01 October, 2008

Not sure why I bother, but I do

The student paper ran an article on the current financial crisis that looks as if the research consisted of making stuff up whole cloth while downing a couple of beers. For some reason I bestirred myself to submit the following letter.


The article on the bailout contains at least two serious factual errors.

1. The article assers, "The economy started to slump in 2003 and the Federal Reserve Bank lowered interest rates in hopes that more Americans would buy a home."

The authors have it backwards. The Federal Reserve Bank started lowering interest rates when the economy slumped in 2000 after the dot-com stock market crash. It fell from a high of 6.5% in 2000 to a low of 1% in 2003. The rate was already lower than 4% in mid-June 2001; after September 11, 2001 it fell precipitously to below 2%. The rate continued to fall until 2003, when the economy began to improve. At that time, the Fed began to raise its interest rate, a technique used to avoid inflation. The interest rate reached a high of 5.25% in 2006. I have attached a diagram that I found online.

This increase in the Fed's interest rate contributed to the situation, as the interest rate on an Adjustable Rate Mortgage increases when the Federal interest rate increases. People who could afford a mortgage payment based on the 2004 rate could no longer afford the payment in 2006, as their ARMs reset to a higher rate. Interest rates on ARMs likewise decrease when the Federal interest rate decreases, but while interest rates have declined recently, they remain much higher than they were in early 2004.

2. "Lenders sweetened the deal by introducing new kinds of loans--adjustable rate mortgages and subprime loans--which made buying a home easier for those with questionable credit. ...[B]anks need liquidity in their assets so they started a process called securitization, which is selling packages of mortgage loans to financial institutions like Lehman Brothers at a profit. The banks would bundle good loans--those that are expected to be paid back--with not so good loans in the sales."

Adjustable rate mortgages and subprime loans existed long before 2003. ARMs were first allowed in the United States beginning with the Garn-St. Germain Depository Institutions Act of 1982. Some people say that ARMs contributed to the Savings-and-Loan crisis of the late 80s.

Securitization also existed long before 2003. In fact, the government agency Fannie Mae has been bundling mortgages into mortgage-backed securities for most of its history.

3. What did change in 2003? (or thereabouts) Banks started pushing ARMs and subprime loans much more heavily. Government officials who wanted to boast that home ownership was increasing either collaborated or turned a blind eye. Those who saw a problem and tried to sound an alarm were criticized as hating the poor or being un-American.

In general the situation is complicated and not easy to sort out, so mistakes are understandable. I hope however that you will issue a prominent correction of these errors, or else inform me how the multiple sources that I've checked are wrong.

john perry

Although I didn't mention it in the article, this situation had a direct bearing on some of my finances. In 2002 I had actually paid off most of my debts and saved some money (about $1000 to be exact), and I wanted to buy a Certificate of Deposit. Interest rates were so low that my credit union was virtually begging people to save money, and ran a special offer where if I bought a 3-year CD, I would earn 3% interest. It seemed a lot better than anything else I could find at the time—I wasn't exactly looking, though, and out of a sense of loyalty* I wanted my money in that particular credit union—so I bought one. I felt pretty good when interest rates fell further, and pretty bad once the federal rate rose above 3% in early 2005. Still, it was nice to have the money at the end of the year. I remember discussing with my wife in late 2005 what we would do with the money once it became available. At the time we were newly married.

A couple of years later, my wife's family gave her some money, which was sitting in our regular savings account. I convinced my wife to buy a CD, which at the time was 5% for 18 months at one credit union. I had done this because I had heard that the Fed might be lowering interest rates. Events vindicated me; you can't find a 5% CD at any institution even for 5 years now. The credit union that sold me the 3% certificate in 2002 won't sell anything higher than 2.75% now, unless you have $25,000 to throw around (I don't).

So I'm not entirely unfamiliar with how interest rates behaved throughout this decade, which is why the article astounded me.

I also remember a bus driver in Raleigh asserting that yes, the economy started to collapse in 2000, but that was because businesses realized that Bush would be President.

*Why a sense of loyalty to a credit union? In 1999 they had refinanced my car loan, allowing me to make lower payments. I had just left seminary, and was short on money, so this really helped. By mid-2000 some stupid decisions on my part had accumulated something like $6,000 of credit card debt, at 14% interest. By then I was earning a graduate assistant's salary of $14,000. I called the credit union and they suggested that I transfer the balance to their gold card at 9% or 10% interest. By 2002 I was well on my way to paying it off. I was debt-free for a few months of 2003-2004. They likely saved me a thousand dollars in interest payments over that time span.

Update! (7 hours later) The chief editor (or something like that) of the paper hunted me down today to tell me that they would print a correction, along with a story by an economics professor. He also said that they would print my letter, minus some cuts… At this point I told him that I didn't need to see my letter in print; in fact, I'd prefer it not be in print. The correction would be fine.

So that's why I bother.

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