The root of the subprime problem is two-fold: first, in an attempt to create an ever-expanding market, lenders relaxed their standards, allowing such things as no principal payment, no down payment, and no income documentation. (This is made possible by weakening of or violation of banking regulations.) Second, certain lenders took advantage of this, plus the FHA guarantees for low-income lenders to created a revolving door by which properties were endlessly recycled through a series of unqualified buyers, with the FHA repeatedly making good on the losses. (This is called criminal fraud, and is a felony.) These shaky mortgages were bundled into opaque investments, which made it impossible for investors, even those with the star MBA wattage of invesment house executives, to know just what they were buying. The sudden and mysterious (to the outsider) fire sale at Bear Stearns has the look of an insider takeover, facilitated with taxpayer funds. Having run out of little fish to eat, the sharks are now eating each other.
- 1
- 2
Beware the Bailout
Email To A Friend
Please fill in the following information and we'll email this link.
Whether Bear Stearns was the victim of unfounded rumor or of genuine rot in its securities portfolio is unclear. But that very uncertainty defines the nature of the modern financial crisis—and the difficulties facing the Fed in trying to contain it. Financial institutions (banks, investment banks, hedge funds and others) are interconnected through networks of buying, selling, borrowing and lending. These require confidence that commitments made will be commitments honored. If that confidence collapses, the process of extending credit for the economy and of trading—for stocks, bonds, foreign exchange—may also collapse.
The Fed can no longer instill confidence by lending to besieged but sound banks. Somehow it must reassure the broader market that there are backup sources of credit and that the failure of any major financial institution won't trigger a chain reaction of failures, as firms refuse to deal with each other and dump stocks, bonds and other securities onto the market. That's why the Fed was eager to see Bear Stearns continue its operations by being purchased and why it has, in the past six months, introduced more and more ways for financial institutions to borrow from the Fed itself. It has gone beyond its traditional role of lending only to commercial banks.
So far, panic has been avoided, though some observers think the Fed's frantic efforts have actually contributed to the market's nervousness. Meanwhile, the real economy of production and jobs, though weakening, is not yet in dire straits. In February manufacturing output dropped 0.2 percent. Bad news, but hardly a calamity. But in trying to calm financial markets, the Fed has spewed out enormous amounts of money and credit that have depressed the dollar's exchange rate and could aggravate inflation. The effort to fix one problem may lead to others.
© 2008
- 1
- 2
My Take
Each Newsweek reader is different—and now your Newsweek can be, too. Use this page to create a experience that's personalized for you and your interests. My Take: it makes Newsweek whatever you want it to be.
Discuss