Much of the United States seems to have been caught up in a financial meltdown for the past few weeks. We’ve all been treated to the sight of insurance industry giants and investment bankers flailing around madly, seeking shelter from the storm. As for myself, I’ve been scanning the headlines only casually. I’ve recently begun a new job, you see, with a nonprofit in Richmond called Caritas. Finally, my working world is far, far removed from the hustle and bustle of Wall Street and Washington.
In fact, I walk to work every morning, and most of my knowledge of the crisis is limited to what I can glimpse from the headlines in the newspaper machines as I breeze on by. Well, that and the flashing signs at the investment houses nestled in Richmond’s quaint “financial district.”
So please forgive me if I oversimplify here, but it seems to me the problem is this. Millions of homeowners, myself included, got eyes bigger than their wallets and bought houses they couldn’t afford over the past decade. Where I managed to get lucky and sell just before the bubble burst, however, most other homeowners kept their homes far beyond the point where prices began to fall and rates –- and thus their monthly payments –- began to rise.
Caught in this money squeeze, these desperate homeowners sought help the only way they knew -- refinancing. And the financial world was only too eager to swoop in like the predators they were, gouging these homeowners for every last cent they could get. In the process, though, they wound up making loans to people they shouldn’t have loaned to, in amounts they couldn’t possibly justify, all in the name of pushing today’s losses off to tomorrow.
It’s the American way, corporate-style.
But in the end, the bubble collapsed, as all bubbles do. Someone, and now everyone, has finally realized that all the crazy financial “instruments” those Wall Street types have been cooking up are worth less than the electronic paper they aren’t even printed on. It calls to mind -- my mind at least -- the story of the Emperor with No Clothes. That, and Chicken Little, of course, except these chickens are coming home to roost right in the laps of those financial geniuses who specialized in building castles in the air.
While all this has been going on, I’ve been watching with a sort of curious detachment, complete with a Zen-like smile on my face. And the word that comes to my mind over and over again is this.
Equity can mean many things. To some people, it connotes a sense of justice or fair play. To others, many of whom are involved in the current mortgage meltdown, it can mean someone’s ownership interest in property, real or otherwise. Equity also refers to an entire system of jurisprudence. American courts, as the English courts before them, continue to recognize, formally or otherwise, the split between law and equity, with courts of equity being created to fashion remedies in cases where legal money damages just won’t do.
This financial storm we’re seeing now implicates each of these meanings of equity, in one way or another. Take, for example, the obvious meaning of an ownership interest in real property. If you’ve been to any cocktail parties in a hot real estate town over the past decade, I’m sure you’ve come to know more than you’d like about “equity.” It’s amazing, really. In the years I lived in Washington I’ve seen people -– otherwise sane people who would never dream of talking in public about their financial affairs -– just blurt out in the middle of a casual conversation how much they’ve gained in appreciation in the past year. Or month. Or week, even, at the height of the craze.
I think I know what it must have been like in Holland in the middle of the whole tulip thing. Washington, D.C. at the height of the real estate craze was just insane. But don’t get me wrong. I’m sure I would have been an eager participant had I not been in the middle of my own personal meltdown. As for selling at the top of the market, that was just dumb luck. I hit my financial bottom earlier than everyone else, so I was naturally one of the first at the fire sale.
Mark Twain tells us that “History rarely repeats itself . . . but it often rhymes.” That was definitely the case in the real estate market. True, we didn’t get ourselves in an uproar over tulips again, but the underlying mechanics were the same. “Irrational exuberance” created a tremendous amount of temporary wealth. Many of you might want to say false or illusory wealth, but that’s just not so. Wealth is wealth, whether it’s “irrational” or not. My house really was worth nearly a million dollars when I sold it, even though I didn’t think so.
How do I know that? Because someone paid me that much for it. Now, whether my house is likely to be worth that much tomorrow is a different story.
In fact, when my wife and I sold our place we negotiated a three-month leaseback. That means we effectively “rented” our house from the new owners for three months, working the rental payments into the purchase price itself. Over the three months between the time we sold our house and the time we actually moved out, the appraisal fell by over $80,000. So while the value of my house when I sold it was real -– I got the check to prove it –- it was definitely temporary.
And this whole messy, interwoven financial crisis springs, for the most part, from the price and credit bubble in the real estate market. Fannie Mae and Freddie Mac are screaming because the billions and billions of dollars worth of mortgages they bought, repackaged and "sold" -- complete with Fannie and Freddie's "guarantee" of payment -- are now going into foreclosure at an alarming rate. From what I understand, it got so bad at one point that Freddie and Fannie actually stood a chance of failing without government relief.
To understand how significant this is, you have to understand that Freddie and Fannie are not just giants in the real estate world. Hell, they pretty much are the real estate world. Rather, they are giants in the global financial markets. All of them.
So when Freddie and Fannie falter, others are sure to follow. Hence Bear Sterns, AIG and the rest of them. And all because a whole bunch of little people got excited about their real estate "portfolios," and in their excitement, created a lot of equity that just couldn't last.
So now the only question is, where’s the equity?
Which brings me to the next notion of equity, the idea that justice and fair play should prevail in our society. That idea seems to have gone totally out the window with this whole bailout discussion.
You see, here’s the question. What were the banks doing while homeowners were feverishly scrambling to outbid each other for that next hot property? Were they diligently looking at the market fundamentals? Were they putting each loan applicant to the test, rejecting those who probably wouldn’t be able to meet their commitments? Were they trying to act in any way, shape or form that was even remotely . . . sane?
No. They, like the homeowner/borrowers, were caught up in their own bubble of irrationality. Only at this level, we’re talking about a speculative lending bubble, one that saw countless lenders roll the financial dice, so to speak, making risky loans to borrowers who ordinarily wouldn’t be able to repay, in the hopes that the rising market would, in hindsight, make these risky loans worthwhile.
It worked . . . for a while. And the profits made by those in the beginning only added fuel to the fire, prompting lenders to make riskier and riskier loans, creating an entire market –- euphemistically dubbed “subprime” -– in the process. When I was looking to refinance my house, two years before I sold it, I was bombarded with loan offers for 125%of my equity and more. If that's not lenders betting on a rising market, I don't know what is.
The whole thing kind of reminds me of a Ponzi scheme. And in the end, it fell apart just like one. People started to get nervous about the market, prices started to cool, then fall, and suddenly borrowers are in serious trouble. Just a few at first, like myself. But as the number of these troubled borrowers is rising, they find themselves competing for a declining number of increasingly reluctant buyers. Houses sit unsold for months, property values start to fall, and homeowners begin to default.
That’s when the banks started to get in trouble. That’s when they start asking to be bailed out, a chorus that has now reached astonishing proportions. These are the same banks who pulled the trigger on every foreclosure, who took houses -- homes -- away from countless families, many of whose only flaw was that their reach exceeded their financial grasp.
But now they ask for help. Our help. To the tune of some $700 billion or so. At least that’s what it was on the last front page I saw.
But why should we help them at all? In many ways, the banks were worse than the homeowners. The banks had rules, or so they said. The banks had standards, or so they said. But in the end, weren’t they just players in the same risky game as the homeowners? Weren’t they speculating on the market, intoxicated by the promise of ever-rising prices, and profits, just like Joe and Susie Homeowner?
Of course they were. But we're going to wind up bailing them out anyway, while the little homeowners are left to twist in the wind.
So once again, the question is where's the equity?
Here’s the equity, and it comes in the form of the last definition: that part of the court (i.e. government) that looks not simply to the literal letter of the law in fashioning a remedy, but considers all factors in making its decision. In the courts, this might take the form a bankruptcy court issuing orders limiting creditors’ rights in order to allow a debtor a “fresh start.” The creditors might be royally pissed off, but the overall system needs a safe haven for people who’ve gotten in over their heads. It might take the form of a domestic relations court weighing all the facts of a family situation and issuing a support and custody order, surely one of the weightiest functions a court can ever perform. It might take the form of a court issuing an order halting construction on a piece of property, where that construction might endanger a wildlife habitat.
In each of these instances, and many more, the court –- and our entire government –- is tasked to look beyond the minutiae of the dispute at hand, and declare some form of relief based on a higher, greater good.
And, God help me, in the case of this financial crisis, I believe the higher, greater good mandates a bailout, pure and simple, if only to prevent further financial damage, further loss to investor confidence, and further threat to our country’s, indeed the world’s, financial future.
Some would have us stand on principle. "The capitalists lived by the sword, now let them die by it." Or something like that. For me, principle is all well and good, but it can turn dangerous when used without regard for the circumstances. Adherence to a misguided principle -- fiscal conservatism in the face of a mounting monetary crisis -- gave us the Great Depression. Should we -- can we -- risk economic harm today to millions of people, some completely innocent, just because we don't like the idea of rescuing some financial ne'er-do-wells?
So we're left with bailing them out, distasteful as it may seem. And it’s not because I like the investment bankers. And it’s not because I want more government involvement in the economy. It’s because these irresponsible bastards have managed to back themselves into a corner –- and the rest of us with them -– so that the only way we can save ourselves is to save them too.
Nobody said equity was pretty.