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Let's point fingers at subprime's real villain

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Denial, anger, bargaining, depression and acceptance. Those are touted as the five stages of grief. But somewhere between denial and anger there is an important but rarely mentioned sixth stage: finger-pointing.

And that's the stage where we are right now in the Great American Mortgage Crisis.

Some people are still engaging in limited forms of denial - insisting, for instance, that the economy won't dip close to recession, even though dipping close to recession may turn out to be a best-case scenario.



But most economists and market analysts are now pointing their fingers wildly in the air - sometimes in several directions at once, like the scarecrow in "The Wizard of Oz" - as they try to assess blame for what may turn out to be an extremely dire economic downturn.

David Shulman, an economist at the Anderson Forecast at the University of California Los Angeles, predicted that all this finger-pointing will result in "a made-for-TV extravaganza," with a series of trials for mortgage fraud, securities fraud and other crimes.

"In terms of the theater of it all, there will be clear heroes, clear villains and before it is over, there will be ritual sacrifices," he said. "Think of the 'perp walks' that came out of the corporate scandals (such as Enron and Tyco). The entire process will be examined, from the mortgage broker to the lender to the Wall Street securitizer and on to the ratings agencies. ... It won't be pretty, and before it is over more than a few participants will be called 'merchants of debt.'"

The merchants of debt were especially active where notices of foreclosure and default are now at an all-time high and home sales are at a 15-year low, such as some areas of Southern California. And it's likely that we are only at the beginning of the downturn. Adjustable-rate mortgages that were taken out when the market was at its peak in late 2005 are only now beginning to spike upward. Over the next 12 to 18 months, many mortgage bills will balloon by hundreds of dollars a month or more, making payments impossible for many homeowners.

Although there are many culprits to blame for this mess, topping the list is the Federal Reserve. Not Ben Bernanke's Fed, which has been stuck with cleaning it up. But the Fed of Alan Greenspan. Guru of the GDP. Maestro of the marketplace. Inscrutable sage of the interest rate. Saint Alan, as some still call him on Wall Street.

After the dot-com stock market bubble burst in 2000, Saint Alan steadily lowered the federal funds rate, flooding the global market with cheap and easy money. "It was our job to unfreeze the American banking system if we wanted the economy to function," he told CBS reporter Leslie Stahl recently. "This required that we keep rates modestly low."

Modestly low? That's like saying the electric chair is modestly dangerous. The federal funds was just 1 percent from mid-2003 to mid-2004, its lowest point since 1958. Considering that the official inflation rate was around 2.25 percent during that period, the Fed was essentially paying people to take money off its hands.

And there were plenty of takers.

Wall Street firms and international financiers that had been burned by the dot-com boom scooped up that cash and started buying bundles of mortgages, because nobody ever loses any money on real estate, right? To meet the demand for mortgages, lenders packaged a wide array of creative but risky loans: no principal, no down payment, no documentation, negative amortization, adjustable rates, subprime.

Speculators swooped in, using those loans to buy homes that they were never going to live in but would quickly flip because prices would just go up and up. Covetous homeowners refinanced their properties so they could buy the latest Humvee or flat-screen television. And a lot of working-class Janes and Joes got swept in too, overestimating the amount of money their house would appreciate and underestimating their monthly payments once their adjustable rates jacked up.
Greenspan confessed to Stahl that he "didn't really get" how serious a threat subprime lending could be to the economy until very late 2005 or early 2006. Just as he was about to leave office. After the subprime market peaked. After most of the damage had been done.

That's funny, because as early as 2003, a number of economists were warning of a housing bubble, prompting Greenspan to assure Congress that "the notion of a bubble bursting and the whole price level coming down seems to me, as far as a nationwide phenomenon, really quite unlikely."

Unfortunately for his successor, Ben Bernanke, the Fed is now faced with just such a nationwide phenomenon.

Bernanke was tagged as "Helicopter Ben" when he came into the Fed, for his one-time assertion that during certain times of crisis money could be plopped into the economy like a helicopter drop.

In August, after 18 months of calm, assured money management, Bernanke lived up to his nickname. Spooked by some wild gyrations on Wall Street, he helicoptered money in, lowering the federal discount rate - affecting direct loans to banks - and pumping billions of dollars of liquidity into the financial sector. While that has temporarily stabilized the stock market, there's no evidence it did anything for the broader economy.

Bernanke soon got another chance to test out his helicopter rotors when he recently cut the discount rate to 4.75 percent. By December, the thinking goes, the rate will fall to 4.5 percent or lower, which will help stabilize the housing market, spur economic growth and save Greenspan's reputation. Or will it?

John Browne, a former British parliamentarian who now writes the online Financial Intelligence Report from Florida, says the U.S. mortgage market is still full of "toxic waste" - loans that should never have been made and may never be repaid. A slash of the interest rates will do little to encourage investors to buy that debt. Instead, it could raise the specter of inflation and further lower the value of the dollar, which is already at 15-year lows against the euro.

"A Fed funds cut will not bring back the U.S. housing market," Wells Fargo economist Eugenio Aleman bluntly said. "What if the housing market remains depressed? Then the markets will ask for another rate cut and another and another and another - and then what?"

The cheap cash that Greenspan and others injected into the world economy after the Asian economic crisis of 1997 helped fuel the stock market bubble of 1999. The cheap cash that Greenspan floated in 2000 helped fuel the real estate bubble. What new bubble will be created if too much cash enters the economy?

"The subprime mess was a bad investment decision from the very beginning and was brought about by having very low interest rates for a very long period of time," Aleman said. "And the only way to go forward is to flush it out, take the loss and move forward, not bring it back."

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