Down on Wall Street

A lot of the media are going on about the current credit crisis and how it is the fault of those greedy, hateful capitalists and Republicans who leech off the poor. This, I find is a very blinkered point of view. The source of the problem actually comes from a relatively obscure piece of American legislation called the Community Reinvestment Act. I know the following explanation is just a broad brushstroke precis, but the facts are true enough.

A little lesson in economic history and the law of unintended consequences is in order here. Essentially the CRA forced mortgage lenders to lend to people who would usually be considered a 'bad credit risk'. Originally passed into US law by the Democratic Carter Administration, it's provisions were massively extended by the Democratic Clinton Administration so that even more of these 'sub prime' mortgages were issued with the increased risk of default in case of economic crisis.

More Americans wanting to buy put pressure on housing stock and forced the price of a home up, thus increasing the need for more credit. This had a knock on effect to all the other markets, UK and European included. The lenders, forced to lower their lending criteria did what they thought was sensible to spread their exposure to bad debt by selling the debt on. Bankers and traders bought and sold the risks rather like anything else they do to make money. In reality what they were doing was trading what was little better than 'junk bonds'. Thus the bubble grew and the exposure to those on the margin of creditworthiness expanded. All it required was a small economic downturn for the whole jerry built monstrosity to go completely tits up.

In the meantime, Congress blocked all attempts by the Republican Bush Administration, who seemed to think all this bad debt was a truly awful idea, to water down the CRA. While Congress blocked all moves to slow the increase of potential bad debt because it would be 'unfair' Bankers kept on selling the risks on in s kind of ever increasing money-go-round to spread the load, rather like a game of 'pass the parcel' where the 'gift' inside isn't all that pleasant to get lumbered with. For some this was not all bad. Those with a little foresight and understanding of what was really going on understood what was coming, made their money and got out of the business of selling credit risk into precious metals. Others didn't. They got well and truly clobbered.

Gasoline prices pushed up by speculators and driven by media panics grew. The costs of transport grew, pushing everyday prices up. Meanwhile the property market saturated, over saturated, then burst when the underlying inflationary spiral of costs not included in the inflation figures got ahead of many people's economic capacity. Companies shed workforce in order to survive. People who were no longer able to pay off their debt began to default on the loans. Bankruptcies grew with ever more foreclosures until the market in selling the mortgage risks collapsed, sucking the rest of the stock market down into a kind of financial space time anomaly.

Banks with a heavy speculative exposure to these risks such as Lehmans in the USA, and Northern Rock and HBOS in the UK, were bound to be hit badly. Anyone with even a little understanding of the market could predict that. Fortunately, the Canadian market does not seem to have quite such a problem with exposure to such bad risks, although property values here on Vancouver Island are going to take a serious hit as many Americans are forced to sell their holiday homes. I'm thinking 15-25% price drops overall.

Looking on the bright side of the whole mess, this crisis means Wife and I can probably buy a decent lot for our dream house at a reasonable price. Wife has a new job. I have a new job. Who says it's all doom and gloom?