Certified Forensic Loan Auditors, LLC

  Upcoming Classes

Search CFLA's Article Archive:

Preventing another meltdown

thewhig.com | October 16, 2016

By Geoffrey Johnston

Knowledge of past financial crises does not necessarily give policy-makers the ability or wisdom to avoid every pitfall or systemic problem that could lead to a future financial meltdown.

However, there is no denying that possessing a firm grasp of financial history could help politicians and central bankers to better understand the perils of lax monetary policy, asset bubbles and mania.

"History shows that even modest financial crises cause horrific pain," writes Timothy Geithner in Stress Test, the definitive first-hand account of the financial crisis of 2007 to 2009, which was the worst to hit America since the Great Depression of the 1930s. Geithner served as president of the U.S. Federal Reserve Bank of New York during the financial meltdown and went on to become President Barack Obama's secretary of the treasury.

"Every financial crisis is a crisis of confidence," states Geithner, cutting to the heart of the matter. The destabilization of major American banks and financial system was precipitated by the collapse of the U.S. housing bubble, mortgage defaults and huge corporate losses in the financial sector. The crisis pushed the world to the brink of financial and economic catastrophe.

"Financial rescue, fiscal stimulus and monetary stimulus -- along with the president's efforts to prop up the beleaguered auto and housing sectors -- would all have to work together, if they were to work at all," Geithner explains in Stress Test.

"But stabilizing the financial system was our most immediate problem," he continued. "A renewed banking panic would quickly overwhelm any fiscal and monetary support we could provide."

Low interest rates

According to Geithner, "the long period of low interest rates in the United States and worldwide helped fuel the crises, because it helped fuel the mania that inflated the bubble, encouraging more borrowing, more homebuilding, more risk-taking." And he also highlighted "the inadequacy of our firefighting tools -- our inability to manage the failure of large, complex institutions in an orderly fashion, our limited authority to stop a panic outside the banking system."

According to Geithner, the "fundamental forces of mania," which can be defined as "the excessive belief that past would be prologue and the good times would continue to roll," fuelled the wave of excessive borrowing, leverage and speculation in the U.S. housing market.

In the run-up to the meltdown, explains Geithner, "this mania of overconfidence fuelled an explosion of credit in the economy and leverage in the financial system." And he pointed out that "much of that leverage was financed by uninsured short-term liabilities that could run at any time."

The rise in borrowing driven by leverage is at the heart of every financial crisis, asserts Geithner. However, the crisis of 2007 to 2009 was more dangerous, "because many of the overleveraged major firms that were borrowing short and lending long were outside our traditional banking system."

Those non-traditional lending institutions were not subject to banking regulatory safeguards that tend to, at least theoretically, mitigate risk. Nor were those institutions covered by the U.S. federal government's safety net.

The stage was set for a catastrophic collapse of the financial system. "When the panic hit and the run gained momentum," writes Geithner, "we did not have the ability to protect the economy until conditions were scary enough to provoke action by Congress."

Inadequate initial response

The U.S. Federal Reserve and other central banks responded to the crisis in the traditional manner, cutting interest rates. But that failed to prevent credit markets from freezing up.

"When the crisis intensified sharply after the bankruptcy of Lehman Brothers and near failure of several other major financial institutions in September 2008, the central banks found their traditional tools to be insufficient to deal with the collapse of aggregate demand and freezing of key credit markets," according to a 2009 report by the International Monetary Fund (IMF). The report is entitled Unconventional Choices for Unconventional Times: Credit and Quantitative Easing in Advanced Economies.

It was clear that the Fed had to come up with unconventional policy responses to the crisis if the total collapse of the financial system and a global depression were to be avoided.

Earlier this year, Janet L. Yellen, chair of the U.S. Federal Reserve, addressed a symposium at Jackson Hole, Wyo., where she laid out her analysis of the central bank's response to the financial crisis, including how the Fed "significantly expanded its monetary policy toolkit."

For example, Yellen noted that "major additions to the Fed's toolkit were large-scale asset purchases and increasingly explicit forward guidance." And these tools were used "to provide additional monetary policy accommodation after short-term interest rates fell close to zero."

Central bank intervention

Like Yellen, Geithner touts the success of the Fed's "innovative credit and liquidity programs for banks and nonbanks." And he also notes the importance of "backstops for commercial paper and money market funds."

The Fed also helped to avert a total collapse of the financial system by rescuing a number of so-called too-big-to-fail firms, including Fannie Mae, Freddie Mac, AIG, Citi Bank and Bank of America. However, such extraordinary measures still weren't enough to bring the crisis to an end.

The Federal Reserve boldly undertook an untried monetary manoeuvre known as quantitative easing. The first round, known as QE1, saw the Fed buy mortgage bonds to, in the words of Geithner, "reduce the cost and increase the availability of mortgages." And he contends that QE1 was "an innovative way to do monetary stimulus at a time when short-term rates were as low as they could go."

In addition, the Federal Reserve took the extraordinary step of expanding the asset purchasing program for Treasuries. The purpose of this monetary gambit, explained Geithner, was "to try to drive down long-term rates more generally."

In order to recapitalize the crippled U.S. financial system, the Treasury and Federal Reserve proposed the creation of the Troubled Assets Relief Program (TARP) to purchase distressed assets. Although controversial at the time, TARP proved to be an effective firefighting tool during the crisis.

The Fed also established the Term Asset-Backed Securities Loan Facility (TALF). According to Geithner, the purpose of TALF was "to create investor demand for high-quality asset-backed securities by accepting them as collateral for Fed loans." Although the initiative did not garner much media attention, Geithner credits TALF with helping to revive credit markets.

Preventing another meltdown

The Canadian banking sector was and is much more highly regulated than the U.S. system, which helped to spare this country the worst of the financial crisis. However, storm clouds are gathering on the horizon.

In 2016, Canadian households continue to borrow and accumulate record levels of debt. Fuelled by sustained low interest rates, heavily indebted Canadian consumers are behaving as if interest rates will remain low forever and that there will never be a day of reckoning.

Sooner or later, interest rates will rise. When that happens, the cost of servicing massive household debts will become unsustainable for many families, leading to defaults on mortgages, loans, personal lines of credit, and credit card debts. Personal bankruptcies will rise and consumer spending will decline, setting the stage for another recession.

However, the Canadian mortgage insurance system is backstopped by federal funds, which would prevent an American-style financial crisis in Canada. But there is still reason to be concerned.

Approximately two-thirds of Canadian mortgages are with traditional banks. The big Canadian banks have had strict lending/underwriting standards for quite some time. However, alternative mortgage lenders have increased their share of the market in recent times by targeting borrowers with less-than-desirable credit ratings and those who only can make the minimum down payment on a house.

Last week, Canada's Department of Finance announced stricter lending regulations for bank and non-bank mortgage providers. The new rules require financial institutions to make sure that potential borrowers could afford a mortgage in the event of an interest rate spike. The purpose of this is to discourage risky lending and speculation in the housing market that could lead to a crash.

The federal government is also reportedly in talks with the financial sector regarding possible alterations to the mortgage insurance system. The Trudeau government wants financial institutions to take on more of the burden of covering mortgage defaults, thereby reducing the amount for which taxpayers would be on the hook in the event of a housing market crash.

What lessons should policy-makers draw from the great financial crisis? "To resolve a crisis," asserts Geithner, "a government has to show the capacity and the will to end it." In other words, "it has to demonstrate through its deeds that its words can be trusted."




Order Cutting-Edge Services Now   Quiet Title Packages from Licensed Attorneys
CFLA Sponsored Attorney Links   CFLA Training Academy



Back to October 2016 Archive


CFLA was founded by the Nation's Leading Foreclosure Defense Attorneys back in 2007 to serve the Foreclosure Defense Industry and fight pervasive Bank Fraud. Since opening our virtual doors, CFLA has rapidly expanded to become the premier online legal destination for small businesses and consumers. But as the company continues to grow, we're careful to hold true to our original vision. For us, putting the law within reach of millions of people is more than just a novel idea—it's the founding principle, just ask Andrew P. Lehman, J.D.. With convenient locations in Houston and Los Angeles, you can contact Our National Account Specialist and General Manager / Member Damion W. Emholtz at 888-758-2352 for a free Mortgage Fraud Analysis or to obtain samples of work product, including cutting edge Bloomberg Securitization Audits, Litigation Support, Quiet Title Packages, and for more information about our Nationally Accredited and U.S. Department of Education Approved "Mortgage Securitization Analyst Training Certification" Classes (3 days) 24 hours for approved CLE & MCLE Credit (Now Available Online).

SEE BELOW- http://www.certifiedforensicloanauditors.com

Call us toll free at 888-758-2352

Bookmark and Share
Facebook Like us on Facebook
Twitter Follow us on Twitter
YouTube View our YouTube Videos
LinkedIn Connect to us on Linkedin
BBB Logo



Contact us or view our Sample Documents & Audits by completing the form below.

  • Reload
  • Should be Empty:


DVD Sets Only $99


FREE Mortgage Fraud Analysis


Order Cutting-Edge Services Now


Quiet Title Packages from Licensed Attorneys


Affiliate Services


CFLA Sponsored Attorney Links


Take-Home Education Package