One of my friends wrote this paper for school. It raises some great points, and I thought I’d share it here, of course with his/her permission. He/She asked to remain anonymous.
During the financial crisis of 2007-2010, everyone was affected. It is estimated that the average American net worth dropped by 25% (Kalita). Still, some were affected more than others. Some lost jobs, others lost homes, and for all too many, both. Foreclosures, along with subprime loans, the deadliest weapons of capitalism, were employed ceaselessly. The banking industry received a bailout, but the American individual, upon whom the nation is built, was cast aside, thrown under a bus, because they simply had to “pick themselves up by their own bootstraps”. The financial industry engaged in wasteful practices that ruined families, communities, economies, and our globe as a whole, and their political friends in our nation’s capital ensured they would never foot the true bill for their economic genocide.
Foreclosure rates during the recession were high, and they continue to be high. In April 2010, 1 in every 386 American homes was in some stage of foreclosure. (RealtyTrac) Some areas, however, are hit harder than others. Detroit, for example. After the auto industry crashed, Detroit began to die, slowly becoming a carcass of empty homes, vacant lots, and abandoned factories. In April 2010, 1 in every 162 homes in Detroit was going through foreclosure. Because there are so many empty homes in Detroit, the average home price has dropped dramatically, as per the laws of supply and demand. The average price of a foreclosed home in Detroit is $10,176. Nationwide, the average price is $177,395. There are some homes in Detroit, however, that can be had for much, much less.
Take, for example, 9631 Mansfield St. This 3 bedroom, 1 bath house with 1,147 square feet includes a master bedroom, a spacious kitchen, a full basement, and a garage. It has two stories, and was built in 1939. It’s just two blocks from the scenic Stoepel Park, and walking distance from Stein Playground. It’s located near the intersection of the 39 and the 96, making it a short drive downtown. In short, this is a great place to raise an all-American family. This house was foreclosed recently and is now bank owned. It is being sold for $500 (Realtor.com 1).
Another example is 15039 Maddelein St. A beautiful home, it has 3 bedrooms and one bathroom. It boasts 1320 square feet. It is located a block and a half from Heilmann Memorial Playground on a shady street. It’s merely walking distance away from the beautiful Lake St. Clair, giving it wonderful recreational opportunities for the fisherman or boating enthusiast. This house was last assessed in 2009 at a value of $19,000. It was built in 1915, making it 95 years old. It’s really a piece of American heritage. The house is now on sale for a mere $50. Get it while you can, for the low, low price of a couple crappy CD’s from Walmart! (Realtor.com 2).
What has happened to our capitalist system? What is determining the value of our products? Why do a few pieces of plastic cost more than a American home? Land is the one commodity that will never change. There is a limited amount of it. As the earth gets more populated, land prices should go up. They should never drop. Housing prices should follow land prices. A house on a piece of land should never sell for 50 dollars. Clearly, someone, or something, has rigged the game.
What do the banks gain from foreclosing on these homes? The Mortgage Banker’s Association estimates the cost of foreclosure for the bank to be over $50,000 (Mortgage Bankers Association 4). If they spend that much to foreclose, and then sell the home for $50, $500, $10,000, even $50,000, they will come out at a net loss. Not to mention that even if the borrower can’t make the payments now, they may eventually pay back some part of the loan; this potential loss of capital is seemingly never taken into account. In foreclosing on homes, and selling them on the cheap, the banks destroy a family and lose money. This is, quite simply, an entirely ludicrous system.
There is clearly something wrong with our lending system. If banks were to avoid foreclosures that would lose them money, then they would save enough money to give a small amount thereof to struggling borrowers who could then use the money to re-establish themselves and resume payments. The borrower and the bank end up ahead. It seems almost as ludicrous as the situation in the first place that no one has thought of this sane, rational, economical alternative to it. Clearly, someone is profiting from this insane, destructive status quo.
Our current financial system has yet another downfall. Subprime lending- or, below-prime lending, a fancy way of saying crappy lending- is a huge player in the foreclosure game. Subprime mortgages are directed at borrowers with a low credit score- usually 620 or below. They are usually adjustable rate loans that are initiated when rates are low. As rates go up, the monthly payment goes up faster, sometimes doubling. The interest rate of a subprime loan is also always, as a rule, at least 2 percentage points higher than that of a “prime” loan. Borrowers quickly find themselves underwater. Unable to make the payments, they default (NPR 2).
Subprime lending is essentially a kind of Predatory lending. Predatory lending involves lenders deceiving borrowers. Often this involves a lender promising a good loan to a borrower. When the borrower goes to actually sign the loan, the loan is magically not good. The interest rate is different than promised. There also may be more adjustments that unfairly benefit the lender at the expense of the borrower. A California study found that 70% of Subprime mortgages had negative (for the borrower) changes at signing (Setzer 2). Pressured be the seller, the borrower signs the documents, hoping to discuss the issues with the lender later. Once it’s signed, however, there is simply nothing the borrower can do, as the lender has coerced the borrower into ceding the protection of the law.
Predatory lending also sometimes involves brokers writing loans that are literally impossible for the borrower to pay off. This generally involves deceiving the uninformed borrower into an interest only loan. The borrower is required to pay only the interest on the loan, and thus, the balance never decreases. After a few years, the payment will skyrocket to cover the balance. Even worse, Negative Amortization loans require the borrower to pay less than the interest. Thus, the balance grows. Eventually, the payment will be increased: Substantially. Negative Amortization is illegal in many states. Lenders engaging in these practices will often ignore the usual guidelines of who can get a loan. The income, the debt-to-income ratio, and the credit score of the borrower may indicate that they should not be receiving a loan, but the lender will give it to them anyway (Setzer 3).
Brokers were, and are, enticed to write loans to people who can’t repay them because they are paid commission based on how many loans they write per month. If the loan defaults, there is no penalty for the broker; this is a serious flaw in the banking system, for obvious reasons. To compensate for this disaster waiting to happen, the financial institution originally writing the loans will often sell the loans in bulk to investors so that they don’t assume any risk (NPR). Sometimes, the lender will write loans with the intention to foreclose. They milk the borrower for payments for as long as they can and then foreclose and sell the home. It is, beyond all the jargon, glorified thievery. The bank makes up the loan balance with the home’s sale and keeps any payments made by the borrower as profit. In short, the people who write the loans do not care if the borrower defaults. The people who write the loans take no real risk. In the second half of 2008, there were 148,697 subprime foreclosures- 18.39% of all foreclosures (Liebowitz 2).
Capitalism is a system designed to reward the seller with the best products. The seller with the best product gets the most customers and thus succeeds while a seller with a lesser product fails. Supply and demand set prices, and everyone is, in theory, satisfied. In our current system, however, the opposite is true. Corporate lenders make money by loaning money to people who cannot pay it back, while lobbying a government to provide tax incentives for homeowners. These average people who unwittingly “take the bait”, are ruined financially, but the original lender, that is, the big corporations, are not held accountable. The investor and the borrower loose, and the lender wins. But the lender produced a terrible product. The investor produced a good product and the borrower is the customer. Why does the bad product make the most money? Why does the customer suffer? How can we fix our broken system?
Subprime lending should not be stopped. People with poor credit should get an opportunity to borrow money. The actual loan, however, should be modified. Instead of an adjustable rate mortgage, use an adjustable balance mortgage. If the value of the home goes up, the mortgage balance goes up. If the value of the home goes down, the mortgage value goes down. Perhaps this could be based on a percentage system, in the interests of fairness. If the borrower has paid back 50% and the home value goes up, they would only owe 50% of the new value. That way, if the home value doubles, the borrower does not pay back double, but a percentage of the doubled value. Thus, the borrower is not ruined by huge payments. If the value of the home goes down after the borrower has paid back 50%, they then owe 50% of the new, lower value. That way, if the home value is cut in half and the borrower has already paid half, the bank is not cut off. They continue to receive payments. This system will allow faltering neighborhoods such as Detroit to get back on their feet by lowering the payments on houses in failing communities. It will also allow the banks to make more money in the end because of the general rise in value of real estate. Everybody wins; even the corporate banks, though they will no longer be able to “win” at the expense of everyone else.
Unregulated capitalism does not work; at least not for the common person. Gary D. Cohn, the President and Chief Operating Officer of Goldman Sachs received a total of 72.5 million dollars in 2007. 4 other Goldman Sachs employees received over 49 million dollars each. In all, out of 54 executives from Goldman Sachs, Bank of America, Citigroup, JP Morgan and Chase, Merrill Lynch, Morgan Stanley, New York Mellon, State Street Corp, and Wells Fargo 53 made over 1 million dollars in 2007. The majority of these executives made over 10 million dollars. All of these companies were recipients of government aid from the bailout (CNN Money 2). These companies were at least indirectly responsible for the financial crash. Why are they receiving so much money when it is the common man who is in danger of foreclosure? Gary D. Cohn will never be in danger of becoming homeless. And yet the taxpayers are paying for his company to pay him; our money has funded the rewarding of criminal, immoral, and unbelievable behavior- we have subsidized our own exploitation.
$536,300,000,000 of government money was used to bail out failing US companies, most of them financial institutions (ProPublica 5). There are 156,297,000 taxpayers in the United States (as of 2008) (IRS 6). That means that $3,431.29 from every taxpayer was given towards these failing companies. For families with two taxpaying adults, that’s $6,862.58. Yet, when homes are foreclosed upon, that amount is not taken into consideration. Families who gave the banks thousands of dollars in their time of need are turned away when they get behind on a few payments. Why didn’t the government bailout the Americans who were in danger of foreclosure? The workers, the teachers, the nurses, the bus drivers, the farmers, and all other hardworking Americans were told to simply deal with it, while the money was given to Goldman Sachs instead.
The bailout was deemed necessary because the banks were considered too big to fail. But why were they failing? The answer lies in deregulation. In 1933, the Glass-Stegall act was passed. This required commercial banks to make relatively low risk investments, such as loans and mortgages, while investment banks could continue to invest in high risk securities. This kept the commercial banks, who were sitting on piles of cash, from making (or losing) as much money as they could. It was, however, relatively risk free, and thus the FDIC was willing to insure them. In 1999, this was done away with by $300 million in lobbying; the result was the Gramm-Leach-Billy Financial Services Modernization Act (Gilani 3). This would allow commercial banks to make high risk investments with FDIC paying the bill if things went wrong. In 2007, things went very wrong. The bill also allowed the merger of Citibank and Travelers Corp to create the world’s largest financial company. Such a company could not be allowed to fail, because if it did, it would take much of the industry with it, and subsequently the entire national, and perhaps international economy; a “snowball effect”.
After a quick recovery, thanks to government money, the banks have been doing very well with deregulation. Citigroup, Goldman Sachs, JP Morgan Chase, and Bank of America all had perfect first quarters this year. That means they had no days with a net trading loss. Goldman Sachs reported earnings of over $100 million on more than half of the days of the quarter. They made an average of $25 million more on days when they traded verses days when they didn’t trade (Mildenberg 4). It’s easy to see why the banks like to trade these high risk securities. If things go well, they make millions. Because banks went down during the crisis, there is now less competition for the survivors. Of course, the survivors were those handpicked by Senators, with the “encouragement” of well-placed financial industry lobbyists, to be “too big to fail”. In addition to having little competition, the surviving banks are also growing. JP Morgan and Chase, for example, absorbed Washington Mutual (Osborne 1). Wells Fargo now owns Wachovia (Triangle Business Journal 6). This is making the big banks bigger and bigger. If they were too big to fail this time, what will they be next time?
This is not capitalism. It is simply thievery. It is class warfare, of the rich against the poor, with all thoughts of a free and fair market thrown out the window, all concepts of common rules to play by laughed off as “socialist nonsense”. What have we come to?
Another major contributor to the fall of the financial industry was shadow banking. Shadow banking is a term for financial institutions that channel money from investors to securities. Since they are technically “channeling” money instead of receiving deposits, they are not regulated as a bank. They invest close to 100% of their “deposits” to make as much money as possible. They purchased securities rated AAA- or rather, got AIG to insure the securities as if they were AAA. A lot of these securities involved large groups of subprime mortgages; not high-class securities worthy of AAA status. When the housing market crashed, the shadow banks lost enormous amounts of money. When their depositors wanted to withdraw, the shadow banks didn’t have enough to cover their debt. As they went under, they pulled AIG (their insurer) with them. With no shadow banks loaning huge sums of money, much of the financial market that depended on them crashed (Mehrling 3).
The banking industry needs to be regulated again. Large mergers, such as Citigroup and Travelers Corp. should not be allowed. If monopolies are watched in other sectors, they should be scrutinized in the financial sector. The Glass-Stegall act, or something similar, needs to be re-instated. The FDIC should not insure banks making risky investments. Depositors need to be made aware of the risks of an investment bank and encouraged to deposit in a safer bank. The shadow banking industry needs to be regulated. Insuring an investment should be illegal. By helping the big banks, the government is only encouraging them and their dangerously criminal behavior. We must not allow our government to be usurped by crooks.
The financial crash can only be explained up to a point. From there, the markets seem to have a mind of their own, doing unexplainable, frightening things. On May 6, 2010, the Dow Jones Industrial Average dropped nearly 1,000 points during intraday trading (It climbed back to close to open by the end of the day). There were rumors circulating that a software glitch at the NYSE caused the drop, but the exchange denied the allegations. Other theories include fear about German and Greek problems. Proctor and Gamble dropped 21% in minutes before climbing back up. There is still no clear explanation as to why the Dow dropped so low, so fast. It was the biggest drop in a single day since 1987 (Krantz 2). If this sot of thing is happening and no one knows why, it shows that the market is completely uncontrollable, that it is bigger than any one person or corporation. What if it drops 2,000 points next time? How about 5,000? 10,000? How can we trust our whole economy to such a system? What happens when the “invisible hand” of capitalism develops a mind of it’s own? Our economy is too big to fail; so we must act preemptively to protect it by seriously reconsidering the way we organize it.
The financial industry has made a lot of mistakes. They also made a lot of money- and the American people paid for it all. They contributed directly to the bailout. They were forced out of their homes because of foreclosures. They were attacked by predatory lenders offering subprime loans. They suffered the effects of financial deregulation. Their shares went up and down for no reason. The government let it all happen.
The financial industry has long tentacles wrapped around the arms of “our” Congress. Over the past decade, the financial companies have spent more than $5 billion pushing the government whichever way it chooses. $1.7 billion was directed at campaign contributions. The remaining $3.4 billion was used for lobbying. In total, that equates to $9,345,794.29 per member of congress (Harder 1). When it comes to political positioning, Goldman Sachs is at the top of the food chain. Henry Paulson, the former CEO of Goldman Sachs was Treasury Secretary under Bush. In 2006, Goldman Sachs Managing Director Mario Draghi became the governor of the Bank of Italy. England and Canada have also recently appointed Goldman Sachs executives to political positions (Lynn 2). During a session of Congress discussing the bailout, Dennis Kucinich questioned aloud “Is this the US Congress or the board of directors of Goldman Sachs?” (Kucinich 1). That statement is a perfect description of the amount of power the financial industry has over our government.
Money is a powerful thing. Though it would seem that the collapse of one person’s mortgage should have no effect on someone else, the financial crisis has proved just the opposite. When one house goes down, that soon brings down another, and the two bring down a street, which brings down a neighborhood, which brings down a city. That leads to a bank collapsing, which pulls down all it’s depositors, linked banks, and insurers. All those collapses lead to larger ones and soon the market is in the dumps and analysts are predicting the worse is yet to come. This leads to widespread fear and selloffs which pulls down stocks even more. Soon, even nonfinancial companies are feeling the push and are laying off employees which leads to decreased buying. This creates a never-ending spiral. Capitalism is linked. If your neighbor goes down, it could affect you very severely. Big finance is everyone’s business. Ultimately, what we should take away from the financial crisis is that we must work more closely together, as a people; that the illusion of competition is less important than the act of collectivization. Adam Smith promoted capitalism with a government whose primary function is to protect the people. What he didn’t realize is that in addition to military protection from thieving armies, the people need financial protection from robber barons. We need the government to protect us from the financial industry. The next crash could be our last.
“Compensation for Top Bank Executives – CNNMoney.com.” Business, Financial, Personal Finance News – CNNMoney.com. 04 Jan. 2009. Web. 26 May 2010. <http://money.cnn.com/news/specials/storysupplement/ceopay/>.
Eye on the Bailout | ProPublica. Web. 26 May 2010. <http://bailout.propublica.org/>.
Gilani, Shah. “How Deregulation Eviscerated the Banking Sector Safety Net and Spawned the U.S. Financial Crisis.” Money Morning. Web. 26 May 2010. <http://moneymorning.com/2009/01/13/deregulation-financial-crisis/>.
Harder, Amy. “Report: Financial Lobbyists Spent $5B – Under The Influence – Under the Influence.” Under The Influence – Under the Influence. Web. 29 May 2010. <http://undertheinfluence.nationaljournal.com/2009/03/report-finds-some-k-street-inf.php>.
Kalita, S. Mitra. “Americans See 18% of Wealth Vanish – WSJ.com.” Business News & Financial News – The Wall Street Journal – WSJ.com. Web. 26 May 2010. <http://online.wsj.com/article/SB123687371369308675.html>.
Krantz, Matt. “Fear Rises While Dow’s 1,000-point Drop Remains a Mystery – USATODAY.com.” News, Travel, Weather, Entertainment, Sports, Technology, U.S. & World – USATODAY.com. Web. 28 May 2010. <http://www.usatoday.com/money/markets/2010-05-10-mart10_ST_N.htm>.
Kucinich, Dennis. “OpEdNews – Article: Kucinich Opposes Bailout, Asks, “Is This the US Congress or the Board of Directors of Goldman Sachs?”" OpEdNews.Com Progressive, Tough Liberal News and Opinion. Web. 29 May 2010. <http://www.opednews.com/articles/Kucinich-Opposes-Bailout-a-by-Dennis-Kucinich-080928-572.html>.
“Lender’s Cost of Forclosure.” Mortgage Banker’s Association. Web. 26 May 2010. .
Liebowitz, Stan. “New Evidence on the Foreclosure Crisis – WSJ.com.” Business News & Financial News – The Wall Street Journal – WSJ.com. Web. 26 May 2010. <http://online.wsj.com/article/SB124657539489189043.html>.
Lynn, Matthew. “Goldman Sachs Has Gained Too Much Political Power: Matthew Lynn.” Bloomberg.com. Web. 29 May 2010. <http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aGS6lvr8ipiw&refer=columnist_lynn-redirectoldpage>.
Mehrling, Perry. “Shadow Banking: What It Is, How It Broke, and How to Fix It – Business – The Atlantic.” Breaking News, Analysis and Opinion on Politics, Business, Culture, International, Science, Technology, National, Food — The Atlantic. Web. 28 May 2010. <http://www.theatlantic.com/business/archive/2009/07/shadow-banking-what-it-is-how-it-broke-and-how-to-fix-it/21038/>.
Mildenberg, David. “‘Perfect Quarter’ at Four U.S. Banks Shows Fed-Fueled Revival – BusinessWeek.” BusinessWeek – Business News, Stock Market & Financial Advice. Web. 26 May 2010. <http://www.businessweek.com/news/2010-05-11/-perfect-quarter-at-four-u-s-banks-shows-fed-fueled-revival.html>.
Osborne, Alistair By. “After JP Morgan Chase’s Washington Mutual Deal, Rescue Talk Turns to Wachovia – Telegraph.” Telegraph.co.uk: News, Business, Sport, the Daily Telegraph Newspaper, Sunday Telegraph – Telegraph. Web. 26 May 2010. <http://www.telegraph.co.uk/finance/financetopics/financialcrisis/3089381/After-JP-Morgan-Chases-Washington-Mutual-deal-rescue-talk-turns-to-Wachovia.html>.
“RBC Bank, Wachovia, SunTrust on Weiss List of Vulnerable Banks – Triangle Business Journal.” Business News | Bizjournals. Web. 26 May 2010. <http://www.bizjournals.com/triangle/stories/2010/05/24/daily26.html>.
“Real Estate – REALTOR.com®.” Real Estate Listings, Homes for Sale and Rental Property Listings â REALTOR.com®. Web. 26 May 2010. <http://www.realtor.com/realestateandhomes-detail/15039-Maddelein-Street_Detroit_MI_48205_1118777526>.
“Real Estate – REALTOR.com®.” Real Estate Listings, Homes for Sale and Rental Property Listings â REALTOR.com®. Web. 26 May 2010. <http://www.realtor.com/realestateandhomes-detail/9631-Mansfield-St_Detroit_MI_48227_1114817485>.
Setzer, Glenn. “Refinance To Reduce My Mortgage Payment – Mortgage Fraud Part 2.” Mortgage News Daily – Mortgage And Real Estate News. Web. 27 May 2010. <http://www.mortgagenewsdaily.com/1052004_Mortgage_Fraud2.asp>.
“SOI Tax Stats – Filing Season Statistics / Taxpayer Usage Study.” Internal Revenue Service. Web. 26 May 2010. <http://www.irs.gov/taxstats/article/0,,id=96629,00.html>.
“Subprime Mortgages: A Primer : NPR.” NPR : National Public Radio : News & Analysis, World, US, Music & Arts : NPR. Web. 26 May 2010. <http://www.npr.org/templates/story/story.php?storyId=9085408>.
“U.S. Foreclosure Trends and Foreclosure Market Statistics | RealtyTrac.” Foreclosure Real Estate Listings | RealtyTrac. Web. 26 May 2010. <http://www.realtytrac.com/trendcenter/>.