Professor Jasper Kim on the Financial Crisis
Professor Jasper Kim, of Ewha's International Studies Department, published a column, "The global financial crisis 101," in last Thursday's Korea Herald that helped clarify for me our current financial crisis, so I'll provide a synopsis of his article.
Professor Kim presents a number of factors contributing to the perfect economic storm.
As the first factor, Kim identifies "the extremely low interest rates following the 9/11 attacks." The Federal Reserve cut rates to about 1 percent for some time, which resulted in very low interest rates on loans, including mortgages, and led to "cheap money."
As the second factor, the low mortgage rates were "coupled with relatively complex mortgage terms and conditions that were often hard to understand for the typical homebuyer." Significant for this point was that mortgages that required "only a 1 percent down payment . . . to buy a home" often had variable interest rates that would result in "lower interest payments . . . first, followed by larger principal payments later." These generous-sounding terms "induced many relatively unqualified borrowers to buy homes they in reality could not afford," and the loans were what have been called "subprime."
As the third factor, Professor Kim identifies "complex financial products that had a direct link to the U.S. mortgage market." On this complex factor, I need to quote the professor directly:
These products, known as mortgage-backed securities, or MBS -- one type of collateralized debt obligations, or CDOs -- were effectively represented by a high-yielding note or bond that entitled the MBS investor to principal and interest payments. These MBS products were also collateralized by money received from pooled mortgages (mortgage receivables). As part of the MBS structure, created by sophisticated financial institutions, investors who bought these MBS products effectively also bought "insurance" against payment default in the form of credit-default swaps, or CDS. So as long as mortgage borrowers continued to make their mortgage payments on time, no problem would exist.I won't pretend to understand this very well, but I do understand enough to recognize that a lot of people had put their money into investments that depended upon mortgage borrowers continuing to make payments. Unfortunately, the US housing market was a bubble that burst as interest rates began to rise, requiring those who had taken out loans, especially subprime loans, to make higher payments that they could not make.
As the fourth factor, Professor Kim identifies "the fall of many of the major investment banks, such as Bear Stearns and Merrill Lynch," which had incurred enormous losses from the large number of bad mortgages on their books. The psychological breaking point was the fall of Lehman Brothers, which put global financial markets into a tailspin. Interestingly, the professor blames "the laissez-faire ideological stance that existed at this time," which prevented "a Lehman bailout of even a few hundred million dollars" that "would have . . . proved a much better policy move compared to a plethora of bailouts and stimulus packages that . . . looks to be in the trillions . . . of dollars."
Well, that's Professor Kim's analysis. Doubtless, the factors are both more numerous and more complex than these four, but the professor does call his article "The global financial crisis 101," thereby acknowledging an oversimplification of the issues. Moreover, as "a former banker with Lehman Brothers, Barclays Capital, and Credit Suisse," Professor Kim would appear to be a person who knows what he's talking about . . . though I must confess to a nagging doubt about precisely what bankers really do know, given their failure in this crisis.
Comments from those more knowledgeable than I are very welcome . . . and that category would include the majority of my readers.