11 January 2008

The Countrywide Affair: Ignorance, Irresponsibility and Fraud

A serious blow has recently cracked the foundation of our economy. The blow came from delinquent sub-prime mortgage loans and the crack appeared in the financial sector at Countrywide, a cornerstone of home lending in the United States. As reported in the Financial Times on Thursday, August 16, 2007, Countrywide had to borrow nearly $12 billion to stay afloat because many of its loans are no good. And its troubles continue:

Countrywide Loses Most Since 1987 Wednesday, January 09, 2008, FreeMarketNews.com - "Countrywide Financial Corp. dropped the most since Black Monday in October 1987 in New York trading on speculation that it needs cash to continue operating its mortgage business. Investors drove Countrywide shares down 79 percent last year on concern the company was suffering from a cash shortage. The company tapped emergency credit lines and got a bailout from Bank of America as the worst housing slump in 16 years fueled bets that Countrywide might seek bankruptcy court protection."

The mortgage market is obviously built upon loans made to people for houses. Based on this basic financial instrument, the complicated mortgage derivatives (leverage) market arose, supposedly to eliminate the various risks associated with such long-term lending. It is in that segment where the financial crisis first appeared. The whole system, of course, is predicated upon the ability of people to make their monthly payments. If the borrower is unable to do this simple yet important task, then the whole system crashes. Currently borrowers are finding it impossible to fulfill their basic but vital role, so we are seeing the ripple effects of mortgage defaults as they work their way through the financial system. The players in the derivatives market - and it is an absolutely huge market - are discovering the hard way there really is no way to eliminate risk, and that one can't ignore time-proven economic fundamentals no matter how clever or complex the financial instruments.

All of this has happened because responsible smart people put their trust and/or money in the hands of fraudulent people (the government and the Fed), irresponsible people (bad credit risks) and ignorant people (naive speculators, and economic simpletons who bought more house than they could afford). As a country, we are about to pay the price for allowing such fraudulent government-inspired lending at artificially low interest rates - rates kept low by government on the pretense of helping the irresponsible and the ignorant. The reality is that government and banks conspired to give risky borrowers loans in order to keep the artificially inflated markets in stocks and housing from imploding. Government's ultimate goal, of course, is to continue to expand both debt and the fiat/paper financial system which support the out-of-control spending that politicians use to garner support and gain power.

The key economic effect of such artificially low interest rates is that they mis-direct investment from secure, productive indeavors into risky, speculative ventures. And the inevitable effects of making such loans to irresponsible and ignorant people are disastrous for everyone and are already being felt. Mortgage defaults are rising quickly to historic highs; home builders are going broke and are firing their workers; well-known Wall Street firms, scores of banks, and financial houses are reporting losses so massive that they may go bankrupt. Take this recent example:

Citigroup, Merrill Lynch Seek Capital Thursday, January 10, 2008, Market Watch - "Wall Street giants Citigroup Inc. and Merrill Lynch & Co. are both negotiating further capital injections from overseas investors as they continue to suffer from the credit market crisis, according to a published report Thursday. Citigroup could get as much as $10 billion from foreign governments and Merrill Lynch is expected to receive $3 billion to $4 billion, with much of the cash coming from a Middle Eastern government investment fund, The Wall Street Journal reported."

And then there is the pathetic - though typical - response by government. With less economic activity, there will be fewer tax dollars coming in. To alleviate that shortfall in revenue, government will then proceed to hurt the responsible by stealing their wealth and savings through both higher direct taxes and the inflation tax (the Fed printing money). This de facto theft from the productive private sector will only add to everyone's financial hardships because government is by its nature is almost totally non-productive. Indeed, tt is a classic example of what economists call a "deadweight cost", that is, it is a drain on the economy that produces no benefits. Thus, any action government takes will serve only to shrink the economic pie and reduce our standard of living.

The only solution to this situation is to let the market cleanse the system by having those responsible - be they individuals, the banks or Wall Street - take the full consequences of their ignorant and irresponsible actions. After all, the essence of this financial fiasco is that they were all simply gambling with the money of others in order to profit in some way. Any government intervention in an attempt to shield companies and individuals from their actions and the resulting consequences will not only further exacerbate the situation, but will punish those who did act responsibly with higher taxes and a devalued dollar. The current government induced crisis in the home lending industry is a prime example of William Penn's saying, "If you protect a man from folly, you will soon have a nation of fools".

(other articles are archived on my Writings page.)

Rebecca Iocca

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