1938 Fannie Mae created by FDR as a government agency to create liquidity in the mortgage market. In 1968 it was converted to a private corporation.
1977 President Carter signed into law the Community Reinvestment Act. On the face of it it sounds like a good thing. Banks were required to make mortgage loans available to people with low incomes and bad credit in areas where they took deposits. The banking community was utterly opposed to the legislation thinking there would be a glut of foreclosures as a result of making these loans.
The Act wasn’t all that strictly enforced at first. Banks took out advertising in lower income areas but people are not, in general, stupid and did not apply for mortgages they knew they could not afford. If only people continued to be that smart.
1995 President Clinton had ordered new regulations for CRA in 1993. These regulations went into effect in 1995 and increased access to mortgage credit to distressed income areas. Community groups were paid fees by banks for marketing these mortgages in their areas. Banks were still facing fall out from the savings and loan crisis and were merging like crazy. They needed to comply with the CRA in order to get approval to merge and continue to do business so they were under enormous pressure to make lots of loans. The number of CRA loans increased 39% between 1993 and 1998 while other loans only increased 17%. These are called subprime loans; loans made to borrowers who do not qualify for traditional mortgages due to risk factors such as low income, employment status, credit history or lack of down payment.
Within five years the default rate was pretty high.
What made this mess worse was to some wits on Wall Street devised a way to sell rights to payments and credit risk to investors. These are called Mortgage Backed Securities (MBS) or Collateralized Debt Obligations(CDO). Or robbing Peter to pay Paul. They knew a lot of these mortgages would default and by selling them they made up the money ahead of time. Since the MBS had very low credit ratings, since they were based on highly risky mortgages, the investment bankers and traders (the dumbest of whom are way smarter than any Senator trying to regulate them) bundled the mortgages into what are called equity (high risk), mezzanine (middle risk) and the much sought-after investment grade bonds (low risk).
Higher
risk equals higher returns, of course, so the equity tranche of the MBS
will earn the highest profits if things go well. But if things start to
go wrong, the equity is lost first, and then the mezzanine. Even then,
the investment-grade bonds could still get fully paid out. This
persuades the credit ratings agencies to give the lowest-risk tranche a
high enough credit rating to qualify for the critical investment grade
rating.
Smoke and mirrors. We’re talking about debt here. Not anything you can sink you teeth into. People are buying debt. Debt is lack of money.
Bankers (Bear Stearns being the first in and the biggest market maker – how’s that working out for you guys? Guys? Oh that’s right you don’t exist anymore) distributed the defaulting debt among all the investors. Kind of like charging up a huge bill on your American Express and then charging that to Visa, Discover and Mastercard. You know you can’t pay it so make the other guy pay. When you default not only is Amex out the money so are the other guys.
Fannie Mae was receiving a lot of money, affordable housing credit, for buying subprime securities.
Wiki explains better than I could….
"Fannie Mae (and Freddie Mac) buy loans from mortgage originators, such
as banks and non-bank mortgage firms. It repackages the loans, as mortgage backed securities , and sells them on the secondary mortgage market,
with a guarantee that the interest and principal will be paid, whether
or not the original borrower pays. Also, Fannie Mae may hold the
purchased mortgages for its own portfolio. By purchasing the mortgages,
Fannie Mae and Freddie Mac
provide banks and other financial institutions with fresh money to make
new loans. This gives the United States housing and credit markets
flexibility and liquidity."
Essentially they were guaranteeing bad loans. Why? Because they were making money at it.
2003 Housing prices are through the roof. Banks, under pressure from Fannie Mae who is guaranteeing all the mortgages, lowers standards for mortgage qualifying even more so people can continue to get mortgages they can’t afford. Bankers are now working on commission so they have great incentive to sell people larger mortgages than they need encouraging them to use the money for the house.
Criminally stupid.
President Bush, seeing where this was headed, tried to create an agency to oversee Freddie Mac and Fannie Mae and completely overhaul the housing lending industry. The new agency would be part of the Treasury Department. The Democrats stopped it. Why? Why would they want this disaster waiting to happen to continue? Fannie Mae contributed money to their campaigns. Buckets o’ money.
2005 Senator John McCain co-sponsors The Housing Enterprise Regulatory Act of 2005. It called for regulation of Freddie and Fannie. Democrats blocked it.
2007 In February the stock market plummeted. Housing prices are declining making those mortgages worth even less. Gas prices are up, food prices are up and people are defaulting left and right.
100 mortgage companies go bust in 2007
There is a a worldwide downturn in the financial markets.
2008 There is, what as being referred to as, a worldwide credit crisis. Citigroup and Merrill Lynch have written off billions in bad loans. The banks are terrified to lend anyone any money which slows business on Wall Street to a near standstill. In March the rumors started about Bear Stearns. It was said they were having "liquidity problems". That’s Wall Street speak for "they have no cash". It wasn’t true, Bear did have cash but the rumors caused the stock to fall like a boulder. It was a run the likes of which the Street had never seen and the death of Bear Stearns was the end of an era. Bear had an entirely different culture than the old money firm I worked for. It was brash and crude and smart and they made money hand over fist. They made it honestly and they worked hard for it. The best stayed and made more money and the second best were tossed out. It was dog-eat-dog and few could take the pressure. They were unapologetic and they were successful. Capitalism at its crudest. When "the Bear" collapsed I felt badly. Badly for the people who built the firm and badly for the poor bastards who had nothing to do with the collapse but were out pounding the pavements anyway.
I digress.
On September 15th Lehman Brothers fell. The rumors had been flying for months but Richard Fuld, Chairman and CEO had been singing "Don’t Worry Be Happy" at the top of his lungs the whole time. That same day Merrill Lynch was bought out in a 50 billion dollar deal by Bank of America. Insurer AIG is largely believed to be unable to stay capitalized so it’s stock drops 60%. The Dow dropped 504 points.
Can anybody see this ending well? Well if you can here’s the death knell.
The government wants to help.
Ronald Reagan once said "The nine most terrifying words in the English language are, "I’m from the government and I’m here to help."
Nancy Pelosi jumped off her broom and waved her wand and got everyone to work on a bailout. Which, yesterday was defeated. Causing the market to drop 777 points. The biggest drop since the crash of ’87.
Stop helping.
I realize that she had a lot of fun blaming Republicans. Everyone needs to have fun but many Democrats voted against the bailout as well. I haven’t caught up on the whole scheme yet but it would appear that the House and Senate Democrats are more interested in covering their butts than actually helping average Americans hang on to what is left of their money. There is plenty of blame to go around here and the Democrats are far from immune. Harry Reid, Chris Dodd and Barney Frank have all repeatedly blocked any attempt to stop this from happening. It’s as if they opened the barn door, led the horse to the door, swatted it hard on the tush and then said "good heavens the horse has escaped and is running away, what do we do?"
Blame everyone else.
I’m closing comments on this one.
