What Is The Current Finacial Crisis Anyway?

From my previous post, our current crisis or predicament is actually pretty easy to follow and understand.

In a time of low interest rates and rising home prices, loans were made to people who could only possibly keep paying on their loans if those two conditions kept up. When the conditions changed, the buyers could not pay their loans, or at least not in full. Hence, a tsunami of foreclosures resulted. When the foreclosures occurred, to clearly make my point, lenders were left with houses they had purchased for $600,000 and could now only resell for $400,000, if at all. Hence, a real loss of at least $200,000. The insurance they had paid for to make them whole being worthless.

We can now see why different people blame different people:

Some blame the Fed and Greenspan, because low interest rates were a necessary condition, they believe, of this mess. Had the Fed raised interests rates, this crisis could have been averted.

Some blame the lenders, because they loaned money on poorly thought out conditions. Had they not loaned this money, this crisis would have been averted. Fannie and Freddie fall into this group.

Some blame the mortgage insurers, because the lenders believed that they were insured against loss. If the true bogus nature of the insurance had been known, or at least some actual capital been required of the insurers, then this problem might have been, if not avoided, not a crisis. So, if regulation had forced either of these conditions, the crisis could have been avoided.

Some blame the regulators, for the reasons just given.

Some blame the borrowers because they foolishly took out loans they couldn't pay. Had they not done this, the crisis could have been avoided.

Some blame the implicit guarantees of the government to intervene in a crisis, because, if these guarantees hadn't been counted on, no one would have countenanced the stupidity of the insurance or lending to unsound borrowers. Had this not been the case, the crisis would have been avoided.

Finally, we can see why TARP is such a controversial remedy to this crisis. The most direct way to deal with this crisis would have been to find a way for borrowers to continue making payments and hence foreclosures be averted. Instead, TARP focuses on the lenders, trying to figure out a way to ease their losses.

From my perspective, it's hard not to fault the lenders the most in this crisis. After all, they're the ones demanding to be made whole ( or solvent, or stable, or whatever they're asking for). As to whether they should have lent the money in these marginal cases, the answer is obviously not. But to absolve them by claiming they couldn't help themselves because the rates were low or the government pressured them, seems little reason or not enough reason for them to abandon sound lending criteria.

Now, I can also address mark-to -marketing, with my usual fudging and taking liberties. Suppose I'm the lender, and I take back the house through foreclosure. Now, I have an asset. A real thing. A house. However, I don't or can't sell it. Maybe I want to try and rent it, or wait for a while and see if the market corrects, whatever. But there's a problem. If I do this, I have to list my house as being, say, $400,000, and I've now a $200,000 loss on my books. And say that there's a rule saying that when I lose $200, 000, I need to come up immediately with $100,000 in capital to stay solvent. Is that fair? On the one hand, I have an asset, a house, that I want to do something with over time. On the other hand, we've just come through a crisis involving lack of capital, so we want to make sure you're properly capitalized. Who's right?

I can also understand TARP better. I've already discussed the mortgage approach to this problem, now I'll address the liquidity problem.

Say I'm the lender. I have two problems:

1) I need to meet capital requirements for my current losses.

2) I have more of these foreclosures out there, but the number is iffy, and I have no idea how much capital I will eventually need to recapitalize.

So, until I solve these problems, I won't loan any more. Suddenly, the oil that greases the engine of our economy dries up. How to solve this?

Well, along comes the government, which says we'll give you the money to recapitalize for interest, stock, ownership, whatever. When we do, start loaning.

So, there are three immediate problems.

1) I've still got this iffy figure to deal with.

2) Even if you give me the money, I'm so shell-shocked I find myself incapable of lending.

3) If you're the government, you've just given money to loan to businesses that have become problematic because they've poorly loaned money.

TARP has been all over trying to deal with these issues.

Let's add another problem, just for fun.

I'm a small country. The big countries all have these government guarantees between themselves to keep lending going on. Tragically, the lending that was coming to me is now drying up because there isn't enough lending to go around, and I don't have these guarantees with the big countries. I didn't start the crisis, but, well, I'll feel the worst of it.