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Saturday, October 15, 2011

Occupy Wall Street? How About "Understand Wall Street"?

"Occupy Wall Street" certainly has gotten a great deal of media attention. That's not surprising. The protestors rail against Wall Street as a center of "greed," and that tends to conform to the predominately liberal media's view of matters.

While there's always been left-wing and populist opposition to Wall Street, these "Occupy Wall Street" protests obviously have been, in part, a response to the deep December 2007-June 2009 recession, which included the credit mess coming to a head, and the subsequent dismal recovery. And since the political class and various parts of the media have pinned blame on banks and Wall Street, it follows that these protestors have placed Wall Street at the top of their target list.

But rather than ultimately pointless protests and marches to "Occupy Wall Street," perhaps it would be better if people undertook an effort to "Understand Wall Street."

Part One of "Understand Wall Street" is that, contrary to what assorted politicians have failed to mention or simply denied, the government played a key role in bringing about the housing/mortgage mess.

Let's review three major policies that played central parts in this sad economic story.

First, there's the Federal National Mortgage Association (Fannie Mae), set up by the federal government in 1938 and converted to a "government-sponsored enterprise" in 1968, and the Federal Home Loan Mortgage Corporation (Freddie Mac), set up in 1970. These GSEs had private shareholders, but also were under political control. And with the implicit backing of federal taxpayers, Fannie and Freddie were able to borrow funds at lower rates to purchase mortgages. In the early 1990s, Congress mandated an "affordable housing" agenda for Fannie and Freddie, with the Department of Housing and Urban Development cranking up the share of Fannie and Freddie's new loans that had to go to low and moderate-income borrowers. Late in the decade came mandates for smaller down payments and bigger loans relative to income. For good measure, changes to the Community Reinvestment Act in 1995 required that banks step up lending to so-called underserved communities. All of this meant mortgages based on political preferences, rather than sound finances and economics. That is, a vast increase in low-quality mortgages at the behest of politicians.

Second, the Federal Reserve kept short-term interest rates at historically low levels from 2002 into early 2004, creating a bias in favor of more debt, including increased use of adjustable rate mortgages. Once short-term interest rates started climbing, economic reality hit. Bad loans translated into rising default and foreclosure rates. Many borrowers with little equity in homes walked away. The value of mortgage-backed securities plummeted.

Third, after the Enron mess, new accounting rules imposed, with approval from the Securities and Exchange Commission, mark-to-market asset valuation. In the housing mess, financial institutions were forced to revalue assets, even when the value of those assets may not have been known, when price declines were temporary for assets that could be held to maturity, and/or when a mortgage, for example, was not in default. The write-downs required larger reserves, and hence financial firms got sucked down.

So, while various banks and some on Wall Street played willing partners, it was the government - our elected officials - who called the tunes.

Part Two of "Understand Wall Street" is to simply review the role of Wall Street in our economy.

The populist notion that it's Main Street vs. Wall Street is mistaken. In fact, when Main Street businesses see opportunities to innovate, boost efficiency, expand, grow and hire more employees, they need to get the necessary capital. "Wall Street" is that capital market. It is Wall Street that provides a liquid, fluid, and deep market in which entrepreneurs and businesses can access the capital they need.

And these capital markets ensure an efficient allocation of capital. Both profits and losses serve as signals to investors as to where they should invest their capital, and when they might need to reallocate that capital.

In the end, that's what "Wall Street" is. So, the idea to "Occupy Wall Street" as a protest in effect is a protest against small, medium and large businesses that need capital to create new goods and services, to innovate and improve products, and to expand employment.

Hmmm, ironic, isn't it?

Perhaps if they truly tried to "Understand Wall Street," the "Occupy Wall Street" forces would be transformed into something along the lines of "Occupy Washington." Or, it could just be that the leaders of the "Occupy Wall Street" movement, if any leaders exist, are all about a blind anti-market ideology, in which case the chances that they would be open to "Understand Wall Street" would be darn slim.


Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His new book is "Chuck" vs. the Business World: Business Tips on TV.

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