Sunday, November 27, 2016

Background Part 1, the Enabling Via Legislation

It all started with legislation. The Community Reinvestment Act (CRA) of 1977 was designed to make it easier for low-income families to get mortgages. But due to a long string of misguided and probably politically-motivated amendments, revisions, and related legislation over the next 25 years, the CRA train left the tracks and good intentions turned into idiotic mandates. One by one, checks and balances intended to ensure that lenders didn't write bad loans were removed. And by 2002, the Department of Housing and Urban Development (HUD) required pseudo-government agency Fannie Mae to dedicate 50% of its funds to back affordable housing. We're talking hundreds of billions of dollars to back bad loans. In effect, politically-motivated congressional leaders were responsible for creating the subprime mortgage crisis, which I like to think of as a deadly virus. In addition, Fed Chairman Alan Greenspan and, to some extent, then treasury secretary Robert Rubin, kept interest rates down and supported sub-prime loans. That was an important catalyst for spreading the virus. Then the bankers found a creative way of getting all those risky loans off their balance sheets by packaging and selling them to investors and institutions all over the world. But they couldn't have done it without help. Rating agencies like Standard & Poor's and Moody's essentially told the banks how to structure mortgage-backed securities in such a way that the agencies could rate them as investment-grade when they weren't. That's like the banks and rating agencies knowingly infecting the entire world with the deadly virus. Another key catalyst was then-Chairman of the Senate Banking Committee Phil Gramm pioneering the exemption of over-the-counter derivatives, such as credit-default swaps, from regulation. Greenspan and Rubin also supported deregulation of derivatives. And that's pretty much what nearly turned the American subprime mortgage crisis into a worldwide financial meltdown. Gilbert calls it, "-- a conspiracy of greed among bankers, investors, rating agencies and regulators --" I think that's pretty darned accurate. The only thing I still don't get is this. The politicians responsible for oversight of the housing and banking sectors leading up to and during the meltdown - Chairman of the House Financial Services Committee Barney Frank, and Chairman of the Senate Banking Committee Chris Dodd - have to date born zero responsibility and are still in charge of regulation of those sectors. That's the top of the food chain, folks. And they're still there. Source: CBS MoneyWatch By STEVE TOBAK March 26, 2010, 2:51 PM

Background Part 2, The Role of Securitization

The securitization of subprime mortgages into mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) was a major contributing factor in the subprime mortgage crisis. Subprime MBS and CDOs were attractive to investors due to the higher interest rates they offered versus assets backed by prime mortgages. Subprime borrowers with less than perfect credit had higher interest rates on their mortgages due to the increased risk of default. Further, many loans with adjustable-rate mortgages were made that later added a great deal of fuel to the mortgage crisis. During this time, lenders pooled the subprime mortgages into MBS and CDOs. These financial products often received high ratings from credit agencies. Tranches of these securities were then sold to unsuspecting investors, who were not aware of the risk associated with them. The lower-quality tranches offered higher interest rates but absorbed the first losses associated with defaulting mortgages before the senior tranches. Subprime lending caused a dramatic increase in available mortgage credit. Many loans were made to borrowers who would have previously had difficulty obtaining mortgages due to below-average credit scores. Private lenders made a lot of money by pooling and selling the subprime mortgages. However, the risk of foreclosure increased with the relaxing of credit standards. Lenders and buyers incorrectly assumed that real estate values were impervious to a downturn. Private-label MBS provided a lot of the necessary capital for the subprime mortgages. Around 80% of subprime loans were made with private-label MBS in 2006. In March 2007, the value of subprime mortgages was valued at around $1.3 trillion. The mortgages issued by private lenders had greater risk since they were not backed by the government, like those from Freddie Mac and Fannie Mae. The real estate market boomed, with more buyers bidding up the prices of available houses. The real estate markets in Florida, Arizona and the Las Vegas area were very hot during this time. At first, subprime borrowers who fell behind could refinance their mortgages based on higher property values or could sell homes at a profit. The amount of risk for subprime mortgages was not an issue at this time. Only when property values began to decline did issues begin to appear. Adjustable-rate mortgages began to reset at higher rates, and mortgage delinquencies grew substantially. The default on subprime mortgages led to more problems. By August 2008, around 9% of all mortgages in the U.S. were in default. MBS and CDOs began to lose value with the higher default rates. Freddie Mac and Fannie Mae were seized by the government in 2008 as they began to realize large losses. Foreclosures and repossessions increased, with more properties being placed on the market as banks attempted to liquidate their inventories. This depressed property values even more, leading to a downward spiral for the real estate market. Some borrowers attempted short sales for their underwater mortgages, but they often found lenders difficult to work with or unwilling to negotiate. Source: Investopedia http://www.investopedia.com/ask/answers/041515/what-role-did-securitization-play-us-subprime-mortgage-crisis.asp#ixzz4RG8wdyO5