Sunday, March 15, 2009
News, Q&A

Out of the crisis

Atlanta business guru Gary T. Jones on how the financial meltdown happened—and what we need to do next

By Diane Loupe

In an opinion piece for the Wall Street Journal last week, former Federal Reserve Chairman Alan Greenspan wrote: “There are at least two broad and competing explanations of the origins of this crisis. The first is that the ‘easy money’ policies of the Federal Reserve produced the U.S. housing bubble that is at the core of today's financial mess. The second, and far more credible, explanation agrees that it was indeed lower interest rates that spawned the speculative euphoria. However, the interest rate that mattered was not the federal-funds rate, but the rate on long-term, fixed-rate mortgages.”

This is all familiar ground to Gary T. Jones, a retired managing director of mega-bank Credit Suisse First Boston and a professor in Georgia Tech’s College of Management.

Jones knows a lot about the subprime mortgage fiasco.

He was L. F. Rothschild’s youngest partner in charge of high-grade corporate bond trading and sales, and worked at the investment banking firm Donaldson, Lufkin, & Jenrette (DLJ), which eventually merged with Credit Suisse First Boston. He teaches a popular course for MBA candidates and upperclassmen on the management of financial institutions.

The Sunday Paper recently asked Jones for an overview of how our current financial mess came to be, and how it might be corrected.

Who’s to blame for our current financial mess?

Every possible constituency imaginable was complicit in exacerbating this bubble. There is enough blame to go around for everyone, from the sourcing of the loans and the forces that inflamed the origination process, to the rating agencies, to the bond insurers, to the Financial Accounting Board, to the Securities and Exchange Commission, to Fannie Mae and Freddie Mac. The investment managers who, through their insatiable appetites, demanded more and more mortgage products, all contributed to make this truly a “perfect storm.”

Are housing bubbles cyclical?

Housing bubbles happen when prices expand so fast they burst. We had them in 1942 through 1944, 1957 to 1960, 1974 to 1975 and 1988 to 1990. For example, in 1980 a house near mine in the New York area was worth $250,000. By 1988, that same house was worth $1 million, a 400 percent increase. In 1990 it was again valued at $250,000, and in 1997, back up to $1 million.

In 2005, we were due for another bubble. But what was different this time was that lending standards were less regulated. There was enormous pressure from mortgage originators, mortgage bankers, mortgage insurers, bond insurers, investment banks, rating agencies, regulatory bodies like SEC, accounting firms, Congress and community organizations like ACORN [the Association of Community Organizations for Reform Now] to drop standards. They wanted everyone in the country to own a home. It was like putting fuel on a fire. It wasn’t just providing homes to people who were financially irresponsible; it was providing homes to people who were financially unqualified.

Before this period, you had to put a down payment of 20 percent to 30 percent to own a home. But in 2003 to 2006, they were doing mortgages that were 120 percent of the value of a home. There are 600,000 mortgages out there that are five to six times the annual income of the buyer.

What’s more, many of these loans were made with no documentation, no employment verification. We call them liar loans, or no-income, no-asset loans: loans made in which the borrower did not have to prove any income or assets. This lending model assumed that the price of a house always goes up.

Should lenders have expected the housing bubble to burst eventually?

We knew there was another housing bubble coming. One comes around every 15 to 18 years. What made this one so bad is that everything was so leveraged. So, when you paid a bank a fee of $1,300 for a mortgage, that money was spent on fees for income verification, appraisals, checking FICO scores [a credit score developed by the Fair Isaac Corporation]. But the institutions thought, “We don’t need to check on any of that, and we’ll just keep all the fees.” Remember “the price of a house always goes up"?

What needs to happen to stop the slide and get us back on track?

There has to be a major correction on prices. The condos at Atlantic Station that were originally $470,000 recently sold for $270,000. This correction is going to put a major stress and strain on the markets. The system has to de-leverage itself. It’s going to be a four-year to five-year correction. I think the stimulus package will help. Private equity firms are not just buying one house, they’re buying a lot of houses at bargain prices.

What do we need to do to prevent this from happening again?

We need to go back to doing due diligence in the entire process. If I’m going to give Diane Loupe a $100,000 loan, I need to look at her bank statement, her FICO scores, and be sure that she is a responsible and reliable person. SP