While the banking industry has yet to admit any legal wrongdoing for what has happened to real estate during the past ten years, it does not require a forensic scientist to determine that serious mistakes were made by banks and mortgage companies. These financial institutions would like the problem to go away — they have already paid legal settlements of several hundred million dollars to help move their criminal liabilities out of the court system and the public eye.
Foreclosures and Underwater Mortgages
It is not yet clear whether real estate and banking will ever be the same again. Extensive damage has been done, and in many cases banks have effectively stopped lending for commercial real estate and residential property in some areas. Foreclosure properties are a particular problem in at least ten states. Across the United States, approximately 20 percent of homeowners now owe more on their mortgage balance than their home is worth. While this number is down from levels several years ago, it is a very clear indication of the problem that the banks wanted to go away but is still with us.
Banks were pressuring for deregulation of their industry almost from the day that the Banking Act of 1933 was passed to address the bank problems that led to the Great Depression. Until they succeeded in this mission, the financial industry went through five decades of unprecedented stability. The Reagan administration provided the political atmosphere that accelerated deregulation in several industries.
The S&L Crisis Was Just the Beginning
It did not take long before things started to go wrong due to partial deregulation of the banking sector. The savings and loan crisis resulted in the failure of hundreds of S&Ls. But this did not stop bankers from pressuring for deregulation because they could sense that massive profits were waiting for them if they could just combine the activities of insurance companies, banks, and securities firms. The problem standing in the bankers' way was that the Glass-Steagall Act (as the Banking Act of 1933 was called because of the legislative sponsors of the bill) made such business combinations illegal. The simple reason for that was because such intermingling of sensitive financial operations was found to have provided much of the cause for the Depression.
During the 1990s, Citigroup and Travelers decided to merge even though the combined securities, insurance, and banking company was an illegal move under existing laws. The only practical solution (according to bank lobbyists) was to abolish the Glass-Steagall Act in 1999. This would also make it easier for the financial wizards to add more exotic investments like financial derivatives to their portfolio. In another smart move, they would step into a riskier area of real estate financing which became known as subprime mortgages.
Sheila Bair Knew What Could Go Wrong
Sheila Bair, head of the Federal Deposit Insurance Corporation, tried to tell us what was about to go wrong. When her predictions came true, the banks asked for a bailout to cover up and pay for their mistakes. We are all still paying for the banks' mistakes and will be for many years to come.
Should we have saved the banks? Sheila Bair's response is shown in the introductory image.