|Quoting Sv7887 (Reply 21):|
You conveniently leave out the passage of the Community Reinvestment Act in the 1990s that started this little subprime brigade. Banks were sued and the Federal Reserve actually rewrote the lending standards to encourage these loans to so called minorities. Social Engineering gone bad.
Correction - the CRA was passed in the 1970s under Carter. Some important facts about the legislation:
- CRA-governed mortgages defaulted at rates roughly equal to those of non-CRA-governed mortages.
- The legislation specifically instructs banks to follow sound lending principles.
- CRA-governed mortgages were less likely to be resold as mortgage-backed securities.
- Half of all subprime mortgages out there have been issued by non-CRA-governed institutions.
- The Bush administration enforced the CRA less strictly than the Clinton administration, yet it was under Bush that the subprime market imploded.
I don't deny that government policy regarding Fannie and Freddie Mac bought into the same blindness toward risk that struck the rest of the market, but blaming that on the CRA is way off base.
|Quoting Sv7887 (Reply 21):|
You don't seem to get it. Wall St was the SECONDARY market for these mortgages. Collaterized Debt Obligations are only pieces of mortgages that were already made...You seem to make the argument that derivatives are bad without understanding how they work. You also ignore that the cause of the crisis wasn't the derivatives themselves but the defaulting of the loans that created them..
Umm...no. The mortgage-backed securities (a subclass of CDO's) were only part of the problem. And labeling them "only pieces of mortgages" is misleading; it ignores the fact that by combining and redividing thousands of mortgages (spamifying them, if you will), the bad mortgages were spread throughout the economy.
The other part of the problem, that you seem to be ignoring, was another derivative, the credit default swap. This blog post explains it about as well as any source I've seen:
To summarize, the CDS was initially a sort of loan insurance. If Bank A was nervous that Person B wouldn't pay off the loan they took out, they could pay Firm C a regular fee in exchange for the promise that, if Mr. B defaulted, Firm C would pay off the loan. Bank A reduces their risk (and doesn't have to hold as much cash in reserve, allowing them to make more loans). Firm C earns some income. Everyone is happy. Then along come some Republican lawmakers championing deregulation (primarily Phil "Nation of Whiners" Gramm), who prohibit the SEC from regulating CDSs.
First result - now no one is checking to see if Firm C actually has the resources to pay off the loan in case it fails. But hey, housing values are only going up! It's not like we'll ever have to pay off a CDS, right?
Second result - Bank A looks at all Firms C (and D, E, F, etc.) all wanting to sell it swaps. Bank A starts making riskier loans--after all, if they don't work out, all those CDS's will cover it.
Third result - Someone realizes that nothing says CDS's have to be on your own loans. Firm C sells CDS to Firms G, H, and I that will pay off if Mr. B's loan fails, even though those firms have nothing to do with the initial loan. Money for everyone! Million dollar bonuses at the end of the year! How could this possibly go wrong?
Then the housing market slows down, and Mr. B calls up Bank A and says he can't afford the loan anymore. Bank A calls up Firm C and requests the payout on its CDS. So do firms G, H, and I. Firm C doesn't have the cash to pay out all these, but never fear! It took out CDSs against this scenario. They call up Firm J--as do all the other people Firm J sold CDSs to. Firm J can't afford to pay all these out, so they call up the guys they bought CDSs from. This happens a few more times, and before long Firm C gets a call from Firm Z asking for the payout on the CDS they bought. Oops.
And that, my friend, is how unregulated derivatives shelled the financial industry.
By the way, the total value of CDS trades in 2007? 70 trillion dollars. That's more than the GDP of the entire planet.
Hydrogen is an odorless, colorless gas which, given enough time, turns into people.