Tuesday, January 4, 2011

The American Dream

The term, "The American Dream," was first coined by a Wall Street Investment Banker, James Truslow Adams, in 1931 in a book he wrote titled The Epic of America. Before his book, nobody had heard the term. The idea was that everyone should have the opportunity for a better life according to their ability, a conservative idea, and it included the grand concept of homeownership for everyone, a liberal idea. Oddly, Adams is not known as an Investment Banker, but as an author and historian. Most of his ideas were liberal. Education topped his list of critical necessities. He seemed to think that the American Dream had everything to do with education, and lacking an education destroyed the dream. He said:

"There are obviously two educations. One should teach us how to make a living and the other how to live. Surely these should never be confused in the mind of any man who has the slightest inkling of what culture is. For most of us it is essential that we should make a living...In the complications of modern life and with our increased accumulation of knowledge, it doubtless helps greatly to compress some years of experience into far fewer years by studying for a particular trade or profession in an institution; but that fact should not blind us to another—namely, that in so doing we are learning a trade or a profession, but are not getting a liberal education as human beings."

In other words, while we're learning a trade for making a living, we cannot forgo the liberal education that teaches us about our history, our government, our Constitution, our laws, our society and our culture so we can live in our society. He sure knew what he was talking about. I've never heard so many misquotes and concocted ideas on our history, government, the Constitution and our laws and society than I have lately. And, since I too missed that liberal education, either because it wasn't provided or because I didn't pay attention, I find that, if I want to know the truth, I have to verify nearly everything I hear from the right by studying books, essays and newspapers that I should have read years ago. Usually what I hear from the conservative right nowadays turns out to be hogwash. It seems to me that we didn't listen to Adams. We skipped the liberal education part sometime over the past 50 or 60 years. I have in mind those emails I get every once in a while quoting Thomas Jefferson or John Adams or other influential person in our history, usually misquoted or taken out of context, that supports some concocted right-wing idea, and, of course, the occasional brainless comments by John Boehner, Mitch McConnell, Glenn Beck, Sarah Palin, Rush Limbaugh, et. al.

Mom and Dad bought their first house, on the corner of Brummitt and First Streets in Owensville, Indiana, in 1948. Dad was thirty-nine years old and Mom was thirty-six. I was four years old and Jeannie, my younger sister, was not yet one year old. Durward, my older brother, was fifteen years old. Joan (Jo-Ann), my older sister, was eighteen and married with their first child, Diane, who was about one month younger than Jeannie. We moved from the last house at the end of South Main Street, across the tracks, to a "this side of the tracks" house. We didn't get any richer, though. I'm not sure where we fell in regards to the poverty line. Perhaps we were only a hair above the poverty line, barely making the middle-class. It's always nice to be a notch higher than the worst, at least. Dad, who worked at Servel, a P-47 Fighter aircraft manufacturing plant during the war, had been laid off and had gotten a new job at the Hardware Store owned by Byron Marvel. He bought the house from Byron with a loan he got from the First National Bank of Owensville. The bank held the mortgage document. Dad could have, if he wanted, walked three blocks to see that document. Things were looking up, considering what Mom and Dad had gone through for the previous twenty years; the Great Depression from about 1930 to 1940, then World War II for five years and then two or three years of getting back to normal. Dad used to say that during the Depression, "we didn't have a pot to pee in." By 1948, we at least had a pot. By 1948, we were living the American Dream.

I guess, however, that Dad's American Dream and John Boehner's are different. According to Boehner, and the Republican Talking Points making the rounds nowadays, Dad was lazy. In fact, according to Boehner's standards, there were a lot of lazy people in Owensville in those days. He says that those who take unemployment are lazy and those on welfare are lazy. Of course, there was no unemployment compensation or welfare payments in those days. But, there was a lot people who needed them during the 1930s. Dad and Mom were not alone in their struggle during those years. However, it seems that according to Boehner, if a person doesn't somehow become the Speaker of the House or a company CEO, they are lazy. I find that insulting. I would never have believed that Dad was lazy, as I would never believe that all of those people I knew in Owensville were lazy. I don't recall a single person in Owensville that was lazy, although I do recall one or two who were affected by disease, such as alcoholism, that kept them poorer than others. Many in Owensville lacked an education that would have given them a better living wage, but they weren't lazy and I wouldn't say that they lacked ambition. And, besides, a high school education was a good education in those days and Dad and Mom had that.

What really made it possible for Dad to buy the house were laws passed in the 1930s to fix the credit problem and to get money circulating again, to keep banks open and lending and to keep businesses solvent. Does that sound familiar? The Wall Street Barons had all of the money, like they do today, and people like Dad had none and as long as Dad had no money, he couldn't spend any. To fix it, President Roosevelt raised taxes on the rich to as high as 90% and Dad's taxes were minuscule. Roosevelt's idea regarding the wealthiest was that they couldn't make a fortune in a vacuum. They had to have a free country and free citizens who bought their products to make all of that money, and in that case, they owed something to their country for the privilege of becoming wealthy. That's a strange idea today. Another thing Roosevelt did was create the Social Security System to support the elderly. He couldn't let them starve and he needed a way to open up jobs for younger people, so his New Deal system provided a way to retire the elderly with a pension. And, then there was homeownership. Roosevelt needed a way to guarantee more homeownership, a better way than simply leaving it up to the market. It was a new idea, never tried before. But, there were a whole host of problems.

The problem was that when a Savings and Loan (S&L) or a bank loaned out the money for a mortgage or farming or any other reason, it had to wait a long period of time for the loans to be paid back before the money was available again for another loan. A bank in a small town like Owensville, like many banks and S&Ls across the country, could run out of cash periodically. This was especially true when the cash accumulated on Wall Street and didn't circulate back to the local communities. Back then, large companies were taking money out of communities. That, too, should sound familiar. I don't recall if Dad ever said that there was a run on the Owensville bank, but I'll bet it didn't have a lot of cash on hand in the '30s. Roosevelt changed all of that - The New Deal.

From the 1930s onward, a number of laws came out that protected the ordinary guy like Dad from Wall Street. The Glass-Steagall Act (1933) set up the Federal Depository Insurance Corporation (FDIC) that insured all bank deposits, up to a point, so that bank customers wouldn't have to resort to bank runs to get their money back. It also restricted commercial banks from investment risks, so Dad's money in the bank wasn't being used for Stock Market gambling. Blue Sky laws made it impossible for Wall Street to sell risky debt investments to state fund and pension fund managers, investments such as Collateralized Debt Obligations (CDOs) and Credit Default Swaps (CDSs); although neither of these investment instruments were around then, Wall Street had other tricks then. They always have tricks. Usury laws, some of which had been around forever, were tightened to lower the limits to how much interest could be charged people like Dad. Included in all of the laws passed to help the lower and middle-class income people like Dad was the National Housing Act, 1934.

The National Housing Act created the Federal Housing Administration (FHA), the Federal Savings and Loan Insurance Corporation, to keep the S&Ls afloat, and, in a 1937 change to the act, the Federal National Mortgage Association (Fannie Mae). Fannie Mae was supposed to keep the money circulating regarding mortgages. If the loan was a conforming loan, an FHA insured loan, and after WWII, a VA insured loan, Fannie Mae would buy the mortgage, package it in a bond, called "Securitizing" it, then sell the bonds to investors. The local bank could then continue to make loans from the money received from Fannie Mae and Fannie Mae would get its money from investors and a big circle would be formed to go on and on. A conforming loan was a generally a 30-year loan given to a person who could afford to pay it off, which usually meant that the monthly payment, interest, insurance and property tax did not exceed 33% of take home pay, good credit considered. All of this made it possible for Dad and Mom to buy their home at 311 Brummitt Street, a long way from Wall Street. Dad expected that his children would be able to do the same in their time. Joan and Durward probably did, as any of us would have been able to do if we bought homes before the 1980s. Anyone of us who bought homes after that were taking our chances in the open market. As time passed, the more open and hostile to us ordinary consumers the market became.

The chinks started appearing in the armor in 1968 when Congress chartered Fannie Mae into a Government-Sponsored Enterprise, a GSE, which essentially made it into a privately owned corporation that competed with Wall Street in the secondary mortgage market, that "Securitizing" of mortgages. It later became a publicly traded company. Boy, did that ever make Wall Street jealous. The big banks, J.P. Morgan, Goldman Sachs, First Boston, Salomon Brothers wanted in on the mortgage market. That's where the money was and the Baby Boomers were coming. The Boomers would need a lot of homes, but Fannie Mae had the market cornered.

In the late '70s, Lewis Ranieri, a mathematical genius physicist and Solomon Brother mortgage bond trader, Larry Fink at First Boston who would later found BlackRock, and David Maxwell, the CEO at Fannie Mae got their heads together to get Wall Street more involved. Ranieri put the risk-model-physics equation together and Fink invented the "Tranch," and the two together essentially invented Wall Street securitization of mortgages. Maxwell wanted Wall Street involved so he could sell more mortgage-packaged bonds. From that point on, the actual holder or owner of a mortgage that was packaged in a "Tranched" bond couldn't be identified. A tranch is separating various mortgages into different investment instruments, like splitting a typical 30-year mortgage into a 5-year investment, a 15-year investment and a 30-year investment, so different investors would have different products to meet their needs. The "Derivative" instrument is invented.

So, with the Wall Street door open a little more, Fannie Mae started passing more conforming mortgages to Wall Street, Solomon Brothers and First Boston for packaging. But, Wall Street (Ranieri and Fink) were still not happy. Fannie Mae still had a hold on the market. Investors wouldn't invest in mortgages unless they came with some form of guarantee, either a high credit rating from Moody's, Standard & Poor's or from Fannie Mae with its government-backed (taxpayer) guarantee, even though the government guarantee wasn't written in law or anywhere else. And too there were those pesky Blue Sky laws that restricted the large pension funds from investing in any mortgage bond that wasn't guaranteed by Fannie Mae. Wall Street's hands were still tied.

So, lobbyist from Ranieri, Fink and Maxwell ganged up on Congress after President Reagan took office to change the law. Two guys in the Reagan Administration helped, David Stockman, Reagan's Budget Director, and his deputy, Larry Kudlow (now a CNBC pundit). Ironically, Stockman now says the GOP destroyed the U.S. economy. I guess he forgot his involvement. The selling points were "The American Dream" and "homeownership." Nobody in Congress wanted to go against that. They had voters to worry about and their next election. And, so President Reagan and the Congress removed the Blue Sky laws that forced Wall Street to "warn" investors of the risk and that prevented big pension funds from investing in junk bonds and they did one other thing. Congress "officially" made the credit rating companies, Moody's and Standard & Poor's, and later Fitch, the United States Government's "Official" government rating agencies. Whew! Anything these guys said was gospel, or so said Reagan and the Congress. There would be a "homeownership disaster" if the changes in law were not passed, they said, so they were passed. Wall Street had a party!

Another law that helped Federally Chartered finance companies, banks, is the Depository Institutions Deregulation and Monetary Control Act in 1980. It exempted finance companies from State Usury laws, so they could charge as much interest on a loan as it could get away with. Except for "loan sharking" criminal laws, the United States has no federal usury law except for that exemption. But, that didn't save the S&Ls, and as they fell apart in the '80s, a new mortgage brokerage company materialized to replace them, a company that didn't need cash on hand to make a mortgage loan. These companies borrowed money cheaply to make the mortgage and resold it quickly to Fannie Mae or an Investment Bank, like Solomon Brothers, so that they could repackage the mortgage into a security for sale to an investor, after, of course, getting Moody's or Standard and Poor's to give it a triple-A rating. Whoala! CountryWide came into being, along with a thousand other loan brokerage companies more than willing to sell a mortgage to an unsuspecting sucker, or a second mortgage or refinance a house to pay off bills, whether needed or not, all without one iota of thought about the American Dream or homeownership. Only one..., well two things mattered; money and power. Money, money, money and power. Slowly, these new companies became more eager to sell a home to people who couldn't afford them, the "sub-prime" market, people who had no credit history, didn't pay their bills and had a hard time making it from payday to payday. New loans were invented, the Adjustable Rate Mortgage (ARM), Balloon Payment, Pre-pay Penalty Loans, and then finally the Interest Only-Balloon Payment Loan. Gotcha dude! The "sub-prime" had hit the streets, those loans to people laying below the credit limits, those who really couldn't afford a house payment. After all, it was the American Dream that mattered, wasn't it?

But, after all of that, Wall Street Banks still had a few problems. First was the risk on these things, these new "derivatives." They didn't like taking the huge risk and neither did investors. In the early '90s, J. P. Morgan came up with a solution. Along with a complicated physics equation, it invented the Swap, the Credit Default Swap. This instrument let J. P. Morgan "swap" the risk of a CDO to some other company or investor. The other company, such as AIG, was paid a fee to take on the risk, an insurance policy of sorts. If all went well, and the homeowner paid his bill, AIG stood to make money. If the homeowner defaulted, AIG would lose and have to pay J. P. Morgan the money that J. P. Morgan lost. No risk investing! Wow! AIG didn't have a clue. J. P. Morgan then made thousands of swaps on the same investment, sort of like "looking at yourself in two mirrors where you can see yourself through one mirror in the other mirror" (from the referenced book below), it goes on forever. J. P. Morgan couldn't lose, unless of course AIG couldn't pay. Then everyone lost. And, they did.

The other problems banks had was the Glass-Steagall Act, even though by the '90s they were getting around it. It prevented the commercial bank, the bank that Dad used, from investing in the new derivatives, the CDOs and CDSs. Alan Greenspan, Federal Reserve Head, magically reinterpreted the Act, however, and let them do certain things the Act actually denied them. Greenspan is a free-market guy. And, too, the banks got their London or Japan office to do the investing so they could circumvent the law. If they didn't, they said, they would miss making all of the mortgage money, because those sub-prime mortgages were getting hot. Who could have imagined that a house could actually go down in value. Didn't they always go up?

In 1998 Senator Phil Gramm, a Texas Republican, co-sponsored a bill to repeal most of the Glass-Steagall Act so that all banks could gamble in the stock market, and specifically in the mortgage derivatives. Clinton signed the bill in 1999. The last wall had fallen. The hogs were loose.

From 2000, we then had eight more years of the same people who did all of the things that caused the Great Recession of 2008-09, and still going. After a short reprieve of a Democratic controlled Congress, they are back again, taking over the House of Representatives today, January 4th, 2011. We really have to get smarter before next year's election. I don't see that happening, however.

Reference: "All the Devils are Here" by Bethany McLean and Joe Nocera. Great book! But, it will make you sick. All the Devils are back.

Dad didn't have a degree in Physics or Risk Management or Finance or Business Administration like I suppose those guys above do. They have degrees in how to make a living. Dad's degree was in how to live. Frankly, I think Dad was smarter. I have to agree with Mr. Adams, except I would add: A person shouldn't be allowed to have a degree in how to make a living, unless they first get a degree in how to live. I don't see that happening, either.



Jazzie Casas said...

Last year was kinda a bizarre year for the mortgage market. In the first half of the year, you had a decent number of home sales keeping mortgages for purchases stable, thanks to the home buyer credit. In the second half of the year, that changed as demand crumbled when the credit was withdrawn. At the same time, you had very low mortgage interest rates throughout much of the year cause a mini-refinancing boom. 2011 will look very different, as the housing demand continues to struggle and mortgage interest rates have begun rising.

home buyer

Angela said...

what a great and succinct overview of the differences in washington based action between the two depressions and history of the changes to banking laws that made the debacle possible.

i actually would like to know if it would be possible for me to re-post this on two of my blogs :-)

thank you!

Dave Clark said...

Yes, you can use the post, Angela. Thanks for your comment.


Angela said...

thank you so much! :-)