How much is $700 billion? Some perspective:

  • NASA will launch several missions into space in 2009, including remote robots on Mars and has a public relations and media department that puts most large corporations to shame. Cost? $17.6 billion, about 2 1/2 percent of the bail-out sum.
  • The National Science Foundation funds much of this country's research and education in astronomy, chemistry, materials science, computing, engineering, earth science and physics at more than 1,900 universities and institutions across the country for $6 billion, less than 1 percent of the bail-out.
  • From 2003 through the end of 2009, the total costs of the war in Iraq will be about $480 billion, one-third less than the bail-out sum.
  • It's about $20 billion more than the entire pay-out to the nation's social security recipients in a year.
  • It's about $2,300 for every person in America.

The latest credit crisis was about a year in the making, according to press accounts. But actually, it's only the "discovery" of the crisis that was a year in the making. The "set up" for the crisis was in 1999, nearly a decade ago. And actually, the roots go back decades, and those roots tap into government policy that changed the basics of banking. And, since the current crisis is widely agreed to be the most serious since the crash of 1929 that ushered in the Great Depression of the 1930s, it's not surprising the roots reach that far back! Until 1999, there was a clear dividing line between commercial banks and investment banks. The primary differences:

  • A commercial bank could legally take deposits for checking and savings accounts from consumers and then loan that money out to others, making its profit on the spread between what it paid depositors in interest and what it charged borrowers in interest. Furthermore, the FDIC insures deposits up to $100,000 to avoid "runs on the bank" like we saw after the crash of 1929.
  • An investment bank, on the other hand, does not have an inventory of cash deposits. It operates as an intermediary between buyers of stocks and corporate bonds and sellers of corporate stocks and bonds. Interest on bonds is paid to the bond buyers by the bond sellers, not to the investment bank. Instead, the investment bank just keeps a portion of the capital raised for itself; a "fee" that's referred to as the "underwriting discount."

But the line between the two types of banks blurred in 1999, and that blurring has been key in the downfall of big investment giants like Lehman Brothers, AIG, Merrill Lynch and several others yet to come. There are disturbing similarities between the crash of 1929 and what's happening on Wall Street today. Back then, it was caused by too many people taking out high-risk loans to buy stock; loans that were readily doled out by banks on the foolish assumption that the happy days of the "roaring '20s" stock market would continue indefinitely. It didn't. And when the bubble popped in 1929, people rushed to pull their money out of banks, only to find out it wasn't there because banks had loaned it all out for others to buy stock that had plummeted in value.



With banks basically ceasing to function in 1933, newly elected President Franklin Roosevelt put a few measures in place to prevent the same thing from happening again:

  • The Glass-Steagall Act, which forbade regular commercial banks (think Bank of America, pre-Merrill) from offering the services of investment and insurance banks (think AIG).
  • The Federal Deposit Insurance Corporation (FDIC), which promised to reimburse depositors if the bank failed.

Combined with the "lender of last resort" role of the Federal Reserve-the central bank of the United States that was created in 1913-the policies slowly brought confidence in the banking system and helped end the Great Depression.



Lehman Brothers, Merrill Lynch and AIG gamble big and lose. Fast-forward to 1999, when the portions of the Glass-Steagall Act that banned mixed banking were repealed due to pressure from commercial banks wanting to re-enter the lucrative stocks and bonds business. But all that did was make it legal for investment banks (banks for big players such as governments and corporations) to buy up commercial banks and engage in each other's businesses willy-nilly.



Propelling growth for the investment banks was the housing market, which, a few years ago, seemed unstoppable.



Companies such as Merrill Lynch and Lehman Brothers offered mortgages left and right, many to people with poor credit records, gambling that housing prices would continue to rise. They didn't.



Some experts fear the worst and predict that for the first time in recent American history, future generations could be worse off economically than their parents. Other economists doubt this dire outcome, but even "optimists" like Steven Fazzari, an economist at Washington University here in St. Louis says "it will be three to five years before things start to look much better." One thing all economists we've read so far seem to agree on is that the average American will likely feel the effects of what's happening on Wall Street. "I think people are going to live a more austere lifestyle," said David Sicilia, an economic historian at the University of Maryland. "We're going to travel a lot less over the next 10 years."



While some experts are in full-fledged panic mode, others say they're overreacting. They note that real estate had gotten overheated due to reckless lending and lack of oversight on Fannie Mae and Freddie Mac, but that this is all just a "correction" in an overheated bull market, not the beginning of a lengthy bear market like the Great Depression. They say the bail-out will stem the bleeding, government and banking will learn from their mistakes, and healing will "begin" within a year or two.



Complex causes. Why did banks get so reckless with mortgage loans? There are complex causes behind the recent stock market losses and the downfall of a number of major financial institutions. In general, banks lent money to too many people who were not qualified to pay it back, and when they defaulted on their loans, the reverberations spread far and wide. So why did banks get so reckless? Here is where things get VERY hot and VERY political.



Consider the following chain of facts:



1) People were living beyond their means. It used to be that people only took out second mortgages to pay for major home improvements that increased the value of their home. But for nearly a decade now, home equity loans were taken out to pay off car loans and credit card debts so people could deduct the interest-and get more credit cards. It worked so long as home values were increasing. But now millions are upside down in equity, owing more on the homes than the homes are worth-so they're just defaulting and walking away-leaving banks holding the bag. Now the taxpayers will hold it.



2) In 1997, critics began to charge that loan eligibility standards were unfairly discriminatory against minorities and the poor in general and demanded that standards be loosened. President Clinton bowed to that pressure.



3) In 1998, Franklin Raines and Ms. Jamie Gorelick from the Clinton administration were appointed to run Fannie Mae. They "interpreted" regulatory guidelines so loosely they were told by the chief accountant for the Securities and Exchange Commission (SEC) that their interpretation "wasn't even on the page" of allowable "interpretations." But, because their bonuses were tied directly to Fannie Mae loan volume, they began buying thousands of mortgages from banks who had granted them with no documentation for the borrower, no money down and for up to 120 percent of the property's appraised value! By 2004, Raines had claimed $100 million in personal bonuses; Ms. Gorelick had pocketed $75 million.



4) In 2003, President Bush was warned of the potential financial crisis brewing and proposed a new Congressional oversight committee to clean up Fannie Mae. It was rejected after four key Democrats blasted President Bush's proposal as discriminatory against poor people and racist.



5) In 2004, the Office of Management and Budget (OMB) found massive fraudulent bookkeeping at Fannie Mae that resulted in those huge bonuses for Raines and Gorelick every year since they were put in charge. Again, calls for hearings were rejected as an "attempted lynching" of Raines because he is African-American. Both were forced to resign under media pressure, but did not go to jail for the fraud and got to keep the combined bonuses of $175 million. Eventually they had to give back only $31.4 million.



6) In 2005, the "Federal Housing Enterprise Regulatory Reform Act" was sponsored by Sen. John McCain (R-AZ), member of the Senate's Armed Services, Commerce, Science and Transportation committees. He said, quite prophetically, "If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system and the economy as a whole." The reform act was blocked from even making it out of the Senate banking committee, the vote split along party lines; all the Republicans in favor, all the Democrats opposed.



7) Well, it's 2008 and now we learn that Fannie Mae (a government-sponsored entity, mind you) gave millions of dollars to the campaigns of 354 senators and congressmen from both parties. Some say they simply paid the House and Senate to "look the other way." Who got the most?



# 1 - Sen. Chris Dodd (D-CT) Chairman of the Senate Banking, Housing and Urban Affairs Committee.
# 2 - Sen. Barak Obama (D-IL) Member of the Federal Financial Management Committee.
# 3 - Sen. Chuck Schumer (D-NY) Chairman of the Senate Finance Committee.
# 4 - Rep. Barney Frank (D-MA) Chairman of the House Financial Services Committee.



Not one of these top four recipients of Fannie Mae contributions would support Sen. McCain's 2005 reform proposal. Not one gave back a dime of the Fannie Mae contributions. Now Fannie Mae and Freddie Mac are both bankrupt from all the bad mortgage loans they've bought from banks. Lehman Brothers is bankrupt from all the bad mortgages it failed to unload on Fannie Mae. AIG Insurance got $85 billion in loan guarantees after insuring bad loans and projects. Taxpayers hold the bag for all of it. And what happened to Franklin Raines? Republicans seethe that to this day he is top counsel to Sen. Barack Obama on housing issues.



Hope arises from history. After the terrorist attacks of Sept. 11, 2001, the American economy suffered a severe drop that had many experts predicted would escalate into a major recession. But within just a few months, consumer spending was booming again. Economists agree what's happening now is far more serious, a systemic problem rather than a single event that shakes confidence. And before that, in 1987, America experienced a massive stock market decline, dubbed "Black Monday," but afterward the country's economy was able to recover.



Then again, experts agree what's happening now is much closer to the environment that preceded the 1929 crash than the 500-point drop in the Dow in 1987. The consensus is building that while this crisis will prove to be the worst one since the Depression, they don't expect it to become another depression unless the government fails to come through with a bailout, even if they must hold their nose as they do it. As for their "legacy," the most telling test for the current Congress is what they do to admit their own complicity in it, punish those who were criminally negligent and deceitful, and install adequate checks and balances to insure it never happens again.



To contact Dan Manternach, editor and publisher of Doane's Agricultural Report, call (800) 621-2845 ext. 310 or e-mail dmanternach@doane.com.