By Rick Tobin
In our perceived capitalistic country since the start of the Credit Crisis (www.thecreditcrisis.net) back in the Summer of 2007, we have all seen many industries effectively become “Socialized” and taken over by the government allegedly to “bail out” the sectors such as the mortgage industry, automobile industry, insurance industry, and Wall Street. As a prime example, at least 97% of all residential mortgage loans funded in recent years were government backed or insured (i.e., FHA, VA, Fannie Mae, Freddie Mac, USDA Rural, etc.).
The near implosion of the world’s financial system back during the week of September 29th, 2008, as I had forecast about six (6) months in advance for a variety of reasons, significantly changed the way we live in our world today. The figurative financial “tightrope” that most Americans walk on each day became a bit more challenging partly due to less perceived “safety nets” to better protect and to save us.
Prior to the near collapse of the highly leveraged financial markets, partly due to the alleged $1,500 trillion of primarily unregulated derivatives (i.e., Credit Default Swaps, Interest Rate Options, etc.), individuals or investment groups supposedly determined the direction of the stock, bond, commodities, and real estate markets. After the near collapse of the financial markets, bailouts from governments and Central Banks around the world became more of the norm as opposed to “Mom and Pop” investors.
For example, the Federal Reserve became the primary buyer of stocks, bonds, and mortgages by way of Quantitative Easing (or create money out of “thin air” in order to buy assets and drive prices higher such as the Dow Jones index) and other bailouts. Each month, the Federal Reserve allegedly purchases up to $85 billion of Treasuries and mortgage bonds in order to keep interest rates as low as possible, and to allegedly try to better stabilize the financial markets.
The history of the FDIC “safety net”
The Federal Deposit Insurance Corporation (FDIC) was created back in 1933 after the collapse of almost 9,000 banks in the first few years of The Great Depression (Oct. 29th, 1929 – 1939). The FDIC was originally created as part of the Glass – Steagall Act of 1933 (this act was partly repealed back in 1999 which allowed banks to operate in the insurance and securities industries too), and was based somewhat on a deposit insurance program in Massachusetts which insured a portion of banking customers’ checking and savings accounts.
The worst year of the ten (10) year Great Depression era was possibly back in 1932 when “Bank Runs” began to happen on a more steady basis. Sadly, many banks began to run low on cash on hand as customers stood in long lines somewhat reminiscent of a famous scene in the classic film entitled It’s a Wonderful Life with Jimmy Stewart and Donna Reed.
If bank customers did not have confidence that their money would be safe with their local bank branch, then they would try to pull out most or all of their cash and literally place it under their mattresses at home, or in other seemingly less secure places. Some people also just dug holes in their backyards, and planted their money there. Sadly, money does not literally grow on trees though.
Shortly after the creation of the FDIC in 1933, certain bank accounts had coverage protection of up to $2,500. In 1950, insurance limits rose to $10,000. In the mid 1960s, the FDIC insurance limits reached $15,000 which later increased to $20,000 in 1969. In 1974, the FDIC increased their coverage amounts to $40,000. Then, FDIC limits increased to $100,000 back in 1980. In recent years, FDIC insurance limits reached as high as $250,000.
The FDIC and the Savings and Loan Bailouts
Prior to the start of the Credit Crisis, the last major financial implosion event here in the USA took place in the late 1980s through the mid 1990s. Back in the 1960s and 1970s, a very high percentage of Americans borrowed their money to purchase homes from their local Savings and Loan (S & L). Even though banking customers used to earn relatively low rates of return on their savings deposits with S & L’s, many Americans felt confident about the relative safety of these investments due to the existing Federal Savings and Loan Insurance Corporation (FSLIC).
Sadly for S & L’s, they had existing interest rate ceilings in place which limited how much they could pay their banking customers. As a result, many S & L customers began to pull their funds out of their local banking branches, which hurt their banks’ abilities to cover their portfolios of performing or non-performing loans at the time.
As short term interest rates like the Prime Rate reached 21.5% by December 1980 due to then Federal Reserve Chairman Paul Volcker’s alleged concerns about increasing inflation rates, banking customers started demanding or searching for higher rates of return from sources other than their local S & L. Many banking customers pulled their funds out of S & L’s, and later invested them in money market funds, stocks, or real estate investments.
Parallel to the increasing rates in the USA back in the early 1980s, banking laws and rules were eased so that S & L’s may later diversify their investments, and invest in potentially higher yielding investments like commercial real estate, residential and land development, consumer, and business investments. Additionally, capital reserve requirements were eased so that S & L’s did not have to hold onto as much cash on hand as they used to in years past.
Tragically, over seven hundred (700) S & L’s collapsed as a result of increasing rates and non-performing loans. Almost half of the U.S. banks which existed back in 1970 were no longer in business by 1989. As a result of the massive insurance coverage losses, the Federal Savings and Loan Insurance Corporation (FSLIC) later became insolvent. The FDIC had to later step in and take over FSLIC in order to try to cover so many of the billions of dollars of banking losses.
In 1989, a U.S. taxpayer bailout measure named Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) was created in order to provide upwards of $50 billion to help out the failed financial institutions. Shortly thereafter, the RTC (Resolution Trust Corporation) entity was established, in order to help sell or liquidate real estate assets for a fraction of their once recent market values to try to generate much needed cash.
The FDIC vs. Bank Customers in 2008: Who had more cash reserves?
Just a few weeks before the near financial implosion of the world’s then existing financial system in late September 2008, the FDIC announced that they only had about $45 billion in cash reserves left in their accounts.
Shortly after this announcement, Wachovia Bank, Countrywide, Lehman Brothers, Bear Stearns, Fannie Mae, Freddie Mac, AIG, and Washington Mutual (the largest bank failure in U.S. history) all imploded too. Just the collapse of Washington Mutual alone wiped out the FDIC’s $45 billion dollars of insurance cash reserves at the time. So, who really had more cash reserves back in the Fall of 2008 – bank customers or the FDIC?
With the perceived or very real threat of a domino like implosion of the banking, investment banking, and insurance sectors partly due to the exposure of $1,500 trillion in primarily unregulated derivatives (i.e., Credit Default Swaps, Interest Rate Option Derivatives, etc.), then the U.S. government and Federal Reserve stepped in with trillions of dollars of anonymous, and not so anonymous bailouts.
Even large and respected financial institutions like Wells Fargo were admitting that they were borrowing at least $25 billion in these bailout funds in order to better stabilize their investment portfolios at the time. For many of the largest U.S. banks in recent years, they received the bulk of their income from on and off balance sheet derivatives investments as opposed to loans made to their banking customers. As a result, banks still aren’t as motivated to make loans to their customers these days, sadly.
The Quadrillion & A Half + Dollar Meltdown
As I have been writing for many years now, the unwinding of the $1,500 + trillion (a quadrillion and a half) dollar derivatives market is truly the root cause of “The Credit Crisis” financial implosion. This is not just a “sub-prime mortgage problem” as the mainstream media likes to tell their viewers. In fact, less than 1% of all non-performing loans worldwide were supposedly U.S. sub-prime mortgage loans.
Most of the problem “Credit Crisis” loans or derivatives investments (a hybrid of a loan and an insurance contract) were “Interest Rate Option Derivatives” when investment banks bet on the future directions of interest rates. Interest Rate Option Derivatives are at the heart of the “LIBOR Scandal” (London Interbank Offered Rate – the biggest financial scandal in world history), the benchmark interest rate index used by hundreds of trillions of dollars of loans worldwide. In this scandal, banks and investment banks were supposedly told the exact direction of the future rigged interest rates so that they may profit from their derivatives bets.
The origin of “The Credit Crisis” was a downward plummet into a black hole-like financial Abyss. It should not be blamed entirely on U.S. homeowners or “flippers” as opposed to reckless investment bankers who enjoyed leveraging trillions of dollars with their risky financial bets.
Many large U.S. banks, Wall Street firms, automobile companies, airlines, and major insurance companies might have been technically insolvent in recent years. If they were forced to use standard bookkeeping methods like the rest of the Americans, their debts would greatly exceed their assets. As a result, these multi-billion dollar companies would be in bankruptcy court.
What is most frustrating to many Americans today is that these trillions of dollars of bailouts have helped many financial institutions better stabilize their overall portfolios and their balance sheets. Yet, these same banks have not rapidly increased their lending options for individual Americans or small to mid-sized businesses.
Financial Implosions & Investment Opportunities
After the end of The Great Depression and World War II and the collapse of the Savings and Loan industry, many investors created the bulk of their family’s generations of assets by picking up assets for literally cents on the dollar. Why pay retail prices when one may pay wholesale prices from motivated financial institutions or individual sellers?
I used to hear stories shortly after the creation of the RTC (Resolution Trust Corporation) which involved apartment building deals in Texas which sold for something like $800 or $900 per apartment unit back in the early 1990s. If the apartment building was a small 10 unit apartment deal, then the sales price may have been close to just $8,000 or $9,000. If the apartments were possibly 100 units, then the apartment might have sold for $80,000 or $90,000.
I wonder what these same apartment buildings may sell for today. I also wonder if the monthly net cash flow today exceeds their original purchase prices. There are few better real estate investments anywhere in the USA than apartment buildings because we all need a place to live.
The word “Crisis” allegedly is derived from two characters in the Chinese language, which may represent both “Danger” and “Opportunity.” Yes, the financial implosion we have endured since 2007 has been quite scary. Tragically, the real estate implosion when considering median home price percentage losses was even worse in recent years than what people experienced during the depths of The Great Depression.
In almost every well known financial implosion time period, recession, or depression these past one hundred (100) years, boom time periods preceded bust time periods when “easy money” time periods such as “The Roaring 20’s” and the early 2000s were followed by “tight money” time periods (or “slam the brakes” on capital access), due to higher interest rates, tougher margin or capital reserve requirements, and / or more challenging underwriting guidelines like today.
When “tight money” time periods later ease up again, then property values typically increase significantly such as what he have seen between 2012 to 2013 primarily due to near record low interest rates. The most important factor for real estate is related to the availability of capital in order to get in, and to get out of the investment. Let’s hope that underwriting guidelines ease up a bit more so that more people may qualify for loans again!
Fortunately, the combination of near record low interest rates, home listing inventory levels near twenty (20) years lows, and motivated real estate investors who are tired of earning negative net returns from their local bank branches are helping to lead the way back for impressive real estate price gains in recent times (6% to 20% + annual price gains in various U.S. regions).
Life and investments are truly akin to a “rollercoaster ride.” We must hang on through all of the booms and bust time periods, and twists and turns just like so many Americans did through The Great Depression, The Savings and Loan Collapse, and the ongoing Credit Crisis. With persistence also comes opportunity, so please continue focusing on the goals or targets in your life as opposed to the obstacles that may stand in all of our ways.
Author: Rick Tobin
Rick Tobin has a diversified background in both the Real Estate and Securities fields for the past 25+ years. He has held seven (7) different Real Estate and Securities brokerage licenses to date.
Rick has an extensive background in the financing of residential and commercial properties around the U.S with debt, equity, and mezzanine money. His funding sources have included banks, life insurance companies, REITs (Real Estate Investment Trusts), Equity Funds, and foreign money sources.
You can visit Rick Tobin at RealLoans.com.