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Roots of the Banking Crisis

Dr. Michael Beitler
Campaign for Liberty
February 13, 2009

Whenever you try to solve a problem you should look at what caused the problem in the first place. In early 2009, the banking system is wrestling with hundreds of billions (if not trillions) of dollars of bad assets, known as subprime loans, marginal loans, or other vague descriptors.

Based on my years of experience as a Chief Financial Officer (CFO) in banking, I can say with confidence, "Bankers are more intelligent and business savvy than government bureaucrats."

That statement is invariably followed by the question: "So, why did intelligent bankers make so many bad loans?" The answer is government intervention and coercion.

Banking has been heavily regulated, controlled, and manipulated for political purposes for many years. Creeping socialism has existed in the banking industry for decades. Occasionally, the "creeping" aspect has been replaced by giant leaps toward a socialist state. The Community Reinvestment Act (CRA) was more a "leap" than "creep."

The CRA, and a host of related government lending regulations, coerced (forced) banks to make marginal or bad loans to people with low-income, unstable income, and/or poor credit histories. By supporting these laws and regulations politicians pleased special-interest groups. Politicians were repaid for their efforts with large voting blocks.

I remember a meeting with the senior executive team of our bank in which federal examiners told us that we had to make a large number of "marginal loans." In this meeting the Chief Executive Officer (CEO), Chief Operating Officer (COO), and I (the Chief Financial Officer) sat in stunned silence as the federal examiners told us what we must do.

With a stack of loan files (loans we had planned to reject) in front of them, the federal examiners told us these "marginal" loans must be made to improve our CRA rating. While CRA did not mandate civil or punitive damages, CRA required a four-tier rating system with performance levels: outstanding, satisfactory, needs-to-improve, or substantial noncompliance. These ratings were made public. The bottom two ratings meant public outrage. Satisfactory was not "satisfactory" because some of our competitors were already advertising their outstanding rating.

Like hundreds of other banks around the country, we were forced to comply with the government's attempts at social re-engineering. Banks across America originated these loans and then sold them in the secondary market.

Many of these subprime loans were pooled (securitized) into bonds. Bonds backed by mortgage loans (mortgage-backed securities) became very popular investment vehicles. To help "improve liquidity in the secondary market" FHLMC (Freddie Mac) and FNMA (Fannie Mae), two government-sponsored organizations, stepped in to guarantee the securities (mortgage-backed bonds) with implied AAA ratings of the federal government. This meant we now had AAA-rated bonds backed by subprime loans flooding the marketplace.

From the beginning, people like me warned that a disaster was inevitable. We were ignored.

In March 1995, William Niskanen, Chairman of the Cato Institute, testified before Congress. Niskanen criticized the politicized favoritism in allocating credit and the micromanaging by regulators, and warned against bankers operating at losses in the future. He was ignored.

In 2007, blind to the growing problem, Ben Bernanke suggested increasing Fannie Mae's and Freddie Mac's roles in the "affordable housing market" to help banks fulfill their CRA requirements. This meant guaranteeing even more CRA-backed bonds at a time when the system was near collapse.

On April 15, 2008 an FDIC (Federal Deposit Insurance Corporation) official said the FDIC was exploring how to get bankers to offer "pay-day" type loans for favorable consideration in their CRA ratings, blissfully unaware that the banking system was about to collapse.

Who is to blame for the financial meltdown? The government is to blame. The weeds planted by the government decades ago are now choking our financial system.

To fix the banking system we must restore sound business practices. This means we must reject loan applications from people who cannot afford to buy a home. It is perfectly honorable to be a renter.

It is time to return the banking system to the free market. We need bankers running banks, not bureaucrats and politicians.

As I have said on my internet-radio show, the Federal Reserve, the FDIC and other bank regulators, and the politicians created the financial disaster. To believe the government, Barack Obama (who has no financial training at all), Fed Chairman Ben Bernanke (who appears totally confused), Treasury Secretary Tim Geithner (who had a miserable track record at the New York Fed), clueless career bureaucrats, and the current crew of politicians in Washington can fix the financial crisis is completely irrational.

Go back to the root of these problems and you will see government intervention, coercion, and ineptitude.

Michael Beitler (pronounced Bite-ler), Ph.D., CPA, is the host of "Free Markets With Dr. Mike Beitler," a libertarian internet-radio talk show, and the author of Rational Individualism: A Moral Argument for Limited Government & Capitalism. Mike was the CFO of a profitable bank for more than ten years.

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