Can We Avoid Another Cataclysmic Meltdown Of The Global Financial System?

What Can Be Done  To Avoid Another Cataclysmic Meltdown?

Identify The Problems With the American Housing Market

My take-aways from The Economist Magazine’s “Briefing on Housing  in America” has shed some light on what I believe can and should be done. This briefing provides sufficient evidence as to the importance the American housing market plays in in the American economy, in the health of our financial system and in the global financial system. I have concluded that if our financial system is to avoid another train wreck,  addressing some of the problems in the American housing market must be a first priority. And a way to implement some of the suggested  interim solutions must be found.

Develop A Strategy for Reigning In Our Financial System

Clearly we must not allow our broken financial system to self correct, as I fear history will repeat itself and the next crises will be even worse. We have been forewarned that the next meltdown will in all likelihood, result in more widespread and severe losses to both the American and global economy, that ensuing recession could easily morph into a depression, and that the economic recovery will  be even more anemic and protracted than what we are experiencing in 2016.

Identify Specific Actions That Could Work

But I am not a total pessimist, even though the many of the changes that are discussed in Ms. Foroohar’s book are relevant and much-needed, it is my opinion that their implementation requires levels of cooperation and political will that are not now in evidence.

I believe that it may be possible to influence the trajectory of the course we are on. And we may even be able to avoid a significant meltdown, if we concentrate on specific practical and synergistic actions for which there is broad  support. Here are some of the ideas that could work.

Modulate The Bubble-Meltdown-Recession-Recovery Cycle

To formulate these specific actions I believe we first must have a reform strategy designed to `prevent the global financial system from spinning out of control. To do this, ways must be found to interrupt the cycle that creates bubbles that suddenly burst and deep and protracted recessions. Although  bubble formation, financial meltdown and recessionary cycles will always be with us, their impact  can be modulated if we recognize  the mindsets that trigger repeating these cycles and initiate actions that can bring about changes in market  driven behavior.

Stop Fooling Ourselves

As the Economist article points out, America’s economic and financial problems are a direct consequence of our addiction to debt and to how we have been fooling ourselves.  We are using hidden subsidies to mask the wealth inequalities in our economy that occur as a result of not controlling this addiction. They also point to the fact that we are in a continuing state of political gridlock, that has severely impeded efforts to mitigate our problems.

Focus on Fixing The Mortgage Finance System: Deal With The Existing Mindsets

The previous discussions support my conclusion that the place where our deepest problems converge is in our mortgage finance system. It starts with the aspirations of most Americans, that of being a home owner, even if one’s dream home costs a bit more than planned and requires us to borrow more that we would like..

This mindset spills over into the realm of mortgage originators, who are market-driven to originate as many mortgages as possible, even if the potential buyer can barely meet the minimum equity requirements. This leads to granting buyers extended periods in which to repay their mortgage obligation using fixed interest rates, as a way to keep uniform payments within reach of potential buyers.

Mortgage  originators also  have developed a cavalier mindset with respect to risk, as they will seek out less qualified borrowers who they can charge with higher rates and fees, knowing that they can bundle these mortgage loans with higher quality ones and re-sell them to state-run securitizers.

Likewise, these securitizers are incentivized to either buy and hold these mortgage bundles, knowing that  they are implicitly backed by government guarantees, or they can profitably be resold to institutional investors in the form of relatively risk free mortgage bonds.

Offer Specific Fixes

As long as the mortgage  finance system remains as part of our market economy, the mindset of each of the players will be to continue with this broken model.  But there are alternative approaches to force  this “mortgage machine” into a less risky trajectory. One approach is to privatize the mortgage securitization firms, including Fannie Mae and Freddie Mac. This would make the mortgage finance system operate more like the banking system, by requiring them to recapitalize and raise their fees while offering acceptable rates of return. This reform would incentivize the use of more prudent securitization practices as risk of loss is passed onto private investors, instead of the Federal Reserve and ultimately, the US taxpayer.

In addition state-run mortgage securitization firms should not be permitted package their mortgage bonds into derivative securities  such as CDOs and sell them to investors.  They should also be prohibited from offering swap contracts and sell them to reinsurance firms.

Private mortgage securitization firms should only be able to trade derivative products, using funds  generated from trading such products and not from funds generated by selling government backed mortgages bonds or from loan proceeds obtained using mortgages bonds as  collateral.

Likewise, mortgage originators should be required to tighten up on the terms being offered borrowers  by requiring  larger down payments, by reducing repayment periods, by eliminating big balloon payments, by  requiring more thorough property inspections and appraisals, and by verification borrowers’ earnings, employment credit history.

It would be important to consider having mortgage originators impose loan-to-value (“LTV”) limits on borrowers, in a way that adjusts to reflect any significant decrease in comparable housing prices. Such a program could require borrowers to protect against average price  drops of no more than 10% in a given year, by requiring borrowers to  reduce the amounts owed on their mortgages. This probably can be done if borrowers are offered shorter term adjustable rate mortgages with interest rates that could be temporarily relaxed to help subsidize the added principal payments needed to meet LTV Ratio requirements. It is worth a try!