Is the bolded portion of this accepted fact?
If so, was it the main driver?
Thanks,
Rob
Main driver? Probably not. It’s a pretty complicated situation to boil it down to sounds bites. But the general idea is:
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There was a global savings glut, meaning that there was too much money relative to attractive, stable investment opportunities.
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Banks wanted to step in to provide outlets for those funds, but a bank never wants to have money it can’t lend.
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Banks needed to have borrowers. One way to do that is to create stable financial products based on debt.
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Fixed-income securities are one investment vehicle which can be utilized to provide generally stable returns on savings, and satisfy the above criteria.
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Those securities include things like CDOs, which in this case, were bundled mortgages sliced in to smaller, seemingly discrete pieces sold to investors looking for a stable return. Mortgages were a good solution because it’s secured debt, meaning it is backed by a collateral (ie. a house), they generally provide stable fixed-income, and they allow people of modest means to be greatly leveraged.
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The desire for more of these securities led banks to create more of them, which necessitated a need to find more mortgages to bundle and sell.
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That led to more lax regulations as a consequence of needing product. The low-hanging fruit was gone, so now you need people to buy second homes and investment properties. In short, you need people to make riskier decisions.
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This was also made possible by complicated formulas and securitization processes used by banks that were intended to mitigate the extra risk the would typically come with lax regulations and sub-standard or overextended borrowers.
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It was generally accepted that housing fundamentals were strong enough to prevent any catastrophic failure of those formulas. They were wrong.
- Rating agencies like Moody’s took pay offs in the form of fees from the investment banks to rate the sub-prime pieces of crappola as “investment grade”. The vast majority of these “investment grade” bonds lost most of their value.
- Thanks America!
Greed was the main driver of the financial fire.
Do-gooding policy was the spark.
You had the “let’s get everyone into their American dream home” legislators.
You had a supply of dream-home wannabes without the financial management wherewithal to plan responsibly.
You had a bunch of greedy financial people smart enough to sell mortgages to the financially incompetent and smart enough to remove themselves from the risk of the bad borrowers.
It was a lovely perfect storm, and whether you see it as a problem of smart greedy financial people or incompetent stooges borrowing money they never should have is mostly philosophical.
As to the “free market” jabs, my own take is this: In a truly free market, no one is going to lend large sums to the poor, period. There is a suspicion on the part of those with money that there is a reason they are poor in the first place: they are incompetent. What you had here was the opportunity to lend to the poor and stake a bet that the government would cover for their incompetent borrowing (which, of course, the government did, to avoid the financial system from collapsing).
It is amazing the lengths that financial institutions went to to take advantage of all this.
First, the people lending the money weren’t actually taking a risk. This is so absurd and wrong. So, loan money to anybody and everybody. Then bundle them and up and sell to the suckers.
Second, since they knew the packages were bad, they’d create financial securities that would pay off if the loans went bad.
It’s a win-win to make bad loans. So that’s what they did.
Why did other companies buy packages full of bad loans? It just wasn’t the formulas, the companies creating the packages simply lied and the people buying the packages weren’t risking their money. They were risking ours. Bonuses all around.
All of the above are good answers, but I would also add that the banks hired IC mortgage brokers to solicit the loans and paid them a “per loan” rate. If the broker didn’t make a loan, he didn’t get paid.
Obviously one can see how the broker, who wasn’t on the hook for the loan, would lie, cheat, and steal to make the loan conform to the (lax anyways) standards. And not only did the broker not care, neither did the bank because they sold the loans anyways.
That, along with legislators and their whole “let’s let everyone live the American dream” emptyheaded-ness. The old 20% down formula wasn’t just because banks hated poor people and minorities. It was because they understood that having “scratch in the game” made a person less likely to use their home as an ATM and walk away when things got rough.
IOW, you aren’t a home owner (in a real sense) if you have no equity in the house, even if your name is on the deed.
The U.S. CONGRESS.
The Congressional banking committee created laws that push the “everyone should have a home” ideology. Even if the homeowner couldn’t afford the payments. Congress doesn’t read the bills it passes so idiotic bills became law. Mortgage companies, homeowners, banks, and Fannie/Freddie all took advantage of the situation. The subprime mortgaes were broken up and repackaged as sound investments (after all, housing prices never go down :rolleyes: and suckers in the U.S. and other countries bought up everything they could. Then the bubble burst.
I think you need to throw in the real estate business and the lenders pushing folks to refinance every six months. This caused an upward spiral of property values to ridiculous heights.
~VOW
There a many, many, many people who were willing to take advantage of the situation that Congress created. Congress even refused, for years, to correct the situation after several government agencies and Congressional hearings brought the situation to Congresses attention.
No, it’s not accepted fact. The idea that the CRA was the primary driver behind the financial crisis is a right-wing trope that seeks to shift the blame away from financial institutions and slack regulation, and put it on government over-regulation, and it’s almost entirely false.
The CRA may have played a very minor role in contributing to the increase in sub-prime lending, but that it was nothing more than that. There were a host of factors which were much, much more influential - overly low interest rates, reckless financial lending, reckless borrowing and a bunch of new-fangled financial structures that allowed bankers to convince themselves that the risks of such profitable lending had been hedged when they hadn’t.
To add to the story…the “easy mortgages” caused the prices of real estate to go through the roof. People assumed that prices would rise forever-so they promptly took out 2nd mortgages on their houses (they used the money for cars, vacations, etc.). When home prices started dropping, leverage took its toll-and many houses were foreclosed.
Throughout all of this, the Congress stood and watched. Rep. Barney Frank (D-Massachusetts) said that Fanny Mae was “strong and sound”.
Of course, the people who didn’t borrow foolishly (and who paid their mortgages) were then forced to bail out those who did.
Not 2nd mortgages. Those aren’t so sought after in security bundles. People refinanced. First mortgages are much more desirable. Plus it leads to churn. Churn is one of Wall Streets favorite things. Keep the customers selling and buying, selling and buying. People refinanced several times. Fees get added. (But tacked onto the loan of course. Who wants to actually pay now for something? Sheesh.)
Another factor to keep in mind: A bank doesn’t have to do things right. It only has to do things according to accepted industry practice. If everybody made the same stupid decision, you can’t be sued. There was a concerted effort to make sure you did the same thing as everyone else. The sheep mentality lead them straight over the cliff. And they are actually not all that sorry about doing this. Who cares if the economy crashes? At least you don’t get sued.
It’s sort of all the eggs on one basket thing. All the big banks doing the same thing means when it goes bad somewhere, it goes bad everywhere.
A good friend of mine was an unsuccessful mortgage broker before the housing bubble and he was always paid per loan. That did not change before the bubble. What changed was the standards, so that more loans could be written. The reasons standards were loosened was that banks were selling the loans so they had no reason to refuse loans. The reason they could sell bad loans was that people in the financial business thought the had a new way to deal with risk by bundling loans and selling tranches of loans. This securitization was supposed to take the risk out of buying bad mortgages. The problem was that the models that were used to make securitization seem riskless used data from the previous 40 years which did not include the popping of a housing bubble. Because they did not think a fall in housing market was possible they kept buying loans. Thus banks could sell all the loans they could make so mortgage brokers made all the loans they could. It was a case of demand creating its own supply.
It wasn’t “over-regulation” but the “lack of regulation” that led to the sub-prime mortgage debacle. Before CRA, potential homeowners had to be vetted by mortgage companies BEFORE they qualified for a loan. The basic rule was that the homeowner had to prove that they could repay the money borrowed. The initial CRA in 1977 helped homeowners who couldn’t qualify under “prime” mortgage standards. The CRA was later modified to make sub-prime loans even easier to obtain. As more people became aware that anyone could now obtain a poorly-regulated, easy-to-obtain, sub-prime mortgage, sub-primes became the mortgage of choice.
Instead of helping people buy $80K homes, people began buying $200K, $400K, $800K homes as short term investments. As more people bought homes, the pirce of homes went up. The more people bought “investment homes” the faster the price of homes increased. A false market had been created. In some areas of the country, you could double your invested money in less than 2 years. Many people, who should have known better, didn’t want to rock the boat and let the bubble grow.
Congress is supposed to be looking out for the best interests of “We the People”. Congress failed to do the job it was elected to do. Even when various agencies pointed out what was happening to the markets and what the expected outcome (burst bubble) could be, Congress refused to change the situation. Many in Congress repeatedly said that they didn’t see a problem and there was no reason to create more regulations.
Congress was wrong and we all paid the price for their decision.
*Here’s How The Community Reinvestment Act Led To The Housing Bubble’s Lax Lending
by John Carney - June 27, 2009
Contrary to my initial conclusion, the evidence is overwhelming that the CRA played a significant role in creating lax lending standards that fueled the housing bubble. Once I realized this, I had to abandon my suspicion that the anti-CRA case was a figment of the rhetoric of Republicans attempting to distract attention from their own role in the mortgage mess.
…In short, the lax lending standards created in response to the CRA had dug a pit that was waiting to get filled when the circumstances were right.
Ah ha! So it wasn’t the CRA that caused the mess. It was everything else!
Of course it wasn’t the CRA that caused everything. The CRA was a factor in lowering lending standards. This was a necessary, although not sufficient, cause for the mortgage mess.
It’s true that the CRA requirements were relaxed during the Bush administration. But at this point the lax lending standards were already in place.
…What about “No Money Down” Mortgages? Were they required by the CRA?
Actually, yes they were. The regulators charged with enforcing the CRA praised the lowering of down payments and even their elimination. They told banks that lending standards that exceeded that of regulators would be considered evidence of unfair lending. This effectively meant that no money down mortgages were required. A Treasury Department study published in 2000 found that the CRA had successfully lowered down payments not just for CRA loans, but for all mortgages.
Explain the shift in loan to value away from the traditional lending requirement of 80%.
Again, the regulators told banks that much higher LTVs was an appropriate way to meet the CRA obligations.*
Congressional action proved that allowing Congress to arbitrarily push aside market standards and replace them with it’s own idology can only lead to failure of that market.
As an interesting counterpoint, look north. Canada is essentially the same environment economically, but the amrket rules were 180° different - thanks to government regulation.
-first, we never got heavily into ARM’s - there are 5 real banks in Canada and they all offered basically the standard package.
-second, there is one government agency that provides the insurance backing for almost every house mortgage. Others got in toward the end, when the business south was slowing but generally CMHC did all the mortgages, the banks mandated their use, and followed their rules.
-third, CMHC rules mostly did not allow “no money down”. It was a big deal that they relaxed the rules from 10% to 5% down and allowed 30-year amortizations eventually; and since the banks required CMHC insurance, that was what it took to buy a house.
-fourth, this is the biggest - mortgages interest is NOT deductible from income tax. Thus, the vast majority of Canadian home buyers buy, never refinance, and try to pay down the house as fast as possible. (OTOH, there is NO capital gains on the sale of your principal residence!!) Instead of overwhelming debt, many of our homeowners are close to paying off their house. *
A friend of mine worked in a bank head office, and mentioned that toward the end of the US bubble, the mortgage monkeys came up from the USA trying to exploit the untapped market and were amazed at the numbers they were crunching for Canada. As for those highly-rated junk bonds, the story is that one bank VP went to the group that traded them, and asked them to explain the details to him. Nobody could, and he ordered the section to shut down.
You can see what a difference a few simple government rules make. They aren’t responsible for your crisis but they sure greased the skids. Yes, there is no such thing as a free market, except maybe in Somalia…
As a result of these rules, Canada was pretty much immune from the worst of the bubble. Our banks argued over whether they really needed a bailout, or whether the stimulus was just there because everyone in the G8 agreed to stimulate at once. The only thing holding back our economy is a weak major trading partner.
(* My theory is that a lot of the massive run-up in house prices here, is people “trading up”. They bought a house way back when for $100,000, paid it off, and sold it recently for $300,000 to buy a $500,000 house - so they have $500,000 worth of house and $200,000 or less of debt. People just getting into the market have the older, cheaper $300,000 starter house.)
Exactly. Prime-rate mortgages were heavily regulated. You have to prove who you are, that you have a means to pay back the loan, that you had money to put towards the price of the home, that you weren’t already heavily in debt, etc.
Sub-prime mortgages were less regulated and it was Congressal banking committee and Congresses responsibility to provide those regulations. Do you want a loan? Can you sign your name? Here’s your money. Fannie and Freddie were later required to buy up these unvetted loans in order to keep pushing the “everyone should own a home regardless of whether they can afford to pay back the loan”, agenda.
People trusted that Congress could not possibly do something so stupid. The people learned a hard lesson.