an unsustainable economic boom. This was the wondrous response to our DOT.COM bubble.

Our real estate troubles first reared their ugly head in the fall of 2006. Subprime mortgages were the original symptom of a credit boom tuned to bust and of a real estate shock. But large default rates on subprime mortgages does account for the severity of the crisis. Rather, low-quality mortgages acted as an accelerant to the fire that spread through the entire financial system. The latter fragile due to factors unique to this crisis (transfer of assets from the balance sheets of banks to the markets; creation of complex and opaque assets; failure of ratings agencies to properly assess the risk of such assets, and the relaxed accounting rules known as fair value accounting.

In order to counter the Stock Market Crash of 2000 and the subsequent economic slowdown, the Federal Reserve eased credit availability and drove interest rates down to lows not seen in many decades. These low interest rates facilitated the growth of debt at all levels of the economy, chief among them private debt to purchase more expensive housing. High levels of debt have long been recognized as a causative factor for recessions.

The recent events caused a snowball effect that Secretary Paulson thought the private homeowner default could cause lenders to default, causing further defaults through a domino effect. The chances of these follow-up defaults in increased at high levels of debt. Attempts to prevent this domino effect lead TARP to bail out Wall Street lenders such as AIG, Fannie May, and Freddie Mac.

Deregulation of the Banking Industry in November 1999. In 1992, the 102nd Congress under the George H. W. Bush administration weakened regulation of Fannie Mae and Freddie Mac with the goal of making available more money for the issuance of home loans. Whereas banks that held $100 could spend $90 buying mortgage loans, Fannie Mae and Freddie Mac could spend $97.50 buying loans. The 106th Congress, in 1999, under Bill Clinton, passed the Gramm-Leach-Bliley Act, which repealed part of the Glass-Steagall Act of 1933. This contributed to the proliferation of complex and opaque financial instruments which are at the heart of the crisis and this lead to a devastating miscalculation by banks and investors of the level of risk inherent in the unregulated Collateralized debt obligation and Credit Default Swap marketplace.

Under this theory, banks and investors systematized the risk by taking advantage of low interest rates to borrow tremendous sums of money that they could only pay back if the housing market continued to increase in value. The pricing model for CDOs clearly did not reflect the level of risk they introduced into the system. The average recovery rate for high quality CDOs has been approximately 32 cents on the dollar, while the recovery rate for mezzanine CDO's has been approximately five cents for every dollar. These massive, practically unthinkable, losses have dramatically impacted the balance sheets of banks across the globe, leaving them with very little capital to continue operations. And guess who bought these instruments from the bankrupt entities that owned them?

I’m tired and have had enough……

When will the "Middle American" call UNCLE?