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Understanding the current financial crisis

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Legend has it that there once was a knot so complex, so complicated that no one could untie it.

When Alexander the Great attempted to do so he couldn’t find the ends in order to begin the process, so he simply severed the knot with his sword.

The current financial and credit crisis is much like the Gordian Knot, but fortunately there seems to be a beginning, a middle and an end.

Let’s start at the beginning. During Franklin D. Roosevelt’s New Deal, Congress established Fannie Mae (the Federal National Mortgage Association) to make homes more affordable for lower- and middle-income Americans. Freddie Mac (the Federal Home Loan Mortgage Corporation), brother organization to Fannie Mae, was established in 1970.

These two GSEs (government sponsored enterprises) were created to keep money flowing to mortgage lenders, and they do that by buying mortgages and pooling them into securities for sale to other investors, guaranteeing to pay the investors should the borrowers default.

Today, these two entities own or guarantee about half of the country’s $12 trillion in mortgage debt.

Their unusual status was critical in their business in that they were federally sponsored leading the financial markets to believe the government would cover their debts if they were unable to do so.

Freddie and Fannie enjoyed lots of perks because of their charters and government backing; exemptions from state and local taxes, inadequate capital requirements and an ability to borrow money at rock-bottom rates.

The assumption they were virtually as reliable as the U.S. Treasury allowed them to borrow at extremely low rates thus fund their investments with cheap money; it also enabled them to charge a premium for their mortgage guarantees.

Having all their eggs in one basket left the two entities much more vulnerable to a downturn in the housing market, and as home prices plummeted and defaults and foreclosures soared, the companies lost billions of dollars and face the very real prospect of losing billions more.

As the housing market boomed in recent years, Fannie and Freddie, like many other lenders, took on riskier loans on the fear of losing market share.

James A. Johnson, long time Washington insider who previously worked on the campaign of former Vice President Walter F. Mondale, ran Fannie during most of the 1990s. Johnson started the strategy of hiring many officials who had worked for previous administrations as employees and lobbyists to secure access to top government officials and assure clout on Capitol Hill.

Fannie hired Jamie Gorelick, Democrat, a former deputy attorney general in the Clinton administration and creator of the "wall" between the CIA and FBI credited with the two’s inability to communicate over terrorists, and member of the 9/11 Commission; Thomas E. Donilon, who was the Clinton administration’s chief of staff to the secretary of state; and Franklin Delano Raines (no, I didn’t make that up!), who was President Clinton’s budget chief.

As soon as Clinton crony Franklin Raines took over in 1999 at Fannie Mae, for example, he used it for his personal piggy bank, looting it for almost $100 million in compensation by the time he left early in 2005 under a cloud of ethical charges.

Ultimately, what hurt the companies was the failure of home buyers to pay off sub-prime and other risky mortgages that were packaged into bonds and sold to investors by Wall Street banks like Bear Stearns, Lehman Brothers, Merrill Lynch, and Citigroup, with Fannie and Freddie playing a lesser role.

So, what’s AIG’s part in this whole mess? Well, banks wrote mortgages and sold them to investors who then packaged them as securities and sold them to the investment community. AIG wrote insurance on these mortgage-backed securities (MBSs) to protect investors in the event of defaults.

AIG also put up more than $446 billion in collateral to back these obligations.

Those insurance contracts required AIG to provide the additional collateral if the company’s credit ratings deteriorated.

As AIG’s investment portfolio deteriorated, ratings agencies cut AIG’s rating leading to a huge collateral call on AIG obligations covering the mortgage-backed securities. That pretty well brings us up to date on the situation.

Now, let’s do back in time to dig a little below the surface to find out, as Paul Harvey calls it, "the rest of the story."

The year is 1977. Jimmy Carter is president and the buzz-word in the media is "redlining" as media across the country are full of hard-hitting investigative reports about the evil and racist mortgage lenders refusing to make real estate loans to various minorities and to applicants who lived in low income neighborhoods. Carter, along with a Democratic congress, created the Community Reinvestment Act (CRA) over strong banking and lending industry objections. The Act mandates that all banks meet the credit needs of their entire communities.

In 1995, President Bill Clinton put CRA on steroids and imposed even stronger regulations that coerced banks to substantially increase loans to low-income, poverty-area borrowers or face fines or possibly restrictions on expansion. These revisions allowed for securitization of CRA loans containing subprime mortgages. Congress created processes through the Research the Community Redevelopment Act whereby community activist groups and organizers could effectively stop a bank’s efforts to grow if that bank didn’t make loans to unqualified borrowers. Hence, the sub-prime mortgage. These lenders knew a very high percentage of the loans would turn to garbage, but it was something they were coerced into doing if they expected to grow and expand. These garbage loans were then bundled up and sold with the expectation they would eventually be paid off when rising home values led some borrowers to access their equity through re-financing and others to sell and move to bigger homes.

No less than four federal banking regulatory agencies are in charge of enforcing the Community Reinvestment Act; they subject lenders to a racial litmus test and issue regular report cards – the industry’s dreaded "CRA rating." Lenders with low ratings can not only be fined, but also blocked from mergers and other business transactions needed to expand.

Regulation grew exponentially under the Clinton administration, obsessed as it was with multiculturalism and lenders were forced during the mid-1990s to dramatically raise the amount of home loans to otherwise unqualified, low-income borrowers.

The revisions also for the first time allowed radical "housing rights" groups led by ACORN to lobby for such loans. ACORN and the feds made lenders offer zero-down loans. "No credit scores … undocumented income" under the auspices of CRA. ACORN was represented at the time by a young public-interest lawyer in Chicago by the name of Barack Obama.

Freddy and Fannie were pressured by Congress to purchase more sub-prime loans and, in turn, Freddy and Fanny donated generously to the campaigns of leading Democrats like Barney Frank and Nancy Pelosi who suppress investigations into fraud at the agencies.

Soon, investment banks like Bear Stearns were aggressively marketing the "guaranteed" securities and the pitch on Wall Street was that MSBs were as safe as Treasuries with a higher yield. Merrill Lynch’s emergency sale to Bank of America Corp. recently was just another example of the train wreck brought on by Clinton and his social engineers who were the political catalysts behind this slow-motion train wreck.

In 2003, President Bush attempted to rein in Fannie and Freddy by applying more oversight over the out-of-control institutions, and calling for more stringent regulation by setting up a new agency within the Treasury Department that would have the authority – which then rested with Congress – to set one of the two capital-reserve requirements for the companies. Democrats in Congress blocked any attempt at curtailing their lending practices stating, "Fannie and Freddy aren’t facing … any financial crisis." "The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing." So stated Barney Frank, Democrat from Massachusetts and chairman of the House Financial Services Committee. Opposing one such bill in 2004, Senator Charles E. Schumer (D-NY) argued that a hostile regulator could use the proposed powers to choke the companies.

In 2004, Alan Greenspan warned that Fannie and Freddy could "cost taxpayers dearly" as they were growing too aggressively.

During this time, Fannie suffered a $10 billion accounting scandal in which execs falsified results to trigger maximum bonus payments.

In other words, Fannie was cooking the books big time. A 211 page report by the Office of Federal Housing Enterprises Oversight (Ofheo) indicated that by improperly delaying the recognition of income, it created a cookie jar of reserves. And, by improperly classifying derivatives, it was able to spread losses over many years instead of recognizing them immediately.

This flexibility gave Fannie the ability to manipulate earnings within pennies to hit target numbers for executive bonuses. That allowed Fannie’s executives – whose bonus plan was linked to earnings per share – to meet the target for maximum bonus payouts. The target EPS for maximum payout in 1998, when the Russian financial crisis sent interest rates tumbling, was $3.23 and Fannie reported $3.2309. That hit was worth $1.932 million to then-CEO James Johnson, $1.19 million to CEO-designate Franklin Raines, and $779,625 to then-Vice Chairman Jamie Gorelick.

That same year, Fannie installed special software allowing management to produce multiple scenarios under different assumptions that allowed them to assess the impact of income or expense on securities and loans thus enhancing the ability of management to hit maximum bonus targets.

Between 1998 and 2003, the top management team – all four of whom were prominent Democrats – managed to pull down nearly $200 million in pay and bonuses. Franklin Raines managed to eke out a living on a mere $90,128,761; CEO Timothy Richard earned a paltry $30,155,029; Vice Chair Jamie Gorelick $26,466,834; and CEO Jim Johnson $21,000,000 – in one year. Raines was finally forced out of FNMA in 2004 over accounting fraud allegations. In the end, Fannie had to pay a record $400 million civil fine for SEC and other violations, while also agreeing as part of a settlement to make changes in its accounting procedures and ways of managing risk.

But it was too little, too late. Raines had reportedly steered Fannie Mae business to subprime giant Countrywide Financial, which was saved from bankruptcy by Bank of America.

Fannie’s secretive "Countrywide program" gave special loans to connected individuals including the Democratic Chairman of the Senate Banking Committee, Sen. Christopher Dodd, and the Chairman of the Senate Budget Committee, Democrat Kent Conrad.

The disease in all this has been identified. It’s called deleveraging, or the unwinding of debt. During the credit boom, financial institutions and American households took on too much debt. Average household borrowing between 2002 and 2006 grew at an average annual rate of 11%, far outpacing economic growth. Would-be homeowners got mortgages at flexible rates and when the economic downturn began they discovered they couldn’t meet the increase mortgage payments. Unqualified borrowers couldn’t meet the debt from the outset. Thus, the stage was set for the economic meltdown we see today.

Right now this crisis is being sold to the American people by the left as a failure of the free market and greedy capitalists. Not true! What we’re seeing is the inevitable result of social engineering and political interference in free market economics. You don’t really expect the media to blame this whole mess on deadbeat borrowers and political interference when it’s so easy to blame greedy lenders and evil capitalists, do you?

Think about this. Two of Barack Obama’s key financial advisors are, you guessed it, Franklin Raines and Tim Johnson.

Jim Johnson was forced to resign from Barack Obama’s vice presidential search team because of problems associated with the financial scandal.

This mess is far from over. By the time it is the American taxpayer will be paying through the nose for Clinton’s social experiment, one that Barack Obama hopes to outdo by more meddling in the housing and jobs market, not to mention your health care system.

Now, a huge question is: Do you want the same principles applied to your health care? Do you want the same type of political interference by politicians with a social axe to grind to meddle in your health and well being? Do you want a few well-placed Democrats to haul down huge salaries and bonuses for mismanaging the medical welfare of all Americans? I sure as hell don’t!


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Nelson Propane

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