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September 27, 2008 at 13:19:36
The Real Cause of the Current Financial Crisis by Joe Reeser Page 1 of 2 page(s) |
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The FHA Administrator chartered Fannie Mae (FM) on February 10, 1938. The purpose of this organization was to codify the national commitment to housing and to address the inability or unwillingness of private lenders to ensure a reliable supply of mortgage credit throughout the country. The primary purpose of Fannie Mae was to purchase, hold, or sell FHA-insured mortgage loans originated by private lenders. After World War II, Fannie Mae's authority included VA-guaranteed home mortgages as well. In 1954 the Charter Act provided the basic framework under which Fannie Mae operates today. The federal government still had direct control, however. This act also stipulated how the secondary market operations would be transformed to the private sector. The 1968 Charter Act split Fannie Mae into two entities: a reconstructed Fannie Mae and Ginnie Mae (GM). GM was to remain a federal agency responsible for assistance programs while FM became a "government-sponsored private corporation" or what we call today, a "Government-Sponsored Enterprise" (GSE). This act also authorized FM to issue Mortgage-Backed Securities (MBS) and put into place a regulatory framework overseen by the Department of Housing and Urban Development HUD. In 1970, the Emergency Home Finance Act created Freddie Mac. This was essentially in response to concerns over the virtual monopoly enjoyed by Fannie Mae in the secondary market due to the federal protections afforded this GSE. Freddie Mac and Fannie Mae operated under what was essentially a 'separate but equal' regulatory and oversight framework. This law also required the HUD Secretary to approve Fannie Mae's business dealings. In 1984, the Secondary Mortgage Market Enhancement Act updated HUD's regulatory power and authorized Fannie Mae to purchase subordinate lien mortgages.
The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 made regulation of Fannie Mae and Freddie Mac consistent under HUD oversight. It also instructed the Treasury Department and the GAO to conduct studies that led to the regulatory overhaul in 1992.
Now I know this has been rather boring up to now but it lays the framework for what is about to take place. The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 overhauled the regulatory oversight of Fannie Mae and Freddie Mac. The Office of Federal Housing Enterprise Oversight was created as a regulatory office within HUD with the responsibility to "ensure that Fannie Mae and Freddie Mac are adequately capitalized and operating safely." This office is authorized to act without HUD oversight on a range of regulatory issues. It also established HUD-imposed housing goals for financing of affordable housing and housing in central cities and other rural and underserved areas.
This last statement is key and you need to remember this. Starting in 1993, HUD mandated that a certain percentage of Fannie Mae business had to be in three categories: low- and moderate-income, underserved, and special affordable. The goal was to increase home-ownership among minorities and the poor in rural and urban areas. Keep this in mind and we will come back to this later.
Impact of the Community Reinvestment ActLet us step back in time once again to 1977. It was in this year that the Community Reinvestment Act (CRA) was signed into law by President Carter. The purpose of this act was 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." In addition this act mandated that the appropriate Federal financial supervisory agency should assess the institution's record of meeting the credit needs of its entire community, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of such institution; and take such record into account in its evaluation of an application for a deposit facility by such institution.
The CRA was mainly targeted towards the four supervisory agencies: the Board of Governors of the Federal Reserve System (the Board), the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), and the Office of Thrift Supervision (OTS). When these agencies conducted inspections of the banking institutions under their purview they were to evaluate how well the said institution had complied with CRA. This record of compliance was taken into account when and if the institution submitted an application for a charter, a merger, an acquisition, a branch, an office relocation, or deposit insurance. In other words, for a bank to expand and grow, they had to be able to prove that they were lending and providing other services to low- and moderate-income residents in their service area in sufficient numbers.
The problem for the deposit and lending institutions was that the text of the law itself actually set no guidelines to show compliance and therefore the regulatory agencies held hearings to settle the issue. Even then, the guidelines were still somewhat vague and quite flexible in their approach. It was difficult for the deposit and lending institutions to know exactly what would increase their compliance, as there were two parts to an examination record, a public record and a confidential record. The deposit and lending institutions rarely knew what was contained in the confidential record and could not know who gave that information if they did obtain it.
To address some of the resulting concerns Congress amended the CRA in 1989 to require public release of these examinations. With community groups becoming more organized and better informed, they started to make more demands and protesting ever-increasing numbers of applications from deposit and lending institutions. New guidelines issued concurrently with this amendment appeared to demand great emphasis on documentation as the deposit and lending institutions had to show compliance through day-to-day operations. Because of this perceived undue hardship, new guidelines were once again issued in 1992 which specifically said that a lack of documentation would not be the sole determinate of a poor rating. However, it was also stated that any well-run program was expected to include documentation.
Even with all this involvement by the regulatory agencies, however, real progress towards the stated goal of increasing numbers of low- and moderate-income homeowners was considered spotty at best and generally unacceptable by many in the regulatory agencies, in Congress and among community activist organizations.
Impact of the Federal Housing Enterprises Financial Safety and Soundness ActCongress passed the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 in an effort to address the above problems. This act created the Office of Federal Housing Enterprise Oversight (OFHEO) with HUD to oversee Fannie Mae and Freddie Mac (FM2) and to ensure their continued economic stability and safety. It also established housing goals for financing of affordable housing and housing in central cities and other rural and underserved areas to be set and enforced by HUD. In 1993 and 1994, the law established these goals with the goals to be set by HUD in 1995 and onward. This mandated that a certain percentage of loans purchased by FM2 had to be written in low- and moderate-income, underserved, and special affordable areas. In other words, Fannie Mae and Freddie Mac were forced to buy sub-prime loans in considerable numbers.
Unintended ConsequencesWhat are the unintended consequences of these actions? Prior to 1992 and the passage of the Federal Housing Enterprises Financial Safety and Soundness Act if a lending institution wrote a sub-prime loan they essentially had to accept the risk of making that loan, of whether or not that loan would be repaid. FM2 would not purchase the loan because sub-prime loans did not meet their guidelines. Therefore, not that many sub-prime loans were written and those that were written generally performed fairly well. But with the passage of this act, and the resultant lowering of FM2 guidelines to purchase sub-prime loans, these lending institutions could now make them with impunity. The lending institutions could make their money on origination fees and other charges while pushing the risk of the loan actually being repaid onto FM2. Thus, from 1992 onward, the number of sub-prime loans ballooned dramatically. Everyone applauded the great increase in the number of low- and moderate-income homeowners. Very few noticed the risk to FM2 and the entire financial system.
Signs of TroubleThere were signs of trouble that were mostly ignored. Amid investigations of mismanagement and questionable accounting practices and charges of outright fraud, the Bush administration proposed a new regulatory agency under the aegis of the Treasury Department. The New York Times reported on September 11, 2003, ''The regulator has not only been outmanned, it has been out-lobbied,'' said Representative Richard H. Baker, the Louisiana Republican who has proposed legislation similar to the administration proposal and who leads a subcommittee that oversees the companies. ''Being underfunded does not explain how a glowing report of Freddie's operations was released only hours before the managerial upheaval that followed. This is not world-class regulatory work.'' The same article contains the now famous quotes from two Democrats:
''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.'' Representative Melvin L. Watt, Democrat of North Carolina, agreed.''I don't see much other than a shell game going on here, moving something from one agency to another and in the process weakening the bargaining power of poorer families and their ability to get affordable housing,'' Mr. Watt said.
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Did regulations requiring banks to make loans where
they once refused to do so actually cause this crisis, or was it government looking the other way while widespread mortgage fraud was committed by the bankers who we are now being told that we have to bail out? If you think that Florida is a blighted urban area which banks must lend to due to the Community Reinvestment Act, then that may explain why "a quarter of all reported fraudulent loans across the country are for Florida properties." Of course, it could just be the widespread fraud committed by the bankers everywhere including those "blighted urban areas" where it's risky to lend, like Florida. Could it be a case of the Bush Administration looking the other way while all kinds of scamming was going on? Let's see. Bush I is ruling during the Savings and Loan bail out, and Bush II is ruling when the banks need to be bailed out. Does anyone see a pattern here? Find out who caused this mess and learn a better way to get out of it. This article contains links to the Miami Herald articles showing that (surprise, surprise) the Republicons looked the other way while widespread mortgage fraud went unchecked. Please check it out, learn the real cause of this crisis, and pass it along to your friends. Also, use the link Help the Victims, Not the Scam Artists! to send a message to your members of Congress and your local newspaper telling them what you think about the latest Bush engineered crisis! by Mark Adams (20 articles, 0 quicklinks, 0 diaries, 312 comments [39 recommended, 0 rejected]) on Sunday, Sep 28, 2008 at 11:28:40 AM  (0+)
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Housing legislation is not the cause
Sorry Joe - you're wrong. The said legislation, and indeed no legislation, can force banks to make stupid and reckless loans. The banks did it all by themselves. First, the mortgage-originating banks quickly sold mortgages (especially subprime) to investment banks to get rid of the risks, responsibilities, and made a quick buck. Second, the investment banks took $1 of mortgages, leveraged it 30 to 40 times and invested in complex high-risk derivatives. In addition, they repackaged hundreds of mortgages, slice and dice them and came up with a strange security product of questionable value but bride rating agencies to give them fantastic AAA ratings. This way $1 of high risk subprime were resold as $10 of prime quality bonds. These incredible multiplying effects allowed the investment banks to rack in huge profits, and paid $35B of bonus to its executives and traders over the past 5 years. When people walked out of subprime, the reverse multiplying worked agaisnt the banks, so that $1 of foreclosed mortgage destroyed $40 of derivative 'asset' papers. With so much fake assets now under question, the banks balance sheets became meaningless, thus preventing them to make normal loans - thus seizing them up. This my friend is the true reason of the meltdown. Mortgaging banks wanted to make a quick buck, and investment banks wanted to make a killing by inflating the worthless. by TomK (0 articles, 0 quicklinks, 0 diaries, 330 comments [22 recommended, 0 rejected]) on Sunday, Sep 28, 2008 at 2:58:03 PM (0+)
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Reply: I believe it is
I don’t recall saying legislation “force[d] banks to make stupid and reckless loans.” The law essentially said they could not grow and expand their business unless they wrote the number of sub-prime loans the bank regulators found acceptable. In fact, from the banks point of view, the legislation simply turned a “stupid and reckless” loan into what looked like a good investment. Prior to the legislation forcing Fannie Mae and Freddie Mack (FM2) to buy sub-prime loans banks made very few of them. Why? Because they would not assume the risk of repayment. But with FM2 ready to assume the risk, the impediment to making these loans was removed. The banks could make money charging their various fees and make more by selling the loan to FM2. By selling the loan to FM2 they also “sold” the risk involved or so it seemed. So, no, the banks did not “do it all by themselves.” To make such a claim is to ignore the regulatory atmosphere in place at the time. I don’t believe the multiplying effects you describe actually took place, at least not to that extent. The derivatives certainly were overvalued. But they were overvalued because of the assumption that they would perform the same as those based purely upon standard mortgages. Very few people realized the precarious nature of FM2 taking on so much sub-prime mortgage debt. The value of derivatives most certainly dropped precipitously but why? They dropped off a cliff because the mortgaged-backed securities (MBS) upon which they were based also dropped precipitously. But why was that? Because too many of the mortgages upon which they were based were not being paid and were in foreclosure. Had the mortgage market been stable the MBS would have been stable and the derivatives based upon them would have also been stable. It all goes back to the sub-prime mortgage mess. by Joe Reeser (1 articles, 0 quicklinks, 0 diaries, 62 comments [1 recommended, 0 rejected]) on Monday, Sep 29, 2008 at 5:23:30 PM (0+)
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Some people forget so fast.
This problem has been in the works for years and congress has been holding hearings and taking pay offs for years. Watch this 2004 video from CSPAN; http://www.liveleak.com/view?i=cb4_1222537477 by Gallaher (2 articles, 0 quicklinks, 4 diaries, 990 comments [34 recommended, 1 rejected]) on Sunday, Sep 28, 2008 at 6:15:54 PM (0+)
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Reply: I dare the media
The media should show this video 24/7 on all channels. You will never see it except on YouTube though. Why? You can see Acorn at work in this video. Why are all these congresspeople telling the regulators who are warning them to sit down and shut up? A red flag about the size of Wisconsin was being waved and these congresspeople knew it and wanted it silenced. There were lots of other quiet warnings by members of both parties about what was going to happen eventually and no one had the guts to stand up and do the right thing because they did not want to be labeled a racist. A lot of people who were totally unqualified were getting loans for nothing down and there were members of congress who were happy about it. CRA, corporate greed, fraud, governmental incompetence, Acorn or All of the Above. You take your pick. BTW: you anti-Bushies should give it a rest and go pick on Sarah Palin for a while. This crisis was just as much the Democrat's fault as it was the Administration's. Frank and Dodd, who took lots of money from these bankers, should fall on their swords. This will be the Frank and Dodd Depression if we have one. by Mad Jayhawk (3 articles, 0 quicklinks, 2 diaries, 652 comments [56 recommended, 3 rejected]) on Tuesday, Sep 30, 2008 at 12:16:13 PM (0+)
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Derivitives and Leveraging are the real cause
Thanks for that article, very informative. FM & FM2 are government creations to achieve government goals, they should have never become GSE. As for the meltdown, in your comment you say that the "multiplying" effects weren't that severe. Yes they were. The (CDO's) collateralized debt obligation and leveraging (allowed by CDO's) allowed this mess to happen. The mortgage defaults themselves aren't that bad. There is still an underlying asset, the house and the property. Its the inaccuracy of the reporting of these assets coupled with a leveraged position on it that creates a money problem. FYI, Bears Stern was leveraged in excess of 30 times its capital. Lets take you Joe, take all your liquid assets and then borrow against that to the tune of 3000%. So if you have $1000, you can play the derivitives market AS IF you had $100,000. But why not with CDO's? They WERE rated AAA with a rate of return of...lets say, 9%. Heck, lets go with a lesser "traunch" thats rated A but provides a whoping 17% ROR. You know that you only have $1000, but your going to leverage. You'll borrow $30,000 at 5% interest. Heck, your guaranteed to make money. But just in case though, you'll buy some insurance via CDS (credit default swaps) from AIG if too much of the CDO goes sour. Lets go on. Lets say 30% of your "bets" were via CDO's, with an overinflated valuation (because the assets backing them weren't worth as much as reported...ie. the houses, unbenownst to you unless you thought that houses were over valued in which you wouldn't be doing this in the first place). So this is $300 of actual money that's yours but $9000 of borrowed money (i.e. 30% of the $30,000 I borrowed). Your creditors are OK with this since as collateral, they have the CDO's. Ut-Oh - housing market goes south....CDO's lose value, creitors get worried and demand more collateral, you have no money for more collateral...you have to sell CDO's that you borrowed to buy....etc....death spiral. And to make matters worse, AIG can't pay you for that insurance that you bought (the credit default swap). Lets get this straight, we're bailing out the banks. The reason the banks need bailing out is not because people defaulted on loans, it because these idiots were so over-leveraged that a small drop in the CDO would be catastrophic to their ACTUAL capital to the point where any unforseen expense would bankrupt them in the short term. Not a problem, except all the banks won't lend to each other out of fear. Joe, this is a free market event. IF the low-moderate income push hadn't been inacted, this leverage methodology would have continued just making the rich richer while the poor are left to dig themselves out (which isn't a bad thing). Another problem was that these "mortgage backed securities" given by Freddie had the unofficial support of the U.S. government. So China and others (who fund our deficiet) required a bail out. I don't see an inherent problem with the low-income effort. Fannie & Freddie were made to get homes for those who needed help getting one. The problem is: 1 - unofficial government backing of a supposed private company....which encoraged ACTUAL banks to offer CDO's to investment banks (to keep up with Freddie and Fannie)...thats not fair market competition 2 - rating agencies giving these CDO's AAA ratings...obviously not accurate 3 - allowing firms that can have such a big impact to leverage to that extent where they can pull down the entire system....in laymens terms - its one thing if I smoke...its another thing if I smoke so much that it gives 30% of the people around me cancer. by Matthew T. (12 articles, 0 quicklinks, 7 diaries, 305 comments [1 recommended, 0 rejected]) on Tuesday, Sep 30, 2008 at 12:17:58 PM (0+)
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Reply: You said it yourself...
I appreciate your explanation of how the derivatives market works. To be honest I don't know that much about it but let's assume you're correct. Let us assume everything you have said about the leveraging of the derivatives market is true. What starts the whole chain of events heading south? Look at the start of the your fourth paragraph. "Uh-Oh - housing market goes south..." Why did the housing market go south? Because of the sub-prime loan mess. That's why. Too many people defaulting on their mortgage. Suddenly mortgages aren't such a safe investment and all the investment vehicles based upon mortgages aren't either. The problems with the derivatives market are a symptom and not a cause of the current crisis. Also, when you say, "this is a free market event." that's not really true. Once the federal government starts meddling in the market to the extent that they have in the housing market, that market ceases to be "free." From there to the end of your post I would have to agree. by Joe Reeser (1 articles, 0 quicklinks, 0 diaries, 62 comments [1 recommended, 0 rejected]) on Wednesday, Oct 1, 2008 at 11:15:52 AM (0+)
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Nice Republican Talking Points Joe
This is total crap and a now well-propagated Republican talking point over the past week. by E. Nelson (40 articles, 8 quicklinks, 26 diaries, 511 comments [57 recommended, 2 rejected]) on Tuesday, Sep 30, 2008 at 5:09:02 PM (0+)
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Reply: Take Your Blinders Off
My statement that, "for a bank to expand and grow, they had to be able to prove that they were lending and providing other services to low- and moderate-income residents in their service area in sufficient numbers" is most certainly not "a false premise" as you claim. It's the plain language of the law. The Federal Financial Institutions Examination Council says the following: 1. The Community Reinvestment Act is intended to encourage depository institutions to help meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods... 2. The CRA requires that each insured depository institution's record in helping meet the credit needs of its entire community be evaluated periodically. That record is taken into account in considering an institution's application for deposit facilities, including mergers and acquisitions. You then go on to make the ridiculous statement that my position "makes the wild assumption that banks were forced to make bad loans to survive." I have never stated not implied any such thing. As a matter of fact I have stated specifically the banks were never forced to do anything. The rest of your post is similar dissembling for which I have neither the time nor the inclination to correct. Perhaps next time you can argue against something I actually wrote. by Joe Reeser (1 articles, 0 quicklinks, 0 diaries, 62 comments [1 recommended, 0 rejected]) on Wednesday, Oct 1, 2008 at 12:01:21 PM (0+)
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More details please...
Okay Joe, this is great...I have been trying to get more info on this. But, what I really want to do is read the actual Federal Housing Enterprises Financial Safety and Soundness Act of 1992. I want all the facts and figures and these are incredibly hard to find. Can you please cite your sources? Also if anyone has a link to the actual act that would be great. I have tried to searching the Library of Congress but no luck. Which is strange because even HUD (http://www.hud.gov/offices/hsg/gse/gse.cfm) refers to the act and its requirements regarding affordable housing, but won't link to the actual verbage of the act. Thanks for any assistance! by meg mackinley (0 articles, 0 quicklinks, 0 diaries, 1 comments) on Wednesday, Oct 1, 2008 at 12:46:47 AM (0+)
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Reply: Here's the Act - I'll post more later
Federal Housing Enterprise Financial Safety and Soundness Act of 1992 by Joe Reeser (1 articles, 0 quicklinks, 0 diaries, 62 comments [1 recommended, 0 rejected]) on Wednesday, Oct 1, 2008 at 3:54:47 AM (0+)
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BusinessWeek has completely debunked this talking point
BusinessWeek which is a right-leaning well respected journal in the Business world has completely debunked this new Republican talking point on blaming the Community Reinvestment Act (CRA) http://www.businessweek.com/investing/insights/blog/archives/2008/09/community_reinv.html Not that it matters because you certainly wouldn't want facts to get in the way of a good piece of propaganda. by E. Nelson (40 articles, 8 quicklinks, 26 diaries, 511 comments [57 recommended, 2 rejected]) on Wednesday, Oct 1, 2008 at 9:51:31 AM (0+)
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Reply: Don't You Wish
Had I actually made the argument that the CRA was the cause of the current crisis you would have a point. But I didn't and so you don't. by Joe Reeser (1 articles, 0 quicklinks, 0 diaries, 62 comments [1 recommended, 0 rejected]) on Wednesday, Oct 1, 2008 at 12:05:26 PM (0+)
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more...
by CW Blanchett (0 articles, 0 quicklinks, 0 diaries, 34 comments) on Tuesday, Oct 7, 2008 at 3:27:02 PM (0+)
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