Just some thoughts we were discussing in class last semester, given the rhetoric about "Zombie Banks" from Nouriel Rhoubini and others.
In the 80s, we discussed the thrift problem in terms of "zombies" -- some institutions were technically dead, but their existence threatened the other, well-run banks. Just like Romero's zombies from "Night of the Living Dead," these things were artificially kept alive by regulators and their incentive structures were all screwed up. They took on more risk and paid higher deposit rates and hurt their across-the-street competitors and raised everyone's costs.
Romero zombies are the walking dead that eat the living (as distinguished from Haitian zombies, which don't really exist). They will continue to seek and eat the living until their diseased brain is disabled. Max Brooks' "Zombie Survival Guide" or "World War Z" stand as good references here. Michael Lewis' "Liar's Poker" is a good reference for the zombies of the S&L era.
WaMu (or Wachovia home lending) are good examples of that kind of thing today, but I'd argue that most institutions that are in trouble today (starting with Fannie and Freddie) are technically The Possessed and not zombies. They may still harm the living, but they are the manifestations of pure evil in a living host and not the dead brought alive to walk again. Big distinction!
In Sam Raimi's classic film "The Evil Dead," several youngsters (meddling kids) visit the omnipresent cabin in the woods and replay an audio tape of a scholar's reading from The Necronomicon, or the Book of the Dead. This awakens a disembodied evil in the forest that begins to possess them one by one, leading each possessed partier to attack the others in turn. Finally, our hero Ash (portrayed by the terminally underrated Bruce W. Campbell) manages to replay another incantation and send the evil spirits back to their own dimension.
"How does this relate to our current situation?" you ask.
Freddie and Fannie worked fine for years and years before Congress decided that their role could be expanded to backing subprime stuff. Big banks were encouraged, if not outright required, to purchase subprime and "liar" (AKA stated income) loans to meet their Community Reinvestment Act obligations. Most of this activity accelerated in the early 1990s, but it was continued and encouraged by every Congress and administration since Carter. Washington, again, forgot the unintended consequences of messing with the markets.
To be sure, there was enough greed to go around. Congress was hungry to get the credit for "helping" people get home loans. Same with a few presidents in there. Mortgage bankers were hungry to make all those loans and pass them off to investors who had hedged their risk in the credit default swap market. Moody's and S&P gave up trying to rate mortgage-backed securities properly and ignored the risk of credit default swaps in large part. Mortgage originators didn't care whether or not their customers could ever hope to repay loans on homes in CA and elsewhere that were terribly overpriced. Sure they were overpriced -- FHA and others were pumping money into the markets. Congress argued that FHA limits were too low (which, by the way, Frank in the House and Dodd in the Senate have argued again this summer. It continues).
We have a few zombies this time. With WaMu charging no fees and offering services galore, it's hard for the little bank on the corner to compete. It drives down margins and profitability, and therefore capital (via retained earnings or surplus). Pretty simple to understand. Also, if folks worry about WaMu (as they should) they might worry about MyLittleBank and cause it some funding anxiety in the short-term.
With Wachovia creating "Pick-a-Payment" mortgage loans, everyone has to cut their fees to compete. GoldenWest (which was bought by Wachovia and started the trouble there) was making loans based on appraised home value, not based on the borrowers' abilities to repay. And they were getting press and bragging about it! Wow!
But the big distinction this time around is the "possession" of the housing aftermarket by Congress and political types in general. In their effort to "do good" they really threw a bubble into the market, and corrupted the legitimate mortgage-backed security market and the for-fee ratings agencies. There's no trust left in any of it.
Raimi's Evil Dead promised to "swallow your soul." And it looks as though the soul of the mortgage markets will be swallowed for a while to come.
