Was the Sub-Prime Mortgage Crisis Caused by Lack of Regulations?

By William B. Conerly, Ph.D.

Did lack of regulation create the subprime mortgage crisis? I am asked this all the time. The short answer: Of course not. Nowhere close. Not a chance. Here is the long answer.

What regulations have we had? The mortgage originator (your local bank or mortgage broker) was under regulations not to discriminate and to inform you of your interest rate. Those papers you signed without reading? Many of them were “Truth in Lending” disclosures designed to protect you from getting into something you didn’t understand. However, if you didn’t read them, maybe they didn’t protect you.

But you were not the one lending money to a borrower incapable or unwilling to pay the money back. That was your banker. He was not regulated because he didn’t have any risk. He immediately turned around and sold your loan, along with a thousand other loans, to a Wall Street investment bank, which formed the many mortgages into a mortgage backed security or a “collateralized debt obligation.”

There were no regulations protecting Wall Street investment bankers from lending deadbeats money. The idea is that they are smart enough, sophisticated enough, to take care of themselves. (That turned out to be a bad idea, but it was the idea behind the lack of regulation.)

How did these rich, sophisticated investors make such a huge mistake? First they experimented. They tried small variations from the old traditional loans. Variations like adjustable rate mortgages. Low-down-payment mortgages. No documentation mortgages. (How else would strippers who make their living from tips be able to borrow money?)

These experiments worked well. Surprisingly well. Why? Because it was a rising real estate market. Borrowers who were unable to make their payments simply sold their homes at a profit. No big deal, and no default or foreclosure on the mortgage.

The crucial mistake that Wall Street made was extrapolating from the good times to the bad times. They assumed that these subprime mortgages would be good all the time because they had been good in the rising house market.

Would more regulation have helped? Maybe we could have protected Wall Street investment bankers from themselves. Maybe with good regulations they would not have to give up their summer homes in the Hamptons. Maybe.

In reality, regulatory policy has worked in the opposite direction. The government wanted more risky loans made, not fewer. For example, the Community Reinvestment Act pressured banks to make loans in poor neighborhoods. Banks (and I was a banker under the CRA) figured that making some bad loans was just another tax, a cost of doing business as a regulated company. In 1995, the Clinton administration revised the CRA to increase pressure on banks to make more loans to risky borrowers. In 1997, the first pool of subprime mortgages was securitized (by Bear Stearns!).

The law regulating Fannie Mae and Freddie Mac was rewritten to reduce their capital requirements, meaning they would become riskier. Some critics were concerned about the risk, but here is what Congressman Barney Frank had to say at the time:

“These two entities — Fannie Mae and Freddie Mac — are not facing any kind of financial crisis,” said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. “The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.” (New York Times, September 11, 2003)

At the height of the real estate boom, the United States set record home ownership rates. Politicians, including President Bush, bragged about their success at getting Americans into their own homes. As recently as August 2007, the President bragged that he was helping Americans get homes with lower down payments and higher loan limits. He also signed a law making it easier for homeowners to walk away from their mortgage obligations.

Would more regulation have reduced the number of bad loans made? Most likely, more regulation would have increased the problem.


William B. Conerly, Ph.D. is Chairman of the Board of Cascade Policy Institute, principal of Conerly Consulting LLC, and a member of the Governor’s Council of Economic Advisors.

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  • Jerry

    No, it obviously was not caused by lack of regs. It was caused, totally, by the government getting involved in mortgages – where it has no business whatsoever being involved.

  • Steve Plunk

    Thank you so very much for a rational explanation. There are few places to go for accurate information like this.

    Now if we could get all of America to read it.

    • jen

      this article references no facts, no sources, excludes the responsibility of the banks themselves as well as brokers who were selling the borrowers the insurance that wasn’t backed by anyone (cds). way to point the finger (in the wrong direction) as opposed to enlightening people.

      all readers – Please continue to find other sources of information. Facts and figures prove themselves. opinions are simply that.

  • Rupert in Springfield

    Would more regulations have exacerbated the problem?

    Well, it depends on the regulation.

    Regulations that have some sort of tie to financial stability probably might restrict the economy somewhat, but it could also be argued they help keep us out of the idiocy we are now in.

    Regulations that have nothing to do with the economy, and are really vote churning machines for politicians should probably be brought to the fore and discussed a little bit. Of course the problem is people have to be more aware of what their politicians are doing and that assumes a free press, which we don’t entirely have in this country.

    Since the press refuses to engage and prefers to sit back and ask prescient debate questions such as “do you think health care is a right”, we will be condemned to repeat this exercise. Personally I view it as very unlikely that even after adding a trillion dollars to our debt, as the Frank type regulations have, we will probably see more of them, not less.

    However there is some solace free market advocates can take in all of this. Although the problem was created over a period of decades, in the last two weeks, with the passage of the bailout package, the Democrats have managed to lose any issue they might have had regarding profligate spending and Bush2.

  • dean

    I’m surprised to find agreement with Ward Connerly’s analysis, though not with his final conclusion. He points out that the subprime market was in effect not regulated because investment banks, the source of most of the capital, were not regulated (except by the SEC, which chose to look the other way). Then he somehow concludes that “more regulation would have increased the problem,” I don’t get where he drew that conclusion from, particulary since the regulated banks, the ones that WERE subject to CRA and capital retention requirements, are the only ones still solvent. And no one has yet explained how the CRA had to do with overbuilding high end condo markets, or the fact that it is the larger homes and mortgages (not CRA related) where most of the failures seem to be.

    I’m also surprised to agree with Rupert that regulations that are aimed at financial stability could keep us out of these messes. A big ditto.

    I’d like further explanation from him on how it is he concludes we do not have an entirely free press. And I’ll point out that the questions asked at the debate all orignated from “the people,” not from the press.

    For me, the solace free market advocates ought to take is simply that markets are necessary but not sufficient for ordering the economics of a democratic society. In other words, no one is going to impose absolute socialism here because no one, or hardly anyone thinks 100% socialism would work. But it is also now clear, or should be that 100% free market capitalism, or even 80%, also does not work. Somewhere in between is the answer and always has been. Maybe our political arguments can re-engage over how much and what types of socialism ought to be in the mix, rather than branding every regulation or social program as the end of the world.

    • Anonymous

      It really doesn’t take a rocket scientist to see what the press is doing, or rather what they aren’t doing. For quite a few years now, the press has been one sided instead of looking at all sides of the issue.

      • dean

        Maybe so. But that does not make it anything other than a free press that expresses a certain bias. Aren’t private business people who own all the various newspapers, radio and tv stations free to express whatever bias they might have? Should they not be free to do so? Or should they be government regulated…i.e. the “fairness doctrine” that once applied to public airwaves, but is no longer enforced.

  • Steve Plunk

    The CRA had the somewhat noble intention of increasing home ownership in America. Many have long realized that home ownership builds wealth and security. The early days of the CRA were nondescript and it quietly moved toward it’s goals. Later in it’s life the CRA provided the foundation for more aggressive programs that pressured banks into lower quality loans and allowed Fannie and Freddie to adopt ever more lenient standards for loan purchases.

    Looser credit for lower end housing allowed more low income buyers into the system and pushed middle class buyers ever higher in home prices. The demand for housing units also put pressure on available land for building causing the price of lots to rise beyond their associated cost for development to a more speculative basis. The overall demand for housing pushed all prices higher.

    The interesting thing about lot prices is the effect they have on home prices. If a lot can be purchased by a builder for $40,000 it could make sense to build a small house on it and ask $150,000. If a lot costs $100,000 then the builder almost has to build a bigger house (regardless of lot size) to be proportionate to the price paid for the land. That $100,000 lot would turn into a $300,000 or more lot and home.

    So the pressure of more home buyers on a limited supply of existing homes and land for new homes forced prices up and buyers into more expensive homes than previously considered. Those buyers would often be encouraged to buy above expectations by real estate agents, mortgage brokers, and banks who knew the loose credit standards would allow approval. As a side note I find it discouraging that those same people, the real estate agents, brokers, and bankers who sold the paper all came away with commissions intact and no responsibility for their malfeasance. Some of that blame going around needs to get back to them.

    The regulations that serve society best are regulations concerning transparency and disclosure. Socialism has been proven a failure so socialist type regulations that redistribute wealth or give advantage to one group over another make no sense in any proportion. I agree branding every regulation as bad makes no sense but justifying regulation by fairness or good intentions makes no sense either. Good regulations allow markets to work efficiently and allow market players an even playing field. Regulating markets because some get rich and others lose money will in the end hurt more than help.

    The lesson I take away from the mortgage crisis is one of blurred lines. When Fannie and Freddie were neither public or private that was a blurred line. When the CRA pushed banks into making loans they would not have otherwise made that was a blurred line. When local governments control land through regulation and influence market prices that is a blurred line. There has been entirely too much public sector involvement in matters that should have remained entirely private. By blurring the lines between public and private responsibility we now have no responsibility. That’s not working for anyone.

  • crawdude

    The “sub-prime” lending practice was actually a regulation driven invention. There is nothing wrong with regulation, unless its bad regulation.,…..which is what got us in this mess.

    • dean

      Not so Dude. Regulators had nothing to do with the invention of mortgage bundling and resale on secondary markets. THat was pure capitalism. Most subprime loans appear to have been made through unregulated lenders, and many of these were for huge loans way beyond what FAnnie or Freddie could insure.

      This was capitalism running amok. A modern day tulip bubble. Government was asleep at the switch, but did not cause the calamity. It simply failed to prevent it.

      • Crawdude

        6 in one hand half dozen in the other. Its the governments job to NOT be asleep at the switch. One could argue that their failure to do their job was the cause.

        The other interesting fact, is that our problems didn’t cause the worlds problems, which turn out to be the same. It appears that all the countries leaders were asleep at the wheel whether it was a socialist country, capitalist or dictatorship, it was definitely global.

        Potato / potatoe 😉 The bottom line is that this mess is going to hurt a lot of people for a long time.

        The markets crashing is just the beginning. Retail sales were down 14.1% this month, next month is when the work force cuts will start. That will ripple across the country for about a year, then 3 years before a recovery starts……….if we’re lucky.

        Ugly times ahead my friend!

        • dean

          Yep…the European bankers look just as dumb, maybe more so. And their politicians also failed to keep a watchful eye. Irony of ironies, the last big pool of money to right the ship is the sovereign funds held by the Arab oil states and China. Ultimately they will bail us out because if we crash too far we can’t buy their stuff, and oil and plastic are not edible. “Humiliations galore” as was said in the Princess Bride.

          My prediction is 1-2 years of down doobie doobie down, followed by several years of slow growth. We have some big adjustments to make and this is not going to be painless. But, we are still dang rich, dang smart, and have a lot to work with. We should not whine about it. It was all too predictable. Glad we have a big garden and green pastures here.

          • Crawdude

            Lol, I may have to fight off the neighbors next year when my garden, appletree and berries ripen, lol!

            I’m not sure if China has enough to bail us out but they may be able to lessen the blow. The have 1.9 trillion dollars in cash reserves but are already feeling the pinch from this. They cut steel production by 10% this month due to lack of orders and they haven’t imported any gasoline for 2 months which means their industrial usage is way down.

            This country will always be richer than others but I hope we can figure out how to hold on to it a little better.

      • Steve Plunk

        Sorry Dean, Fannie Mae bundled mortgages as securities. Any claim that Fannie and Freddie were private entities ignores the reality of how they were formed, who ran them, and how congress exercised oversight.

        More and more people are realizing this is a government caused problem. The facts are undeniable.

        Oh, Fannie and Freddie didn’t insure loans.

  • Mickey Rat

    There were fools, criminals, enablers and victims.

    1) Political forces: “Everyone has a right to own a home, and if your bank won’t lend to you, they need to be investigated”. This mindset drove the Community Reinvestment Act, and other regulations designed to compel home loans to anybody.

    2) Financial enablers for the banks to make and dump bad loans into a black hole and keep the money: “Fannie and Freddie will buy loans, no questions asked.”. According to the NY Times, Sept 30, 1999, Fannie and Freddie were under pressure from the Clinton Administration to expand mortgage loans among low and moderate income people. In 1998, 44% of the loans they purchased were from this group. The pressure was to raise that number. An abundance of doubtful loans led to their Enron-like books, while their execs took fat bonuses and skated away before the crash.

    3) Easy money: The Federal Reserve kept interest rates low to goose the economy back alive, after the 2000-2002 stock market crash and the 9/11 attack. The low rates helped home ownership, but also enabled a wild speculation spree, which was destined to end badly.

    4) Shoddy lending practices: Banks and mortgage companies made loans that were risk-free to them, because they knew they could take the loan origination fee, and sell the loan to an investment banker or Fannie or Freddie. And they could dictate any terms they wanted to people who weren’t bothering to read and understand the fine print. Had they been lending their own money, perhaps they would have been a little more careful, regulations or not.

    5) Crooked and/or desparate borrowers: Crooked when they know they can’t repay, but expect that the bubble-ride of housing will continue, so they can resell for a quick $50,000. And they were the first to walk away when the housing prices fell. Desparate when low-wage people see themselves forever locked out of home ownership, because the prices are rising so fast in a bubble. So they bought in a frothy market, and paid too much to get in before it cost even more. They are in over their heads.

    6) Crooked oversight: In other words, NO OVERSIGHT. Congressional hacks taking fat donations from Fannie and Freddie and others like them, blocked any meaningful legislation. Even the NY Times story you quote backs this: President Bush tried in 2003 to clean up the mess. (NY TImes, Sept 11, 2003 story). There were enough Democrats and Republicans on their payroll to prevent any meaningful oversight. Some of those names are the people put in charge of fixing this mess today. Oh, goodie.

    7) Innocent bond purchasers: Fannie and Freddie sold bonds to cover their loan load into the marketplace. So did the investment bankers. Your mother’s broker bought some for her and some for his company.

    8: Panic, when the house of cards came down, everyone froze up, selling assets to get cash, and another crash was born. And an new problem: Bad books. Nobody will lend money because they can’t trust the books of the borrowers any more.

    So some of this came from regulations that pressured lenders to make bad loans. Some came when investors made unregulated stupid decisions, or falsely believed that a mortgage-backed bond is safe. Some came from borrowers who bought and sold houses with other peoples’ money. Plenty of blame to go around. We need to see it from a systemic view, so we can understand how to prevent a replay.

  • David from Eugene

    Yes, the lack of regulation was a significant factor in the creation of the Sub-Prime Crisis. It was not the only factor but it was one that if it had been corrected in a timely manner might have prevented or at least limited the severity of the crisis.

    The base cause of the Sub-Prime Crisis was a number of greedy and/or stupidly audacious members of the financial community who figured out how to game an unregulated financial system to their own advantage assisted by naïve, ignorant or greedy members of the general public.

    In simplistic form the process for new home mortgages worked as follows: Unregulated Mortgage Brokers processed mortgage applications with little regard for the applicant’s credit worthyness or long term ability to pay. In many cases the purchaser took out an adjustable rate mortgage with the expectation that the value of the house would rise in value enough that he would be able to refinance the mortgage before the payments would be adjusted upwards.

    The Broker passed the completed applications on to an Unregulated Mortgage Issuer who accepted the application on its face without checking the validity of the information supplied, issued a check to the Escrow Company and a commission check to the Broker. The Mortgage issuer bundled a number of individual mortgages, submitted the bundle to a rating service who assigned a rating to the bundle again accepting the accompanying paperwork at face value with out checking. The rating service received a commission for doing the rating.

    The Mortgage issuer then sold the rated bundle to an Unregulated Financial Institution. That Financial Institution retained a firm to administer the mortgages in the bundle (i.e. collect the monthly checks) and used the bundle of mortgages as the basis for issuing a variety of derivatives which it sold to other Financial Institutions, Hedge Funds Individual Investors and Banks. Many of these organizations paid for the financial instruments with borrowed money and protected them selves by buying credit default swap.

    The process for refinancing differed mainly by the addition of a Real Estate Appraiser who for a commission issued an appraisal establishing the current value of the property for the Broker. Appraisers who came back with a high value for a property got more repeat business then those that didn’t. And no one was double checking their work for accuracy.

    As everyone except the final holder of the derivative got a cash payment for the service they provided at the time they transferred the mortgage to the next step there was no risk to them. The more mortgages that were processed the greater the revenue received at all levels by those doing the processing. As long as the mortgagee made his monthly payments, interest rate stayed low, home values continued to rise and money continued to flow in there was no problem. When those conditions changed everything began to unravel creating the Crisis.

    In some circles the “Community Reinvestment Act of 1977” has been identified as being a regulation that forced banks to issue risky loans causing the Sub-Prime Crisis. That is not the case. First, as Dean has pointed out several times, the CRA only applied to Banks and Thrifts which have FDIC coverage; and not the organizations issuing the bulk of the Sub-Prime Mortgages. Second, It does not require Banks and Thrifts to issue risky loans. The purpose statement for the CRA reads as follows”

    “It is the purpose of this title to require each appropriate Federal financial supervisory agency to use its authority when examining financial institutions, to encourage such institutions to help meet the credit needs of the local communities in which they are chartered consistent with the safe and sound operation of such institutions.” [Section 802 (b) 12 U.S.C. 2901]

  • Hank

    I think you need to look at what the problem is. The subprime mortgages are just a symptom and never would have existed in these numbers if the debt ratios were not raised for the investment banks freeing up billions of borrowed dollars that had to be invested somewhere. Or we could say it was the fact the CDS’ were not regulated as insurance. If the investors could not buy a cheap insurance policy (if they were regulated they would be more expensive due to capital reserve requirements), they essentially saw a subprime CDO as a risk free investment, leading them to buy billions with borrowed money and make the profit on the interest spread.

    In conclusion, I believe deregulation established the framework to create the subprime mess we are in today.

  • Mortgage

    This was a good article about what’s going on in the mortgage world. Thanks

  • myreddy

    suprime morgage financial crisis

    • Crawdude

      I wish that was all it was 🙁 This isn’t just the US, it the world………and many of them didn;t participate in the ” Sub-Prime, let anyone get a loan ” law that was passed by a GOP legislature and signed by a DNC president.

      Even if they are able to get the crdit market going again, there is a titlewave of unemplyment thats going to hit in the next 2-6 months. Before this crisis started , the estimate was 8.5 % by this time next year. I think it wouldn’t be a stretch to see 10% but I hope not.

  • John in Oregon

    We need to be clear on some points.

    While dismissing the effects of the CRA David in Eugene said > *In some circles the “Community Reinvestment Act of 1977” has been identified as being a regulation that forced banks to issue risky loans causing the Sub-Prime Crisis. That is not the case. First, as Dean has pointed out several times, the CRA only applied to Banks and Thrifts which have FDIC coverage; and not the organizations issuing the bulk of the Sub-Prime Mortgages. Second, It does not require Banks and Thrifts to issue risky loans.*

    I would point out that the relevant act is the CRA as _amended in 1995._ David is actually making two claims here. First that front line lenders and realtors were not subject to CRA and therefore the CRA can not cause anything.. Second that CRA does not require risky loan practices. The implicit conclusion of this is that Fannie and Freddie or similar institutions did not make the bad loans.

    I contend the few facts presented are accurate, incomplete and result in an erroneous conclusion.

    Lets follow a buyer through the process to see how the process works. John and Sally, J/S for short, wish to buy a home in the inner-city of Portland. J/S as buyers contact a Realtor. The Realtor or J/S contact a Mortgage Broker who forwards the loan application to a Lender such as Countrywide.

    The logic argued is that since neither the Realtor or the Mortgage Broker are “regulated” the CRA cannot influence what the realtor or broker do.

    That’s theory, what occurred in practice, now that is what matters. Simply put every lender who felt CRA pressure to increase high risk minority loans had only to make it clear that to do business the lender required brokers and realtors increase the numbers of minority loan applications.

    David quotes the > *The purpose statement for the CRA* to suggest that the CRA does not push lenders to make risky loans. Again, that’s theory and what occurred in practice is what matters.

    One aspect of the CRA is the CRA score each lender earned based on the lending rate to low income minority borrowers. Although not precisely a quota the effect is hardly different when the score depends on the level of risky loans.

    And the pressure didn’t stop with the CRA score. Federal lending manuals stated:

    _”Did You Know? Failure to comply with the Equal Credit Opportunity Act or Regulation B can subject a financial institution to *civil liability for actual and punitive damages* in individual or class actions. Liability for punitive damages can be as much as $10,000 in individual actions and the lesser of $500,000 or 1 percent of the creditor’s net worth in class actions.”_

    A challenge immediately taken up by the Association of Community Organization for Reform Now (ACORN) and others filing green line lawsuits against Wells Fargo, Citibank, US Bank, and Others.

    Green line lawsuits were hardly the province of activist organizations. No less that Andrew Cuomo at HUD also used this tool to force lender compliance.

    A situation summed up by Ralph Alter a mortgagee broker in Detroit. Ralph recounted s series of exchanges with various different Countrywide Underwriters for paperwork in which the borrower specifically checked that he did _not_ wish to share ethnic or racial information in the government tracking section of the form.

    Those exchanges with the CW Underwriter ended in the following;

    “Well, you saw him and you know his race and ethnicity. *Our ability to fund our deals and source new money depends on doing a certain percentage of loans with black and minority clients. If you want this loan underwritten at Countrywide, you need to furnish this information:* Is he black?”

    Alter concludes

    “The emphasis on minority lending is readily apparent, even at the expense of the applicant’s stated desire not to furnish this information. As Countrywide became one of the first and most obvious dominoes in the collapsing Rube Goldberg mortgage apparatus, the need for an investigation of the relationship between Fannie Mae and Countrywide seems abundantly clear, to determine the extent of racial strong-arming”

    This, the CRA, wasn’t the only force in play.

    An October 13 article, SPREADING THE VIRUS, in the New York Post describes the roots of today’s economic crisis beginning in 1995. “That March, House Speaker Newt Gingrich was scheduled to address a meeting of county commissioners … some 500 protesters from the Association of Community Organizations for Reform Now (ACORN) poured into the ballroom … demonstrators chanting, “Nuke Newt!” and “We want Newt!” Jamming the aisles, carrying bullhorns and taunting the assembled county commissioners, demonstrators swiftly took over the head table and commandeered the microphone, sending two members of Congress scurrying.”

    The Post continues

    “Editorial writers from Little Rock to Buffalo condemned ACORN’s action as an affront to both civility and freedom of speech.”

    As the article describes;

    “Two days later, 50 to 100 of the same protesters hit their main target – a House Banking subcommittee considering changes to the Community Reinvestment Act, a law that allows groups like ACORN to force banks into making high-risk loans to low-credit customers… The CRA’s ostensible purpose is to prevent banks from discriminating against minorities. But Rep. Marge Roukema (R-NJ), who chaired the subcommittee, was worried that charges of discrimination had become an _excuse for lowering credit standards._ She warned that new, Democrat-proposed CRA regulations could amount to an _illegal quota system. “_

    “FOR years, ACORN had combined manipulation of the CRA with intimidation-protest tactics to force banks to lower credit standards. Its crusade, with help from Democrats in Congress, to push these high-risk “subprime” loans on banks is at the root of today’s economic meltdown. When the role of ACORN and congressional Democrats in the mortgage crisis is pointed out, Democrats reply that _banks subject to the CRA represent only about a quarter of the loans that led to our current troubles. In fact, the problem goes way beyond the CRA.”_

    “..ACORN … campaigns against local banks, quickly hit a roadblock. Banks would tell ACORN they could …reduce their credit standards by only a little – since Fannie Mae and Freddie Mac, the federal mortgage giants, refused to buy up those risky loans for sale on the “secondary market.”

    “So ACORN’s Democratic friends in Congress moved to _force Fannie Mae and Freddie Mac to dispense with normal credit standards._ Throughout the early ’90s, they imposed ever-increasing subprime-lending quotas on Fannie and Freddie. ”

    In some circles the desire is to pronounce markets guilty and acquit Government intervention. For those I ask this simple question. If the CRA and lax lending standards are ineffective and do not increase low income burrowing, why then all the intimidation-protest tactics?

    Dean we all keep playing old CDs. Our current problem has little to do with the housing bubbles. It had everything to do with the credit bubble. You did mention the real problem but didn’t connect the dots.

    > *1: Global financial networks that could move capital around quickly and freely.*

    Moving money quickly is not new. In 1960 the old TELEX network at 50 baud moved money only slightly slower. What is different is financial institutions are no longer isolated within national borders.

    > *2: Absurdly low interest rates, making other safe investments (T-bills) unatractive (sic).*

    At first blush this does appear to be a factor. In reality it’s minor. Low prime interest rates keep all rates low not just mortgagees. Higher interest return rates are indicative of higher risk. “Safe investments” such as T bills have lower returns.

    > *3: Creation of the new funding and bundling strategies that bypassed traditional mortgage lenders.*

    BINGO

    The NY Times article you referenced has a number of deficiencies, just the same that article did get this right.

    “Fannie [and Freddie] never actually made loans. It was essentially _a mortgage insurance company,_ buying mortgages, keeping some but _reselling most to investors_ and, for a fee, _promising to pay off a loan if the borrower defaulted.”_

    This is precisely the mission for which the GSEs Fannie and Freddie were created. The NYT article continues with more detail;

    “Fannie, a government-sponsored company [GSE], had long helped _Americans get cheaper home loans_ by serving as a _powerful middleman, buying mortgages from lenders and banks_ and then holding or _reselling them [as mortgage backed securities] to Wall Street investors._ This allowed banks to _make even more loans — expanding the pool of homeowners.”_

    Expanding the pool of homeowners is a laudable goal, but not at the expense of the stability of the financial system.

    Dean you keep chanting “the Republicans did it. The Republicans did it.”

    At worst that’s an intentional distortion, otherwise known as a Democratic Party talking point. At best it’s sloppy logic that contends;

    *O* Republicans are conservative. (Flawed premise number one.)
    *O* Republicans have ruled in recent years. (Flawed premise number two.)
    *O* Everything wrong in that time is therefore due to conservatism.

    The good old post hoc ergo propter hoc fallacy, even if based on good premises. It is always fallacious to suppose that there is a causative link between two things simply because they coexist.

    But that is now old tapes. Despite repeated warnings, the explosion of the sub-prime bundling bomb has rent asunder financial institutions. Dealing with the cause of the sub-prime mess will only stop us digging the hole deeper.

    The task today is to deal with the liquidity problem, the fallout of the explosion of the sub-prime bomb. The free fall of the stock market is a different problem.

    Consider what has happened in the last ten days. Ten days ago, delayed by partisan political advantage, the bailout bill finally passed. And nothing happened.

    Early last week commercial paper was added to the “solution”. Nothing happened.

    Mid week a coordinated worldwide interest rate cut. Nothing happened.

    At the end of the week the Government began buying interest in banks to inject liquidity. Nothing is happening.

    Might not it be time for the Government to stop spending money it doesn’t have?

    • dean

      John…to be fair, I did not chant “the Republicans did it.” I stressed in several posts that voters are going to hold Republicans POLITICALLY responsible because they controlled all branches of the federal government in the years immediately before the current crisis. One can argue this is not fair and try to finger Barney Frank, but as I pointed out, when we think back on the stagflation days of Jimmy Carter, we did not hold Nixon and Ford equally accountable. This allowed Reagan to ride to the rescue in 1980, and it allows Obama to do the same this year. If the economy fails to recover during his first term, he will be held responsible and will be shown the door in 2012 (assuming he is elected in the first place).

      To your latter point, I disagree. The financial crisis we are experiencing is dangerous. If left for time and markets to sort out, it could easily lead to a deflationary cycle that will take a decade (see Japan asset bubble) to recover from. Governments across the world are going to keep throwing borrowed money at this problem from every direction until markets stabilize. Then they and we will begin the longer term problem of learning to live on what we earn, while paying off accumulated debts and adjusting to lower asset values.

      Another way to put it is this. Governments are spending money they DO actually have. It is borrowed money, but it is money they have. If you or I borrow $10K from a bank, we have that $10K and can use it for whatever purpose we borrowed it for. Governments are no different, except that they can in effect borrow it against their own credit, no collateral needed.

      And don’t you find it a bit ironic that the Bush administration has now accepted George Soros’ strategy for getting out of this by capitalizing banks in exchange for shares?

    • David from Eugene

      John

      The Equal Credit Opportunity Act also does not require a lender to issue risky loans. It does say they cannot discriminate “(1) on the basis of race, color, religion, national origin, sex or marital status, or age (provided the applicant has the capacity to contract);
      (2) because all or part of the applicant’s income derives from any public assistance program; or (3) because the applicant has in good faith exercised any right under this chapter.” [15 U.S.C. § 1691]

      Now I can see how some “bean counter” at a lending institution might decide that issuing risky loans is cheaper or easier then defending a sound lending criteria system in court. Particularly as there is no down side to doing so, as the firm would have taken its cut of the transaction and passed the loan up the chain long before any default. This financial crisis is a product of a lack of proper regulation not the Equal Credit Opportunity Act or CRA.

  • John in Oregon

    I thought to cross post this comment as relivant here as well.

    I find I agree with David in Eugene. I want to go into more depth of subjects that are worthy of more thought. David said > *In as much as we will not know in what form the next financial crisis will be or its trigger it is unlikely that a set of regulations could be developed to prevent it. Besides, if by accident we were successful in crafting regulations to prevent the next crisis we would not know we did because that crisis would not happen. What we can do and should do is craft a set of regulations that would prevent a Crisis similar to the current one from happening again.*

    This has a lot of the feel of Rumsfeld’s known unknowns explanation the media loved to chortle and poke. We cannot know what didn’t happen and we guess at what might happen, and if what we thought might happen doesn’t can we know why it didn’t. It all sounds very philosophical. Master tells Grasshopper, don’t think of the White Horse. That’s a reference to an old TV show for those that may not know.

    Philosophy is nice and all but lets simplify. So in simple terms, no significantly complex system can be optimally controlled centrally. What we should do I will come to later.

    David showed > *Basically, “Mark to Market” is good policy, it is much superior to allowing any value to be assigned to an asset by the institution holding it. But as the present situation shows there is a problem when…*

    I view “mark to market” as a tool. In its basic form, we value stuff by comparing our stuff with other similar stuff that was sold recently. We, our friends, and neighbors do that every day. The blue book for used cars is but one example.

    David also pointed out that sometimes tools don’t work. What are the “Dead Sea Scrolls” worth when nothing like them have been sold? What is a bushel of wheat worth that “might” be contaminated with mold?

    David mentioned > *Similarly, Sarbanes-Oxley Act of 2002 is not perfect but it is better* [than] *allowing companies to lie to the public. If it is causing real problems it may need to be adjusted.*

    Some of the problems David is referring to are the constitutionality of the way Sarbanes-Oxley was implemented. Notwithstanding those questions, my view is, in the wake of Enron and Globalcrossing, the goal of Sarbanes was to provide a consistent method of reporting company performance. The goal was and is honest reporting of performance.

    I totally agree with David’s comments that > *Which means that we need to revisit the regulations on a periodic basis to insure that they are working in the manner intended and getting the desired results and if necessary to tweak the regulations to avoid undesirable effects.*

    I would take this further. The goal should be at least three fold.

    *O* To remove regulation that no longer serves a useful purpose.
    *O* To change regulation that distorts the normal function of markets.
    *O* To strengthen regulation when necessary to prevent gaming or manipulation.

    When Politicians and Bureaucrats talk about regulation the mean the later. Stronger, more regulation. They never acknowledge the first two, that would diminish Government Bureaucratic power.

    Now we come to the point at which David and I depart company. David said > *A careful examination of the current crisis shows that an unregulated mortgage market is at the root, a market that rewarded abuse and punished prudence… The government influence on this crisis was minimal. This Crisis is the result of an un-regulated market run wild not government regulation.*

    I suspect that David would agree that the markets were not functioning normally. The normal hesitancy to lend to borrowers with few prospects of repayment was not operating.

    BUT, is that due to LACK OF REGULATION?

    The ample public record clearly shows the resistance of Banks and Lending Institutions to making those loans. Yet loans were being made that were against the self-interest of the lenders.

    This was not caused by lack of regulation. It was caused by forces external to the markets which distorted the market operation and suppressed lenders self interest.

    I contend those forces were Government and “social justice” green line lawsuits. If anyone wishes to identify different forces such as greed, feel free to show the evidence of how self interests of lenders was suppressed.

    The goal, increased minority home ownership is laudable. The pressure for low income minority lending was intense, and yet it was not sufficient to bring down the financial system.

    David mentioned Sarbanes-Oxley. We hear that name often without knowing why it exists. Three companies, Enron and Globalcrossing, cooked the books of their profit and loss statement. In short both lied to the public about their financial condition.

    Everyone knows Enron, few know Globalcrossing, and the third remains unreported beyond the dark bowels of the legacy media. For those wondering about the invisibility of Globalcrossing simply follow the money and who profited prior to the Globalcrossing crash.

    And the third? That came after Enron/Global and in the face of Sarbanes-Oxley. An enterprise that cooked the books worse than Enron. We have come full circle to Fannie Mae and Franklin Raines.

    What should regulation look like?

    I contend the proper role of regulation, oversight, is policing business to make sure that, when business makes decisions, it does so honestly. Government’s more natural and appropriate role of policing business to maintain honesty. To punish unethical behavior

    In contrast, many politicians, reporters in the legacy media, and non-profit organizers view the role of regulation as promoting “social justice.” Everything they say and report is filtered through that prism.

    Our job is to understand those two concepts are hugely different from each other. Because nobody’s articulating this difference, politicians and the media are getting away with conflating the terms, muddying the waters.

  • John in Oregon

    David

    Your quotes are correct and those words mean nothing.

    The words that matter are the words published by the FED. The words that say using credit rating, income, and ability to pay are evidence of discrimination.

    The words that matter are the words spoken by the person in the black robe as the gavel hits the bench.

    The words that matter are the words spoken by the Governor and Mayor upon seeing the pickets at the bank door. We will not do business here.

    The words that matter are the words spoken by members of Congress to force Fannie Mae and Freddie Mac to dispense with normal credit standards.

    The numbers that matter are the numbers of CRA score imposed by the federal bureaucracy.

    The actions that matter are the rules of HUD secretary, Andrew Cuomo.

    David. If you can provide a factual basis to explain why lenders made loans which were contrary to the lenders best interest, I would like to hear it. Loans made with little or no expectation of repayment. Lenders are not stupid so why did they do those things.

    Show me the evidence.

    • dean

      John, how do you explain the data that shows that credit unions provide a higher percent of their loans to low and moderate income than banks and S&Ls, and they provide a higher percent of loans to minorities, yet they have avoided the sub-prime problems that conventional banks have.

      And how do you explain that investment banks, which had no CRA requirements (nor do credit unions) were way more exposed by sub prime loans and foreclosures than conventional banks?

      In other words, the overwhelming evidience is that the CRA had zip to little to do with the sub prime meltdown. Yet you keep insisting it was a primary cause. This is just blame shifting.

      You seem to be basing your entire argument on anecdote rather than data, and that is not like you.

    • John in Oregon

      Thank you Dean. That one is soooo easy to answer. 🙂

      > *how do you explain the data that shows that credit unions provide a higher percent of their loans to low and moderate income than banks and S&Ls, and they provide a higher percent of loans to minorities, yet they have avoided the sub-prime problems that conventional banks have.*

      Simple. They sold the loans before the ink was dry.

      > *And how do you explain that investment banks, which had no CRA requirements … were way more exposed by sub prime loans and foreclosures than conventional banks?*

      Even more simple. They bought the loans thinking they were reasonably sound investments.

      > *In other words, the overwhelming evidience (sic) is that the CRA had zip to little to do with the sub prime meltdown. Yet you keep insisting it was a primary cause.*

      To the contrary. This is exactly the pattern one would expect. That conservative lenders, based on the antiquated standard of credit worthiness, would get rid of risky loans ASAP.

      I can see you did not read the New York Post article. Otherwise you would recall this line… *As ACORN ran its campaigns against local banks, it quickly hit a roadblock. Banks would tell ACORN they could afford to reduce their credit standards by only a little – since Fannie Mae and Freddie Mac, the federal mortgage giants, refused to buy up those risky loans for sale on the “secondary market.”*

      Any first year law student will tell you, NEVER ask a question unless you know the answer. If you do its likely the answer will be slammed back in your face. Kinda like what just happened, HUH?

      > *You seem to be basing your entire argument on anecdote rather than data, and that is not like you.*

      Markets are based on millions of rational people making decisions in their own best interest. The actions of people based on the current set of circumstances (including Government) they face. What did people do, how did they act, and why did they do as they did?

      Please take off your blue colored glasses.

      Markets cannot be reduced to an equation. Besides, figures don’t lie but liars… and politicians protecting their butts use figures.

      Did I say earlier never ask a question? HEH

  • jumeirah

    i agree..i saw a lot of mortgage and related corporations that really lacks proper management and regulations to ensure both the customers and the company..therefore resulting to bankruptcy

  • liezelee

    Maybe we could have protected Wall Street investment bankers from
    themselves. Maybe with good regulations they would not have to give up
    their summer homes in the Hamptons. Maybe.-Paul Perito MD

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