Posts Tagged ‘subprime’
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Recapping my previous post. Government legislation would only allow banks and lending institutions to merge and grow if the CRA (Community Reinvestment Act Score) was high enough. Growth could mean something as simple as adding another branch in a different part of town. The way to increase your CRA score was through subprime loans. Wall Street discovered a method to make the process very profitable. Below is an explanation of how Wall Street turned subprime loans into AAA investments.
An application is made for a loan through a broker. The applicant has no down payment, bad credit, and has no proof of income level - a good candidate for a subprime or low documentation (referred to as a liar’s) loan. The broker has no vested interest in making sure you can repay the mortgage. The broker is paid a commission, among other fees, for each loan generated. The broker packages a subprime loan for the applicant and uses Bank X to finance the mortgage.
The collapse of the US Economy, circa 2009, has been deemed a failure of the free market system. The Federal Government changed the rules regarding mortgage lending practices, encouraged the issuance of loans to those who could not afford them, and used Fannie Mae- Freddie Mac to carry out this new public policy.
Definition of a free market economy: Business governed by the laws of supply and demand, not restrained by government interference, regulation, or subsidy.
Government polices falsely stimulated demand for housing. Only in Washington could today’s economic situation be blamed on our “free” market.
The quick fix to our economically challenged economy? To allow government even more control over our “free” markets. Does no one remember the $640 toilet seat, the $7,600 coffee maker? This cannot end well.
What exactly is a subprime loan? You want to buy a house. You have no money for a down payment. You have no way to prove how much money you earn. This normally would and should be a no brainer. You can’t buy a house. Enter the subprime loan.
No money down, low interest rates for the first few years of the loan, no credit check. It sounds crazy now doesn’t it. Don’t worry if the interest rate on your house triples after five years. Since your house will always increase in value you will be able to refinance or sell at a profit long before you get into trouble.
Subprime loans have always existed. Most financial institutions have always had a small percentage of subprime, risky loans. What happens if that small percentage of risky loans becomes a large percentage? What happens if housing prices decrease instead of increase? Welcome to 2009.
If you read my previous post, you now know how various political maneuverings created the subprime crisis. How did this crisis spread throughout the economy?
Government policies created an artificial demand for housing. The increased demand caused housing prices to go up, but only in the less expensive houses, right? Wrong. Two houses, one cost $125,000, the other $75,000. The $75,000 house is in great demand, causing the price to increase to $100,000 (supply/demand economics). The value of the $125,000 will also increase by approximately $25,0000. The more expensive house is in a better neighborhood, is newer, is simply better than the cheaper house, and a new market price has been established . Prices do not exist in a vacuum. The price of anything is always in comparison to the price of something else.
If Apple sells an Ipod for $250.00, SanDisk will price their line of MP3 players accordingly. If the SanDisk players have more features, charge more than $250.00, if the SanDisk players have fewer features, charge less than $250.00. An oversimplification – yes, but all free markets work primarily the same way (notice I’m referring to free markets here- starting to see the problem now?).
Therefore, prices at the bottom of the housing market (subprime) have an influence on prices in the middle and top of the housing market. The housing boom was created.
1977 Community Reinvestment Act, enacted by President Jimmy Carter . The purpose of the 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.” Banks and other financial institutions were mandated to provide “services” (loans) to people and businesses with low to moderate incomes. The act was very vague and difficult for anyone, including the government, to interpret and enforce. This led directly to the passage of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992.
1992 The Federal Housing Enterprises Financial Safety and Soundness Act. This act, purportedly passed to ensure the safety and financial stability of Fannie Mae and Freddie Mac, also provided that the goals for the percentage of loans given to those with low to moderate incomes would be established by HUD. HUD (dependent upon congress for its budget) was given the responsibly of overseeing Fannie Mae and Freddie Mac.
Early 1990’s – Congress relaxed the capital requirements for Fannie Mae and Freddie Mac , allowing more loans to be given to low income communities and individuals through the use of additional leverage.
1994 – Congress revised the Community Reinvestment act allowing those with no money for down payments and or bad credit to be eligible for government backed loans. Fannie Mae’s purchases of sub prime loans skyrocketed from an estimated $18 billion(1995) to $175 billion (2004).
1999 Gramm-Leach-Bliley Act- signed by President Bill Clinton. Allowed commercial and investment banks to consolidate. President Clinton required an amendment to the Gramm-Leach-Bliley Act ensuring that the minority lending requirements as provided by the Community Reinvestment Act were enforced prior to any commercial and investment bank merger.
2003 President Bush attempts to pass legislation reforming the way Fannie Mae and Freddie Mac manage risk and capital. Rep Frank, ranking Democrat on the Financial Services Committee, said “Fannie Mae and Freddie Mac are not facing any kind of financial crisis.” No legislation was passed.
2004-2008 President Bush attempts to reign in Fannie Mae and Freddie Mac (17 times). No reforms received Congressional approval.
Translation
The Community Reinvestment Act put into play the idea that the Federal Government could force financial institutions to provide loans to people who would normally be denied due to money, credit, or income level. The Federal Government lowered the capital requirements of Fannie and Freddie, increasing leverage with a concurrent increase in risk, allowing more sub prime loans to be purchased. The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 gave banks a “CRA” score (the more sub primes loans the better the score), which was then used by the Gramm-Leach-Bliley Act to determine if banks could merge. The mergers and consolidations allowed by the Gramm-Leach-Bliley act helped hide the problem of systemic risk related to sub prime loans. Problems in the housing industry were dismissed by Congressional leaders.
Why You Haven’t Heard This
It is evidently considered racist to credit even the slightest responsibility for the sub prime meltdown on the passage of the Community Reinvestment Act. I have never seen a breakdown, by race, of those supposedly helped by the Community Reinvestment Act, and I am not the slightest bit interested in seeing said breakdown. I do happen to know the rate of home ownership for African Americans in 1970 – 42%, and in 2008 – 47.2%. Our government in action.
Nutshell Version
The Federal Government meddled in private business. Wallstreet found a way to have its cake and eat it too. Everybody is busy blaming everybody else (Bush did it-the most popular target for both Democrats and Republicans). You and I pay the bill. Politics as usual.
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