Halloween and the Derivatives Goblin

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Halloween is approaching with ghosts, goblins and witches galore. This year the Democrats will not be pointing to the ghost of George Bush as they did in 2008, because he is just not that scary anymore. Also, we will not be hearing too much about witchcraft in Delaware as Ms. O’ Connell is well behind in the polls. Here in Pennsylvania, however, Democrats will continue to air ads about the "Derivatives Goblin."

Attack ads alleging that Pat Toomey made a career pioneering derivatives that led to our recent financial crisis are incorrect and misleading according to non-partisan sources. However, the Democrats and Mr. Sestak persist in making Mr. Toomey the Derivatives Goblin. They contend that a major contributing factor to the economic crisis was the use of derivatives. Mr. Toomey, who left the financial sector years ago, did work with derivatives – – interest rate and foreign exchange derivatives. Most economists believe the housing market collapse was the leading factor causing our recent financial crisis. No serious economist contends that interest rate or foreign exchange swaps led to the crisis. Some – not all by any means – believe that another form of derivative, the credit default swap (CDS) played a role into the housing crisis.

Real estate prices were run up to unsustainable levels by rampant demand. Democrats would have us believe that the housing market collapse was due a crisis of confidence in the market caused by lax regulation and the ability of large financial players to bet against the mortgage securities through CDS. The real problem was not that some investors could bet against the market, but rather that banks that originated the loans did not have enough skin in the game. They sold their loans into pools of mortgages bought by others which assumed the risks associated with deteriorating lending standards.

Furthermore, the existence of government supported entities, Fannie Mae and Freddie Mac, through which many real estate loans were repackaged and sold to others, gave investors the sense that these instruments were financially sound. It should be noted that when Rep. Chris Shays (R, Conn.) questioned the sufficiency of Fannie Mae’s equity base, that he was chastised not by "pro-deregulation" Republicans, but by Rep. Maxine Waters (D, Calif.)

The bottom line is that real estate market collapsed because prices were unsustainably high. Individual home owners and developers bought properties that they could not afford in the long run. They had plenty of help. Laxer underwriting standards, in part, encouraged by Clinton era government regulations favoring home ownership by lower income individuals, made it easier to obtain mortgages. Also, mortgages that were deemed "innovative" offered borrowers payment structures that were manageable in the near term , but could balloon over time. Many were encouraged by mortgage brokers (who themselves were many times clueless) to sign up for mortgages they did not understand. However, I do not believe Americans are that dumb – – there were many people who knowingly bit off more than they could chew.
The trotting out of the derivatives goblin by Democrats and Mr. Sestak is not just a Halloween prank. The ads are incorrect. But what is more frightening to me is that that Mr. Sestak and his fellow Democrats in Congress may actually believe their ads, and do not fully understand the causes of our financial crisis and their complicity in the debacle.

Denise M. Furey is a corporate bond analyst and a Republican Committeewoman in the 27th Ward in Philadelphia. She can be reached at [email protected]