BANKS THAT IGNORE THE MISTAKES OF THE PAST ARE DOOMED TO REPEAT THEM----PART ONE

A MINI-HISTORY OF FINANCIAL FOLLY About 25 years ago America’s lenders made such a gigantic industry-wide goof that it took hundreds of billions of U.S. taxpayer dollars to rescue the nation. Most of the boys and girls who are loan officers today were still awaiting puberty then so they wouldn’t remember the trauma that the nation suffered. Give yourself some time to read this three part series. It will help you understand the crazies in our financial markets. Now they’ve gone and done it again. The numbers will differ, and a different group of people will be hurt, but here we have another shocking reminder of how undisciplined the financial industry can be. Let’s review the history, because it will repeat itself yet again, and you’d best keep the lessons thereof in the back of your mind. Going into the 1980s almost all home loans were made by financial institutions: banks and those formerly known as “savings and loans,” or S&Ls. S&Ls were the biggest players. The more deposits the banks and S&Ls could attract, the more home loans they could make. Investors were willing to deposit their money in banks and S&Ls because they knew that up to $10,000 was insured by the U.S. Government (Federal Deposit Insurance Corp. For any amount over $10,000 the depositors relied on the lenders’ expertise in making loans that would be paid off properly. If the lender made bad loans that weren’t paid off properly---uh oh. The depositors would want their money, and the lender wouldn’t have it. . The $10,000 coverage protected most all of the small depositors, but not the big depositors----those with hundreds of thousands, and more, to invest. So those Fat Cats invested their hundreds of billions elsewhere, such as with Uncle Sam himself (U.S. Treasury Bills, Bonds and Notes) or with big corporations (corporate bonds.) Here Comes the Clout Enter the Construction Industry, particularly the Home Builders division. They wanted Congress to increase the amount of deposit insurance so that more people would deposit more money with home loan providers such as S&Ls, so, in turn, more people would buy more houses. Simple enough logic, right? The builders wanted to get their mitts on those billions of dollars that were being invested outside the home loan arena. Bear in mind that the home builders had a lot of clout. In addition to their own companies, a huge chunk of American industry profited from home building: lumber companies, carpenters, brick-layers, electricians, telephone installers, carpet retailers, appliance dealers, and on and on. And lots of those people would vote and make campaign contributions along the same pathways that their money came from. Congress responded to the pressure by increasing the amount of deposit insurance from $10,000 per account to $100,000! Big jump. Now the lenders could be more liberal, lots more liberal, in making loans. The lenders knew that Uncle Sam would step in to protect deposits of up to $100,000, so if some bad loans slipped into their books, not a problem. In those days, $100,000 could buy a pretty fine home in almost all of the country. And the lenders started having a field day. People who otherwise might not have been able to get home loans suddenly found themselves being hustled by the lenders, who now had little worry about making less-than-safe loans. (“If this loan goes bad, no problem. Uncle Sam will make sure the depositors get their money when they want it.”) Loans that otherwise might have been turned down were being made. The lenders were reaping a fortune. And, lo and behold, they found that they could sell a lot of the loans to other investors and keep the loan origination fees for themselves, and let those who bought the loans worry about getting the payments promptly. Getting Sloppy The experienced loan officers---those who knew how to make a safe and proper loan---were swamped by the applications. To speed matters up (and increase the flow of income) the lenders hired loan officers who weren’t sharp enough to know a good loan from a bad one. The lenders said, “Don’t worry if the appraisal of the property isn’t high enough---we can fudge it if we need to.” And “Don’t worry if the borrower’s income isn’t high enough to warrant making the loan.” And “Don’t worry if the borrower’s credit history is spotty. Just get the loans on the books, grab the origination fees, sell the loan to some other hungry investor, and move on to the next deal.” You can guess what was about to happen. And remember---we’re back in the 1980s, not the present day. The next deal, it turned out, was not another home. It was a shopping center. Or an office building. Or an indoor skating rink. Or a fast-food eatery. Or whatever. The big bucks weren’t in houses. One strip-mall shopping center mortgage equals ten home loans, and it doesn’t take that much more work to do a shopping center loan than it does to do one home loan. Or so they thought. Problem was, the lenders were clueless as to how to make safe and proper loans on commercial buildings. Even the ones who were skilled in making good home loans didn’t know the fine points of making good commercial loans. Aside from the basic construction elements, commercial properties required careful analysis of tenants, leases, building and safety regulations, insurance (particularly public liability), and lots more. Greedy borrowers lied to greedy lenders. Greedy appraisers lied to greedy loan committees. Greedy stockholders of the banks and S&Ls looked the other way. And before you could say “Catastrophe!” the whole lending industry was near the edge of going under. A plague of bad loans bankrupted hundreds of lenders, who walked away unscathed and unpunished because the U.S. Government was writing checks to the depositors for up to $100,000 to bail out the lenders by paying off their otherwise defunct deposits.. Pardon me. The taxpayers of the United States were writing checks to cover the otherwise defunct deposits. It cost Mr. and Mrs. America hundreds of billions of dollars to bail out the depositors---many of whom, of course, were themselves. It didn’t cost as much as the Iraq war, but in terms of 1980-90 dollars, it was close. Virtually all of the S&Ls closed. Many of them were absorbed by still healthy banks. Many just fired their employees and shut their doors. It was a debacle of extreme proportions. Ripple effects caused a stock market crash in 1987. The housing market was in turmoil: prices plunged and didn’t recover until the early 1990s. Builders and realtors, and all their employees, were clobbered. Hundreds of thousands of families who had bought homes with mortgages that they really couldn’t afford had to endure foreclosure, eviction and their own bankruptcies. As all of this was happening, news reports told the stories fairly accurately. The storm was clearly visible on the horizon, but nobody, nobody, did anything about it. Not Congress. Not the banking industry. Not the home-building industry. And certainly not the individual families who were buying dream-houses they thought they never could afford. Everyone was too happy with the cash flow. When the storm subsided, everyone, everyone, said, “We can’t let this happen ever again!” And it didn’t. At least not for about 15 years. Tomorrow---Part Two: History Repeats Itself