Fixing America’s Broken Banking System

By Mike Colpitts

Beset by a series of frauds, failed accounting practices, lack of proper government oversight, including the failings of law enforcement agencies America’s banking system is broken. At the heart of the massive problem are the nation’s two mammoth mortgage giants, Fannie Mae and Freddie Mac, also known as America’s biggest money pit.

President Barack Obama is joined by (left to right) Council of Economic Advisers Chair Christina Romer, Treasury Secretary Timothy Geithner, National Economic Council Director Larry Summers and OMB Director Peter Orszag.

Government officials are working to come up with a plan to repair the lenders, who represented the dream of American homeownership. The struggling U.S. economy may go on suffering until the broken bank lending system is reformed and new policies are adopted to fix the ailing mortgage lending market. The financial crisis that nearly destroyed the economy was rooted in financial manipulation that stemmed from Wall Street working in concert with mortgage lenders.

Authorities were either asleep at the switch or agencies that police the businesses didn’t care to look to far to find out what was going on. But today’s problem is much bigger than the financial crisis that government bail-out programs may finally be making inroads at over coming.

The crisis at Fannie and Freddie, which supply upward of 80% of all U.S. mortgages is magnified by the reality that both lenders are on government life support, and have been for more than a year and a half. The Treasury Department has bought $1.4-trillion in mortgage backed securities in part of the government’s efforts to heal the ailing economy. The purchase of mortgage securities came to an end by the Treasury and the Fed last Wednesday. Tax payers are footing the bill.

The crisis is also magnified by the fact that the U.S. economy is fully dependent on a banking system that works and operates efficiency in order to sustain successful business commerce. The over extension of credit has ruined hundreds of banks and bankrupted businesses and is certain to take down hundreds more.

As the government winds slowly through its process to repair the broken system, the unprecedented number of foreclosures rise. The crisis is impacting every income level and all mortgage types.

“The housing finance system clearly cannot continue to operate as it has in the past,” Treasury Secretary Tim Geithner told Congress. “A broad reform process of the housing finance system must be undertaken to achieve comprehensive and effective reform that delivers a more stable housing market with stronger regulation, more effective consumer protections and a clearer role of government with less risk borne by the American tax payer.”

The failures of Fannie and Freddie are part of the massive financial crisis, which revealed flaws in the “entire housing finance system,” Geithner said. A successful lending system is key to home financing, and the stability of housing markets. “The risk of a fall in home prices was ignored by most and there was too much leverage in every part of the system,” Geithner told lawmakers.

Ignoring the decline in mortgage origination quality under-writing standards set the stage for the real estate crash. The failures of Fannie and Freddie were symptomatic of the financial crisis. “They were allowed to earn private gains for many years,” Geithner said. “But ultimately the taxpayer subsidized their losses. They were allowed to expand and manage their investment portfolios without regard to the risk they posed to the system.”

The White House is working on a plan to repair the system, and is listening to experts in finance and education for its cues to reform a system that was destroyed over years of fraud and neglect. How the government sets out to repair and reform the banking system is critical to the stabilization of housing markets.