The Real Cause of the Credit Crisis

Politicians and other talking heads (and thus the general public) seem to agree that the current credit crisis was caused by lack of governmental oversight of the big bad bankers. In actual fact, it was just the opposite. The cause of the crisis was Government pressure (mostly but not entirely from Democrats in the White House and Congress) imposed on the mortgage lending industry as far back as the beginning of the Clinton era. Semi-government institutions, Freddie Mac and Fannie Mae, caved in to the pressure, and by readily buying ever-increasing numbers of shaky loans, they made it highly profitable for loan originators (mostly local brokers and bankers) and loan "bundlers" ( Wall Street) to willingly go along.

Starting in 1992, a majority-Democratic Congress mandated that Fannie and Freddie increase their purchases of mortgages for low-income and medium-income borrowers. Operating under that requirement, Fannie Mae, in particular, became aggressive and creative in stimulating "minority gains." The Clinton administration investigated Fannie Mae for racial discrimination and proposed that 50 percent of Fannie Mae's and Freddie Mac's portfolio were made up of loans to low-to medium-income borrowers by the year 2001. The Clinton administration criticized the mortgage industry for looking at " outdated criteria, "such as the mortgage applicant's credit history and ability to make a down payment. Threatening lawsuits, Clinton's Federal Reserve demanded that banks treat welfare payments and unemployment benefits as valid income sources to qualify for a mortgage. That isn't a joke – it's a fact.

By 1999, liberals were bragging about extending affirmative action to the financial sector. A Los Angeles Times reporter hailed the Clinton administration's affirmative action lending policies as one of the "hidden success stories" of the Clinton administration, saying that "black and Latino homeownership has surged to the highest level ever recorded." After 2001, a major new market was found for these loans-illegal immigrants.

Meanwhile, a few economists (but no politicians) were screaming that the Democrats were forcing mortgage lenders to issue loans that would fail as soon as the housing market slowed and overly-stretched borrowers couldn't get out of their loans by refinancing or selling their houses. In Bush's first year in office, the White House chief economist, N. Gregory Mankiw, warned that the government "implicit subsidy" of Fannie Mae and Freddie Mac, combined with loans to unqualified borrowers, was creating a huge risk for the entire financial system . Rep. Barney Frank denounced Mankiw, saying he had no "concern about housing". The New York Times reported that Fannie Mae and Freddie Mac were "under heavy assault by the Republicans," but these entities still had "important political allies" in the Democrats.

During the 2004 presidential campaign, George Bush bragged about the fact that a greater percentage of Americans owned their own homes than ever before, but (except for praising low interest rates) he did not explain how or why this happened. President Bush pushed even farther; he asked lawmakers to eliminate the down payment normally required for FHA loans. So Republicans have dirty hands too.

Nevertheless, in 2005 after Fannie and Freddie were investigated and heavily fined for accounting fraud, Republicans in Congress wanted to take away Fannie and Freddie's privileged status, but by a strict party line vote Democrats won, and Fannie and Freddie were allowed to continue their businesses largely unchanged, but with one condition … they had to increase their support of loans for challenged borrowers. By this time, those working in the mortgage industry were calling such loans, "liars' loans".

By the end of 2006, 30% of new mortgages in the USA were subprime mortgages, up from 2% in 2002. Most such mortgages were sold off by the banks who originated the loans and converted into CDO's, securities backed by bundles of mortgages. Despite the junk loans in these bundles, these securities continued to be rated AAA by the bond rating agencies. Many financial institutions all over the world continued to invest in them, because of their AAA rating, their reputation as being backed by the US government, and a slightly higher interest rate than "comparable" securities. Many banks did not buy them at all, and some hedge funds entered into swaps whereby they made money if these securities lost value.

Lax standards for borrowers and low interest rates after 9/11/2001 expanded the demand for houses which, in turn, inflated prices. Seemingly reliable price increases attracted flippers and people who figured that owning a second or third house would be a good investment, further adding to the demand. Total demand drove housing far beyond any sustainable price level. Confidence in ever-increasing housing prices tempted many to cash in their "profits" by taking home equity loans.

When the housing bubble finally burst in 2005, the huge inventory of dubious first mortgages along with accumulated second mortgages piled on many properties caused the mortgage loan default rate to spike. This caused the market for mortgage-backed securities to soon collapse. Those who bet against these securities collectively made billions, but others like Merrill Lynch and AIG were stuck. Because no one would buy them, these securities had to be recognized on the books as essentially having no value, as per one of the new regulations ("mark to market") adopted after the Enron debacle. Per accounting standards, financial institutions that owned these securities had to write down these assets against their equity, leading to huge decreases in the equity of a few of the largest banks. These banks no longer had enough equity to meet the loan / equity ratios required by banking regulations, so they had to virtually stop making loans of any kind, thus triggering the present credit crisis. Some large banks like Citigroup tried to cope by selling 10 or 20% of themselves to sovereign funds, namely the investment arms of the Chinese and various Arab governments, but these countries soon lost confidence in the system and withdrew further support. Finally, major financial institutions began going bankrupt. As some economists predicted, the affirmative action loan time-bomb has exploded.

Now, at a cost of hundreds of billions of dollars, taxpayers will have to rescue one of the Democrats' most important constituent groups: rich Wall Street bankers. It is likely that soon after that deal is done, billions more will be spent to bail out a bigger group of Democratic supporters: welfare recipients, illegal immigrants, and other unqualified borrowers, who were given loans that twenty years ago would have been considered laughable .

The mainstream media has no stomach to criticize liberal Democrats, who, more than anyone else, caused all of this. While government intervention caused the problem, the fix, ironically, is supposedly greater government involvement (regulation) in the future. Politicians are participating in this cover-up, because nearly all of them are on record supporting easier-to-get mortgages, and they want people to believe they had little to do with causing the problem. Both Obama and McCain say it is too bad better regulations were not in place, as if it were possible to regulate against large companies making bad investments. Both candidates probably had focus group data indicating that voters did not want to hear what was the real cause of the credit crisis.

Apparently, the country has learned nothing from this expensive mistake, so it will only be a matter of time before the government again will wreck the economy.

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