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In October, I had an opportunity to hear 4th District Congressman Barney Frank address the Newton Chamber of Commerce. Frank, as Chairman of the House Finance Committee, has been at the center of Congressional efforts to confront the country's current financial crisis and the stagnant housing market at its center. He shared with us his perspective about the interrelationship between the housing market and the financial crisis.Frank was conspicuously toting around a copy of Financial Shock: A 360ยบ Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis, by Mark Zandi. I bought this book after the meeting and highly recommend it to anyone interested in a closer look at the events leading up to the crisis, including the 1994 bill passed specifically to address sub prime regulation - and never implemented by Alan Greenspan. The book is written in plain English, and I was surprised at how quickly the alphabet soup of financial derivatives at the heart of the financial crisis started to make sense.
Recently, Frank has been under the fire from conservative quarters for
bearing partial responsibility for the financial crisis because he
supported legislation that facilitated loans to individuals living in
distressed neighborhoods. So it's not surprising that he began by
vigorously defending himself from these charges.
He pointed out that while Republicans were in control of Congress, Republican leaders rarely consulted him on matters pertaining to financial regulation. He asserted that it has only been in the last two years, with Democrats in control of the House, that he's been effectively responsible for legislation with a financial impact.
Frank described the financial meltdown as a "perfect storm" brought on by a combination of unemployment and lack of regulation of critical financial institutions. In his view, a crisis of this magnitude could only take place in a government culture that clung to the belief that "markets are smart and governments are dumb." He finds it remarkable that now, in response to the crisis, Secretary of the Treasury Henry Paulson's approach to Wall Street has been very much, "I'm from the government and I'm here to help you."
Frank places most of the blame for the financial debacle on the lack of regulation of mortgage companies. He believes that "Know your borrower" should be the mantra of "real" banks, and that this principle was lacking from the financial system that led up to the crisis.
In this financial system, lenders - unregulated mortgage companies - took careless risks because they were buffered from consequences if the loans failed. In essence, because mortgage companies were not lending their own money, they were willing to make more precarious loans.
The modern financial system proved to be dangerously efficient at spreading these questionable loans. The system quickly and widely distributed the bad loans and their derivatives to undermine the entire system and investor confidence. Rating agencies awarded AAA ratings on sub-prime loans when, in Franks' words, "It turns out they did not know what they were talking about!"
According to Frank, credit default swaps are insurance and no one thought they would be a problem. Said Frank, "The default swaps were akin to issuing life insurance policies to vampires, who are supposed to live forever -- except the vampires started to die."
Congress has already taken steps to address the crisis with a $700 billion rescue plan. In defense of the plan, Frank pointed out that the $700 billion will not increase the deficit. The government has purchased preferred stock in banks at a very low point. Once the economy recovers, it is likely the government will make money on this deal.
Whether the rescue plan works, or is sufficient, remains to be seen. Meanwhile, Congress faces another critical question: What to do to prevent such a disaster in the future?
Frank pointed out that Congress has already addressed one of the root causes of the crisis. Tighter regulations on credit are now in place to prevent a recurrence of the tsunami of foreclosures we've seen this year.
The second cause of the problem, lax government regulation of some brokers and financial institutions will be the target of Congressional work in 2009. A new set of laws and regulations governing securitized financial instruments must be established to ensure the benefits of securitization, without the risks. Frank expects to be at the center of these efforts.
Frank also sees job loss statistics at the heart of this crisis. He pointed out that in September alone, 159,000 jobs were lost. It is projected that in 2009 about 1 million jobs will be lost. And, while the picture had been somewhat brighter for public service and public sector jobs, that is expected to change. For example, here in Massachusetts, Governor Patrick has announced the elimination of 1000 jobs in an effort to address the state's $1.4 billion budget deficit.
So, Frank proposes addressing the problem not only by putting in place stronger controls on the nation's financial institutions, but by addressing the financial challenges confronting those on the lower end of the economic spectrum. He suggests creating jobs by focusing on government investment in public works, schools, bridges and other infrastructure, and to increase the federal share of Medicaid to give states more cash to weather the coming financial storm.
He also suggests that we question the central role of home ownership in American Dream. As worthy a goal as owning one's own home is, Frank believes that it may simply be unrealistic for many. Instead, we should focus on making attractive, safe, and affordable rental housing available to those who can't afford to purchase a home. Yes, Frank wishes more people could purchase their own homes, but he says, "I also wish I could eat more and not gain weight."
He pointed out that while Republicans were in control of Congress, Republican leaders rarely consulted him on matters pertaining to financial regulation. He asserted that it has only been in the last two years, with Democrats in control of the House, that he's been effectively responsible for legislation with a financial impact.
Frank described the financial meltdown as a "perfect storm" brought on by a combination of unemployment and lack of regulation of critical financial institutions. In his view, a crisis of this magnitude could only take place in a government culture that clung to the belief that "markets are smart and governments are dumb." He finds it remarkable that now, in response to the crisis, Secretary of the Treasury Henry Paulson's approach to Wall Street has been very much, "I'm from the government and I'm here to help you."
Frank places most of the blame for the financial debacle on the lack of regulation of mortgage companies. He believes that "Know your borrower" should be the mantra of "real" banks, and that this principle was lacking from the financial system that led up to the crisis.
In this financial system, lenders - unregulated mortgage companies - took careless risks because they were buffered from consequences if the loans failed. In essence, because mortgage companies were not lending their own money, they were willing to make more precarious loans.
The modern financial system proved to be dangerously efficient at spreading these questionable loans. The system quickly and widely distributed the bad loans and their derivatives to undermine the entire system and investor confidence. Rating agencies awarded AAA ratings on sub-prime loans when, in Franks' words, "It turns out they did not know what they were talking about!"
According to Frank, credit default swaps are insurance and no one thought they would be a problem. Said Frank, "The default swaps were akin to issuing life insurance policies to vampires, who are supposed to live forever -- except the vampires started to die."
Congress has already taken steps to address the crisis with a $700 billion rescue plan. In defense of the plan, Frank pointed out that the $700 billion will not increase the deficit. The government has purchased preferred stock in banks at a very low point. Once the economy recovers, it is likely the government will make money on this deal.
Whether the rescue plan works, or is sufficient, remains to be seen. Meanwhile, Congress faces another critical question: What to do to prevent such a disaster in the future?
Frank pointed out that Congress has already addressed one of the root causes of the crisis. Tighter regulations on credit are now in place to prevent a recurrence of the tsunami of foreclosures we've seen this year.
The second cause of the problem, lax government regulation of some brokers and financial institutions will be the target of Congressional work in 2009. A new set of laws and regulations governing securitized financial instruments must be established to ensure the benefits of securitization, without the risks. Frank expects to be at the center of these efforts.
Frank also sees job loss statistics at the heart of this crisis. He pointed out that in September alone, 159,000 jobs were lost. It is projected that in 2009 about 1 million jobs will be lost. And, while the picture had been somewhat brighter for public service and public sector jobs, that is expected to change. For example, here in Massachusetts, Governor Patrick has announced the elimination of 1000 jobs in an effort to address the state's $1.4 billion budget deficit.
So, Frank proposes addressing the problem not only by putting in place stronger controls on the nation's financial institutions, but by addressing the financial challenges confronting those on the lower end of the economic spectrum. He suggests creating jobs by focusing on government investment in public works, schools, bridges and other infrastructure, and to increase the federal share of Medicaid to give states more cash to weather the coming financial storm.
He also suggests that we question the central role of home ownership in American Dream. As worthy a goal as owning one's own home is, Frank believes that it may simply be unrealistic for many. Instead, we should focus on making attractive, safe, and affordable rental housing available to those who can't afford to purchase a home. Yes, Frank wishes more people could purchase their own homes, but he says, "I also wish I could eat more and not gain weight."
Peter Dwyer is a Newton, MA real estate investor and ForeclosuresMass member. He can be reached by phone at 617-633-6187 or by email at: pdwyer@thecertainitygroup.com.
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