Wednesday, March 3, 2010

Architects of Ruin, by Peter Schweizer

Architects of Ruin: How big government liberals wrecked the global economy---and how they will do it again if no one stops themThere are a couple of narratives "out there" about how we ended up with the subprime meltdown and the massive government bailouts a couple of years ago. One of them blames the lack of government regulation of the banking industry for encouraging predatory lending practices, and the other blames the government for encouraging banks to make loans to people who traditionally didn't qualify for them, and encouraging big financial players to take on huge risks, with the expectation that the government would bail them out if the worst happened. This book is a tale of the second of those.
Schweizer traces the roots of the subprime mess back to the Community Reinvestment Act, which was designed to stop the passive racism of banks denying loans in geographic areas that were heavily black or hispanic. It was thought that home ownership would be the key to raising minorities out of poverty. People in poverty stricken areas typically do not have good credit ratings, substantial down payments, or (obviously) a history of steady income. These are things which banks have traditionally looked at when underwriting home loans.
A rather large coalition of activists pushed the government and banks to relax their lending standards in order to get more minorities loans to own their own homes. They demanded that things like paying rent and utility bills should be considered as if they were a part of credit history, and that down payment requirements be reduced from 20% to 5% and even, eventually 0%, with flexible methods of covering closing costs, and that verifying income be downplayed, resulting in the "stated income" rule. As a result of these changes, home ownership among minorities did indeed increase, but the relaxation of traditional lending standards introduced an element of risk that had not previously been there, and so there were billions of dollars in loans that were extremely likely to fail.
In addition to this, over the last couple of decades, firms like Goldman Sachs and Bear Stearns had made risky investments in places like Asia, Russia after the fall of communism, and Mexico. When the governments in those places came to the point of defaulting on their bonds, and these firms and others like them should have taken the loss, they were determined to be "too big to fail" by their political allies in Congress and the White House, and taxpayer money was used to bail out those investments, so that the financial companies reaped all of the profits, but the American people covered the losses.
The law of unintended consequences and the snowball effect created the huge housing boom, and the speculative runup of home prices with cheap borrowed money. When the bubble collapsed, it delivered a massive hit to the US economy, and we're in the midst of a recession today because of it.
There's a ton of interesting information and history in this book, and I highly recommend it to anyone able to stomach the double-dealing and corruption that plague our government these days.

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