Banking & Finance  August 27, 2010

Black September ’08: Economic meltdown

Editor’s note: In October 2008, Business Report staff asked local experts to discuss what the economic turmoil at the time might mean to Northern Colorado and the nation. For this story, we asked them to revisit the topic from their current perspective.

Listen to the entire 2008 Roundtable at

http://ncbr.flex360.net/ncbr%20economic%20crisis%20roundtable.mp3

Download the entire 2008 Roundtable transcript at:

http://www.ncbr.com/podcasts/ncbr crisis roundtable complete.pdf

How is this the same or different from the Savings and Loan crisis of the 1980s or the Great Depression of the 1930s?

John Clinebell, professor of Finance, Monfort College of Business, University of Northern Colorado: The current crisis was caused by a real estate bubble that led to a short-term liquidity problem. The major similarity with the Great Depression is the psychological impact: Fear. Fear caused the run on the banks in the Great Depression and fear led to the market crash in October 2008 and to many of our current economic problems.

What are the strengths/weaknesses of the legislation that has come out of the crisis?

CLINEBELL: The TARP legislation was successful, but was too large (about half the size would have been enough) and there were insufficient restrictions on the use of the funds. The infusion of liquidity into the market from TARP stopped the initial panic and allowed financial institutions to recover. The investment banks that received TARP funds repaid the money, with interest, in a relatively short amount of time. The lack of restrictions on TARP money allowed it to be used for non-financial firms – specifically the auto industry.

The stimulus package provided a short-term boost to economic activity through massive government spending but did little to encourage private economic growth and actually has hurt private economic growth because of the fears created by the massive deficit.

The recently passed financial regulatory reform does provide some oversight of the derivative markets and hedge funds but the full impact is yet to be seen. Until the regulations implementing the law are put in place and the actual role of the oversight committee are determined, the effectiveness of the law cannot be determined.

I do believe the legislation did little to actually address the underlying causes of the original financial crisis and completely ignored the role of (government-supported enterprises) Fannie (Mae) and Freddie (Mac) in the financial system. Because of the many parts of the bill that are unrelated to the financial problems we faced, I believe there is a strong possibility the new financial reform law will hurt the economy and financial system more than it will help.

Julie Piepho, executive vice president, Cornerstone Mortgage: Speaking on the mortgage front, the legislation that came out of the crisis has been crafted to protect the consumer against the “bad actors” in the industry. Unfortunately, what has happened is anything but – it has created more paperwork that is unclear, longer waiting times to close and stricter controls on mortgage lenders that still don’t prevent the fraud legislators thought we were doing.

As a lender, our cost to comply with all of this legislation has increased dramatically with increased staff and software applications, so therefore the cost to the consumer has increased. Licensing, with the SAFE Act, has not decreased the amount of fraud in the industry. In fact, fraud is on the increase and, once again, the cost to the consumer increased.

Ronnie J. Phillips, senior fellow, Networks Financial Institute, Indianapolis (on the economics faculty at Colorado State University in October 2008): We should be reassessing every aspect of our financial system as we did in 1910 through the National Monetary Commission which created the Federal Reserve System. The recent legislation is better than nothing, but unless further measures are taken, it will not prevent the next financial crisis. The fact that it takes more money to bail out Citibank than GM is evidence that our financial system is severely dysfunctional for the average consumer and small business.

In October 2008, did you predict or sense that the crisis would spin us into a recession this deep? Have there been any surprises?

CLINEBELL: I did not believe the financial crisis was going to lead to such a deep recession. The financial crisis was the initial blow to the economy but I did not expect the government to take so many actions that negatively impact growth in the private sector. I am also disappointed that the government is only now, almost two years after the initial crisis, starting to address the underlying problems with Fannie and Freddie.

John Green, Northern Colorado regional economist: Yes, I expected it to be this deep and to last a good while. I still don’t think we’re through it nationally, but we are through it in Northern Colorado. Surprises were private nonbank bailouts like GM, the depth of AIG assistance, and homebuyers credits. Government should have directly bailed out mortgages, individually and via a Federal Reserve credit line. I was expecting more unanimity in Congress to deal with this crisis. We badly need a change in the way our political system is financed.

PIEPHO: I truly did not believe the recession would be this long or this deep, as it relates to the mortgage industry.

PHILLIPS: In 2006-07, I was expecting inflation to be a problem in the years ahead. (FDIC Chairman Ben) Bernanke is more worried about deflation because we don’t have the ability to combat it in our fractional reserve system that allows the creation of an enormous amount of debt. Under deflation, the debt burden will be increased at a time when unemployment is rising. This outcome is the greatest fear of the Federal Reserve, the Wall Street elite, and the politicians.

How has your industry changed since 2008?

PIEPHO: The mortgage industry has become highly regulated, the cost to the consumer has increased, and the amount of paperwork that is still unclear to the consumer has increased, while foreclosures are still continuing because of the lack of jobs. Fraud continues to rise as people try to stay in homes they can’t afford because they don’t have jobs.

The industry was already self-regulating itself before legislation was passed. The plethora of legislation – and even the effect of how some legislation needed to change another regulation and it didn’t – has caused the mortgage industry to tread carefully.

PHILLIPS: We need to get back to the fundamentals of banking: a safe and stable payments system and a system where the originator of the loan should monitor and bear the full risk of that loan. As the late Lloyd Mints – one of the founders of the Chicago School of Economics, who lived in Fort Collins after his retirement – said on his 100th birthday: The problem is bankers making too many loans that shouldn’t be made.

The only way to solve the problem definitively is to abolish fractional reserve banking. I’ll never forget the shock when I first learned that $1 in bank reserves interjected by the Federal Reserve might result in a $10 increase in the money supply because $9 worth of debt is created. That is why I remain an advocate of narrow banking or what was called 100 percent reserve banking in the 1930s.

I seriously question whether the United States can continue with a financial system that is so far removed from a safe, stable, and efficient financial system.

Editor’s note: In October 2008, Business Report staff asked local experts to discuss what the economic turmoil at the time might mean to Northern Colorado and the nation. For this story, we asked them to revisit the topic from their current perspective.

Listen to the entire 2008 Roundtable at

http://ncbr.flex360.net/ncbr%20economic%20crisis%20roundtable.mp3

Download the entire 2008 Roundtable transcript at:

http://www.ncbr.com/podcasts/ncbr crisis roundtable complete.pdf

How is this the same or different from the Savings and Loan crisis of the 1980s or the Great Depression of the…

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