Observations on the Meltdown
of the U.S. Financial Sector

Edward J. Dodson

[Comments provided to C-Span in response to a program aired 22 April, 2010, a roundtable discussion with journalists Louise Story and Kara Scannel]

In the discussion of the financial meltdown and the role of bank-created derivatives and other financial instruments the repeated assertion is that no one saw the crisis coming. This is certainly not the case, although those analysts who attempted to provide warnings were ignored or instructed by their superiors in some organizations to keep their views to themselves. The senior executives of many financial organizations were promising annual double-digit earnings to stock analysts and to shareholders. The only way to accomplish this at a time when the profit margin on conventional mortgage lending was narrowing was to move into higher risk markets and generate huge transaction volumes.

As a market analyst and business manager with Fannie Mae throughout the 1990s and until retiring in 2005, I participated in numerous meetings and discussions in which concerns were shared over the expanding incidences of fraud, misrepresentation, predatory lending practices and the efforts by Wall Street and the major banks to by-pass the GSEs and the uniform standards of loan eligibility and borrower creditworthiness that were continuous under evaluation. What is now described as the "sub-prime" mortgage market emerged after the 1986 Tax Reform Act created new opportunities for tax advantages for borrowing subject to a second or even third mortgage lien. We should not be surprised that this business, which was always plagued by unscrupulous participants, proliferated.

As early as 1992 or 1993 it was clear to many of us that property prices were escalating at an unsustainable rate, while household incomes and household savings were losing ground. What few mainstream analysts acknowledged (even if they had an understanding of the dynamics) was that property markets are driven by land markets, which are inherently speculative and dysfunctional. I was fortunate to make the acquaintance of several economists whose research focused on the operation of land markets and the effects of various public policies (particularly tax policies) on the effectiveness of price as a market clearing mechanism. What this small group of economics professors argued is that price does not clear markets for locations as price does for labor, capital goods and (for the most part) credit. British economist Fred Harrison had provided evidence in his book 'The Power in the Land' published in the early 1980s that an 18-year land market cycle was the key driver of what we commonly think of as business cycles. He accurately forecasted the property market crash of the late 1980s and described in detail the reasons for the collapse of the Japanese economy. In 2003, he approached me to provide him with research assistance on the United States economy for a book he was working on that warned of the coming property market crash and the domino effect this would have on the economies of the United States, the United Kingdom and other countries where property markets were stressing economic stability. Harrison's book, Boom Bust: Housing Prices, Banking and the Depression of 2010, appeared early in 2005.

After retiring from Fannie Mae, I decided to revisit my research on the United States and try to look at the long chain of legislative changes, deregulation, innovations in the financial sector and other variables that brought us to the precipice of the depression Fred Harrison was predicting. What I conclude is that any reasonable person could see the collapse coming as a result of the actions of our legislatures and regulators going back to the early 1970s. Why senior people at the Federal Reserve or the nation's economic think tanks failed to see the connections I can only ascribe to theoretical or ideological blinders. I have put my finding into presentation form with the title "Death by Debt Strangulation" and placed a narrated version online at a public website called Authorsteam.com. I invite you to take a look at this material; and, if you have any interest in talking with me about the analysis I will be pleased to do so.

There are several economists besides Fred Harrison who could shed additional light on the issues I am raising. Bringing them together for a roundtable discussion might be highly informative. They include Nicolaus Tideman (Virginia Polytechnic Institute); Mason Gaffney (University of California, Riverside); Fred Foldvary (Santa Clara University); Kris Feder (Bard College) and William Peirce (Case-Western University).

I will be out of the country beginning this Saturday until Tuesday, May 4. You can then reach me at 856-428-3472.