EVENTS

Date:	Wednesday, January 28, 2009
Time:	3:30 PM -- 5:30 PM
Location:	Wohlstetter Conference Center, Twelfth Floor, AEI 1150 Seventeenth Street, N.W., Washington, D.C. 20036

WASHINGTON, JANUARY 30, 2009--The Washington Post proclaimed that "the future of the nation's financial system is in view" and that the nation must get used to big-name institutions failing and prepare for the financial sector to go through a "wrenching change." A late 2008 editorial? No, 1991--a fitting reminder that the first step in understanding today's financial and economic crisis is to look to the past. Speakers at a January 28 AEI conference examined just how we found ourselves on a precipice of financial doom.

Barry Ritholtz, author of The Big Picture, observed that "for the past fourteen million years, [lending] was based on borrowers' ability to service the debt." In sharp contrast, he argued, stands the period from 2002 to 2007, during which time lending suddenly became "based on a lender's ability to take debt and sell it off to someone to securitize it." At the same time, Josh Rosner of Graham Fisher & Co. added, the mortgage industry reduced down payment requirements from 20 percent to zero, weakened underwriting standards, and perverted the appraisal process.

These lending practices quickly inflated the housing bubble and greatly expanded the number of borrowers who could get a home loan. Former Freddie Mac executive Tim Bitsberger classified bubble homeowners into three categories: those who should have never gotten a mortgage, those who could afford a mortgage but were talked into bad loans, and those who could afford the mortgage that they agreed to. He recommended that the government allow the people in the first category to fail and that all rescue efforts be focused on mortgages in the second category.

Ritholtz affirmed this stance, noting that in the 1990s and early 2000s, 3-4 million homes were sold each year, but that from 2002 to 2007, this number soared to more than 7.5 million homes per year. During this period, a glut of 6-9 million homes built up, which Ritholtz estimated were purchased primarily by people from Bitsberger's weakest echelon of borrowers. He forecast that there will be 2-3 million additional foreclosures in the coming years, on top of the 2-3 million that have already occurred. "Foreclosures are painful but necessary," Ritholtz said. "I cringe whenever I hear someone from Congress say that they want to rescue homeowners."

Other panelists advocated a painful recovery process for the banking sector. Chris Whalen of Institutional Risk Analytics said that the top four banks are responsible for two-thirds to three-quarters of the one trillion dollars of banking losses. "Community bankers are not happy," he explained. "We've been giving the big New York banks passes for years."

Walker Todd, a research fellow at the American Institute for Economic Research, elaborated: "[The] regulators have allowed banks to bring us to the brink of systemic risk four times in the past thirty years. Now they want another chance. . . . No one should be too big to fail. . . . [It will be] less costly in the long run and we'll have a healthier banking system if we can bring ourselves to do it. . . . If you allow these guys to come back again, without putting them out of their misery, we'll be back here again in ten years." He identified several options for separating the bad banks from the good: creating a Resolution Trust Corporation, nationalizing the banks, declaring a bank holiday, or developing a Home Owners' Loan Corporation.

Both Rosner and Ritholtz worried about the government bailing out the banks with taxpayer money and making them investors in failed institutions. Rosner suggested that the government buy senior preferred stock to improve this situation, and Ritholtz advocated nationalizing the banks so that taxpayers will be guaranteed to get at least some return on their investment.

Ritholtz and Whalen clashed over whether modifications to the fair-value accounting standard would be necessary to moderate the effects of future economic upswings and downturns. Whalen called the accounting rule the "last remnant of bubble-think" and criticized it for "accelerating the problem" of the housing bust. He encouraged companies to publish a variety of financial metrics, including the historic cost of assets and the inter-period movement of prices, to generate a complete picture of their financial situation (as proposed by AEI's Alex J. Pollock in The American Spectator on December 22, 2008). Ritholtz disagreed with Whalen's perspective, noting that "banks didn't mind marking-to-market every day when the markets were going up." He said that the accounting standard couldn't be blamed for the fact that "someone made the decision to buy hard-to-value, difficult-to-exit paper. . . . They need to pay for that."

In discussing possible future legislation and ballooning Treasury debt, Bitsberger suggested that all government intervention be judged on its ability to smooth out the progression to long-term market equilibrium. Additionally, successful legislation should have clear goals, means for monitoring progress, exit strategies, and a feasible implementation plan. Above all, he noted that "the unintended consequences of borrowing are what led to this mess. . . . Let's not make the same mistake again when devising a solution."

--KAREN DUBAS

For video, audio, and event information, visit www.aei.org/event1866.

For media inquiries, contact Veronique Rodman at 202.862.4870 or vrodman@aei.org.

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