Uh-Oh, Here We Go Again?

There's been a lot of talk about how lax lending standards helped blow up the housing bubble. Talk about short memories and logic disconnects, though; apparently Massachusetts Congressman Barney Frank and New York Representative Anthony Weiner are trying to pressure Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) to lighten up a little and relax condo lending practices. Um … I think we've seen this disaster flick before.

This is the type of thing that's been bugging me for a long time about our recent economic problems and policymakers' response to them. I've often had a hard time wrapping my brain around all talk of wheedling and forcing banks to lend because it sounded an awful lot like trying to cure our problem with exactly what has ailed us. (That was how I felt about the TALF plan.)

Given the nature of the beast we've created, banks need to be a lot more prudent about who they lend to. Otherwise, we'll end up right back in the danger zone. But the word on the desire to lower some standards hints that forces at work may tempt us all back into the same black hole.

Welcome to the ugly reality
The reality that many American consumers (and companies) are already overly indebted does not bode well when it comes to who exactly banks will extend credit to as the Federal Reserve continuously attempts to grease the wheels of lending.

There's a real paradox at work: Lax lending has been a huge problem, but without it, we've lost a heck of a lot of economic activity. I'm not sure that it's a welcome connection to realize that a significant amount of spending wasn't tied to actual employment income.

Welcome to the world of slippery slopes and more chutes than ladders. Meanwhile, there is still a major glut of housing inventory out there, and if nobody can or will buy, that's not going to change anytime soon. And of course, given increasing job losses and mounting foreclosures, it's not too hard to imagine that a bottom in the housing market may not come as soon as optimists would hope.

When the dot-com bubble popped with few Internet start-up survivors, a mild recession followed. The questionable answer was low interest rates and that brand-new inflating bubble to replace the old one, which certainly helped with that whole "mild" part (although you might call that instead a temporary fix).

Flash forward, and people were using their homes as ATMs and gorging on debt like home equity lines of credit and wallets bulging with credit cards from the likes of Visa (NYSE: V  ) , MasterCard (NYSE: MA  ) , and their banking partners, and this helped pump up our entire economy (and government tax revenues and stocks) artificially. Everyone from Starbucks (Nasdaq: SBUX  ) to Toll Brothers to banks like Bank of America (NYSE: BAC  ) (and its acquisitions Countrywide and Merrill) all bubbled up, too. And of course, many corporations -- a high-profile example might be Sirius XM (Nasdaq: SIRI  ) -- also gorged on debt in so-called good times, which as we can see, all probably seemed reasonable when everyone was doing it … until the party stopped.

Let's not roll the dice again …
Our economy needs to correct and our culture needs to get past the speculative, artificial, bubble-hungry mindset that we've relied on for too long, where easy credit gave too many people just enough rope to hang themselves with.

However, Frank's move underlines the concept that politicians are going to have a heck of a time doing the logical but painful thing. Letting the correction happen hurts in the short term, and just like corporate leaders, there's a huge temptation to make the short term look good even if it's not sustainable. Logic says it could take years to recover from this mess (and my Foolish colleague Morgan Housel points out that our debt binge started before the housing bubble). I don't think the political types are willing to take the logical route here, but instead are desperately looking for bandages so that things don't feel so much worse on their watch.

Motivations for lowering condo lending standards supposedly are that the housing recovery could be slowed, and that the tightened standards could endanger the "viability" of some condo developments, but that just says to me they weren't viable to begin with, except under the absurd and fantastical models of an out-of-control bubble mindset.

All the chit-chat about how regulators and government can make everything right may appeal to people emotionally right now, but I think we're increasingly seeing plenty of rational argument for why there's plenty of blame to go around, and government policies that mess with markets are fraught with economic peril.

Recent reminders that often-quoted economist Paul Krugman was OK with the "solution" to the previous recession that led to the housing bubble, and that Fannie and Freddie were both major parts of our disaster and were highly regulated, political entities can make you question some of the assumptions right now. And of course, Barney Frank was a force in some of the loose mortgage lending practices to begin with; the quote going around at the moment is how he said Fannie and Freddie should "roll the dice" for "affordable" housing back when the housing bubble was starting to take on some air.

Hold on to your hats, folks. This news sounds like a red flag; it suggests that we are again making the same mistakes while calling them the solutions. Free market policies may frighten a lot of people, but politicians' meddling in the economy -- complete with short-term "fixes" to charm voters and the public -- are really bad medicine for what ails us.

Starbucks is a Motley Fool Stock Advisor pick. Starbucks is a Motley Fool Inside Value selection. The Fool owns shares of Starbucks. Try any of our Foolish newsletters today, free for 30 days.

Alyce Lomax owns shares of Starbucks. The Fool has a disclosure policy.


Read/Post Comments (15) | Recommend This Article (37)

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  • Report this Comment On June 26, 2009, at 11:05 AM, oSUNo wrote:

    How do you tell the 2010 economy to get back in to it's old clothes from 1991? Don't know. It's a near impossible political sell. There's a difference between saving the finance sector with future taxpayer's money and restoring confidence in the finance sector. It's alive. That doesn't mean its got all its marbles.

    The law required regulators to step in before a bank tanked and at least sack the management and replace them. It just wasn't done. Now it has to be done.

    The government is a bad investor (so are most people) . What I mean is... for 25 years of banging on about how regulation stifles industry, Gramm, Enron and Co made a career of €it. That doesn't mean we now want to hear 25 years of communist intervention and regulatory jackbooting. What is it with these people?

    If a bank is lending like a loon isn't it clear to everyone? Not if they have their own accounting formulas.

  • Report this Comment On June 26, 2009, at 12:15 PM, cantbefoolish wrote:

    They should be a little more relaxed for responsible people.

    I've been trying to get lending for a high rise condo in Las Vegas, but lenders are being way too tight. The previous condo I bought was in Orange County, and the price was $60k more than what this place in Vegas will be. I didn't have problems making payments before. So, there's no reason I can't pay for something that's much cheaper now.

    These lenders are basing their policies on my income not being high enough, and me not having enough credit history. Well, I've never had a big income, and I've never used a credit card. So, basically I'm being penalized for using an ATM card rather than paying a credit card company. If anything, that should show that I'm good with money and don't have to borrow.

    I've been patiently waiting out the downturn in the market, since selling my last place in '05. Now I have 3 times as much cash, and can easily put over 20% with plenty left over. Not to mention the $8k tax credit, which would buy me another 8 months of payments. This should be a slam dunk.

    If they want to base the lending on people having a good paying job, and having credit card debt - that is stupidity. What if someone loses their job? I have almost enough to pay the place off outright, and they still turn me down.

    On top of that, our tax dollars have been going to bail these morons out, and instead of lending it like they should be - they're using it to buy up other financial institutions.

  • Report this Comment On June 26, 2009, at 12:22 PM, tootun wrote:

    You guys also realize that your favorite company to BASH being SIRI is taking care of their debt situation RIGHT? Didn't say much about that didi ya?

  • Report this Comment On June 26, 2009, at 1:00 PM, RaulChapin wrote:

    Alyce: Here is a game for you:

    You take 100 people. For ease of comprenhension, say they each have $1000 each.

    10 people are allowed to bet up to $3000 each. On a game in which on average they win 6 out of 10 times.

    If they bet $300 each time, they will on average make $600 out of each 10 rounds.

    The party owner, gets 10% of all earnings, so the players get $540 clean, they take this money out of the house and start again, with their $1000 intact, and still the possiblity of betting up to $3000

    The party goes on for a long long time. Until the unlucky turn in which the player loses 10 times in a row, now he is maxed out his capacity to bet, and has no money in his pockets. He could bring back the money he took out of the house... but choses not to (as it is more than $1000, so he already won)

    since the $3000 were never there, the house owner, takes $11. out of each non playing individual, and calls it a bailout.

    The paying group has lost some money (as they only have $990 instead of $1000) so they are "losing like everyone else"

    Question: How likely are the 90 people not playing to make a huge fuss over the $11 they had to give... specially if the game host is good enough at convincing them that if the bailout does not happen, the people that were playing are going to fail and in doing so total catastrophe will be certain...

    Question 2: If the game is still there for the betting... what are the chances that the 10 players who "lost" $10 (but were allowed to take $540 who knows how many times while the game was good) will stop playing. What are the chances that the house host will stop the game since the players are giving a $30 kickback on each round wiht 0% risk, what if the house player knows that he also can have his turn after a few rounds... some one else will step in and be the house one while he plays.

    What is this game called???

    It is called MONEY PRINTING. The bailout was a catastrophe for all the people not betting their savings and resources. It was NOT a catastrophe for the government (which just printed money...) and it was NOT for all the people who were allowed to gamble money they did not have and instead of being sent to jail for fraud were given a bailout and a chance to start again... but this time we will be watching... really? really????

    Condo developments... the constructors, the realtors, the banks, the goverment, all of them sit to profit from the sale... even if inflated.

    Everyone else sits to lose from the bad mortgage if it happens... but as all the gains are concentrated in a few people, and all the missery is spread amongst many... the game can go on, so long as the few don't get too greedy. (This is exactly why monarchies worked for such a long time... the pain of serving a king was not high enough to risk getting killed... until the king got so excesive that the pain was felt by many and was big enough to risk death... and so came the revolution)

    Don't bet on the game changing, don't bet on the gamers changing. Don't bet on the masses becoming intelligent.

    One of the saddest things of baliouts is that they spare the pain to the biggest losers, by sparing this pain, the loser is just tempted to try again next time... and why not bigger... if 1 trillion bailout is possible... why not try 1.2 ... seriously... do you thing any president faced with a similar bubble will say no to 1.2 trillion... if the previos one got away with 1 trillion...

  • Report this Comment On June 26, 2009, at 1:33 PM, RaulChapin wrote:

    Sorry an error in the calculation. The non playing people have to pay $333.33 each. That is more painfull, but still they get to keep 66% of their cash... vs total catastrophy.

    I am not sure if the Trillion+ in combined stimulust package money creation will cause a 30% inflation, anf if so how long will it take for its full effect to reach Joe Mainstream. (30% over 10 years, added to the "normal" inflation would hurt... but not Revolution hurt :))

  • Report this Comment On June 26, 2009, at 2:51 PM, JRSmithman wrote:

    I can not wait for this stock to be at .50 by next week

  • Report this Comment On June 26, 2009, at 4:09 PM, ReadEmAnWeep wrote:

    RaulChapin,

    Good analogy/point.

    So if we had a few years of rampant credit wouldn't that cause inflation, since there would be so much added (fake) money to the economy that wasn't really there. So my questions are:

    Did they print all that bail out money? How much is that printed money vs the money in circulation? That should give a good idea of what possible inflation would be if it happens.

    Was the bail out money just replacing that made up credit?

    But I repeat myself (because thats what I want to know most)... Did they really print all that money? That sounds like a lot.

    What do you think the chances are for the 30% inflation? and what can we do to protect ourselves from it?

  • Report this Comment On June 26, 2009, at 4:11 PM, ReadEmAnWeep wrote:

    Also RaulChapin,

    If you are talking about possible inflation just from that printed money look at this:

    http://caps.fool.com/Blogs/ViewPost.aspx?bpid=218819&t=0...

    Imagine if the printed money, the downside of Cap and Trade, and free healthcare all really do hit us hard like some are saying.

  • Report this Comment On June 29, 2009, at 1:40 AM, khurania wrote:

    I agree with this article as we are in total mess right now. The housing market will still go down because of these reasons:

    There is no demand in the market

    Since May, Mortgage rates have gone Up…

    Too much supply of houses

    Option ARM – The next wave of default

    Still loosing jobs

    Fear in the market

    On top of it, the <a href="http://www.housingnewslive.com/is-the-housing-market-recover... efforts are not helping.</a> .I think this a kind of a vicious circle which doesnt seem to end soon..If we stop lending the whole economy will slow down....I have read an interesting news....see the first news on this site unless they have changed the news:

    http://www.housingnewslive.com/

  • Report this Comment On June 29, 2009, at 1:41 AM, khurania wrote:

    I agree with this article as we are in total mess right now. The housing market will still go down because of these reasons:

    There is no demand in the market

    Since May, Mortgage rates have gone Up…

    Too much supply of houses

    Option ARM – The next wave of default

    Still loosing jobs

    Fear in the market

    On top of it, the Government efforts are not helping.</a> .I think this a kind of a vicious circle which doesnt seem to end soon..If we stop lending the whole economy will slow down....I have read an interesting news....see the first news on this site unless they have changed the news:

    http://www.housingnewslive.com/

  • Report this Comment On June 29, 2009, at 9:50 AM, scooter1958 wrote:

    Why don't the people of Mass. stop voting for Barney Frank?

  • Report this Comment On July 03, 2009, at 12:05 PM, cgscouten wrote:

    lighten up a little and relax condo lending practices. Um … I think we've seen this disaster flick before.

    You are undeniably correct - but absolutely foolish (and I do not mean Foolish). Sure, lenders can cut risk by not lending - we have that today, and you seem happy that this situation continue. What you and the US taxpayer shoiuld demand is competence in our banking community. Most bankers seem to think a lack of competence should be no bar to high pay. I disagree. Frank & Co. ought to be developing metrics for competent lending before we wander into another mess.

  • Report this Comment On July 03, 2009, at 2:28 PM, Northville wrote:

    Here are a couple of thoughts that keep running around in my head about this whole mess:

    1) How can so many extremely intelligent people (bankers, finance people, politicians etc) not see that this is a mess & we're going to repeat it? And why haven't many of them grown a spine and spoken out against it?

    2) Even if we do work out this financial mess (and I agree that we are NOT going about it the right way - the only way to change someone's behaviour is with a dose of pain, which hasn't been delivered to banks or politicians), as soon as we do work our way out of it we're going to run right into social security and medicare going broke. What do we do then? We're going to be in "GM mode" and everyone will just be working for the retirees.

  • Report this Comment On July 03, 2009, at 5:12 PM, tex41 wrote:

    In addition to Northville's question, "How can so many extremely intelligent people (bankers, finance people, politicians etc) not see that this is a mess & we're going to repeat it?" I would like to add two more related to his in that all can be answered with two words, self interest.

    First, how can the major players in the capitalist financial system here and world wide denigrate their own cash cow by condemning capitalism? They supported and still support government intervention in their industry!

    Second why do some of the largest suppliers of energy openly support cap and trade. Doing so will ensure a huge, some say up to 50% increase in electricity cost. Whatever the increase should end up being is of no concern to the provider passing on the increase to consumers, including the so called poverty elements so treasured by those promoting cap and tax.

    It is Common Sense fools, look at which industy will benefit from a new tax allocation, excuse me investment, and you will find those who rationalise abandoning control of their business under capitalism, for blatent self interest.

    I am learning how to blog and failed to transfer articles from IBD.com's editorial pages supporting what i have written. Please see www. ibd,editorials.com, Subject headings include cap and trade, electricity cost increase and bailout of wallstreet.

  • Report this Comment On July 04, 2009, at 7:18 AM, ronb111 wrote:

    Reading the last three comments, I would have to ask:

    Why would we allow the Reps in Wash to control pay when they don't have to control their own. They have an ATM, called the American taxpayer ?

    When are we going to stop this foolishness that everone has a right to the American Dream? Last I heard or remember we had to earn it, There is no guarantee or entitlement.

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