What the Hell is Going On?!

Local experts untangle the background of the crisis on Wall Street and discuss what might follow Congress’ "no" vote on bailout plan

Wall Street lay in near shambles Sept. 24 as President George W. Bush pleaded on national television for a resolution from Congress, saying a $700 billion bailout of the collapsing financial industry “should be enacted as soon as possible … our entire economy is in danger.” Following  a weekend of bitter debate, Democrats and Republicans expressed respective reservations with the plan drawn up by Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson, and the House voted the proposal down Sept. 29 in a 228-205 vote, with only 65 Republicans casting "aye" votes as opposed to 60 percent of Democrats who supported the proposal's passage. 

Regardless of the ultimate outcome and which presidential candidate will inherit this financial quagmire, red and blue agree on at least one point: The U.S. economy is in the midst of a crisis not experienced in decades, perhaps not since Franklin Delano Roosevelt occupied the Oval Office. Still, many question the use of taxpayer dollars to assist corporations that were “too big to fail” and the seeming abandonment of basic capitalist principles that maintain the market will correct itself without government intervention.

The phrase “capitalize the gains, socialize the losses” was repeated throughout blogs and bar-room discussions leading up to the vote and news reports on the crisis toss around terms like “sub-prime mortgages,” “toxic assets” and “secondary markets,” even though the average citizen, whose taxpayer dollars are likely at stake, may find it difficult to sift through the jargon, figure out exactly what’s happening and determine how we got to this point.

KV spoke Sept. 26 to local professors, professionals and politicians who make it their job to navigate this ever-changing economic climate to clarify the details of the meltdown and learn what led to the downward spiral.

THE EXPERTS

Dr. James Wansley, head of the finance department at the University of Tennessee and the department’s current Clayton Homes Chair of Excellence
Sherman Jones, vice president and chief operating officer of the Knoxville Area Urban League and former financial adviser for Edward Jones
Wendy Cherry, financial adviser for 18 years, currently with Edward Jones
Dr. Matthew Murray, professor of economics and associate director of UT’s Center for Business & Economic Research
Chris Lugo, Green Party candidate running for U.S. senate

THE GOOD OLD DAYS

Wansley: Twenty years ago, when banks made mortgage loans, they used them as assets. Today almost all banks don’t keep loans on their books, but rather create securities and sell them on the secondary market. The verb that’s created here is to securitize loans; banks package them as securities and sell them to second or third parties like Fannie Mae or Freddie Mac. These government-sponsored enterprises were created to facilitate the secondary market, so banks could sell mortgage loans then go make another mortgage loan to someone else. By itself it’s a healthy thing. Around 2005, the housing market started to thrive and more and more people started to participate in that. More and more people were buying a second home or a condominium because they thought it was a good investment and the financing was incredibly easy. The Federal Reserve had lowered financing rates lower than they probably should have, and people were turning around their houses to make a profit.

Jones: There was a time when you could only get a mortgage when you put 20 percent down. Sub-prime loans came into the equation and are called that because they are simply not prime — they run a higher risk. If you’re not a prime loan candidate you can only get sub-prime loans, and if it wasn’t for those, there are a lot of people who wouldn’t be able to get homes at all. So they aren’t necessarily bad. Then adjustable-rate mortgages, which used to only go to prime borrowers, came into play. In an effort by the government to expand the housing market, lenders began to offer ARMs to sub-prime candidates and they couldn’t afford them.

Murray: This is what would begin the sub-prime mortgage crisis: Loan originators felt safe in giving people loans who didn’t have strong credit because of housing market growth, and investment firms felt safe in buying these in bundles because of the strong market.

WHEN MORTGAGES HIT THE FAN