Subprime Mortgage Crisis

In the United States, the subprime mortgage crisis involved a series of happenings and environmental factors that eventually culminated in the financial crisis of the late 2000s. This was characterized by steadily rising rates of subprime mortgage delinquencies and defaults, which ended up causing the insolvency of the securities these types of loans backed up.

As the percentile of lesser quality subprime mortgages climbed from its historical level of 8% or less to the substantially greater level of roughly 20% between the years 2003 and 2006, the ratios of these types of mortgages were still higher in a few areas within the U.S. With a percentage as high as 90% or more being both subprime mortgages and having adjustable rates, this problem reached its peak in 2006. The failure rate came as the practice of reduced lending standards began to converge with the equally broad trend of more high risk mortgage products, though the increasingly indebted level of the average household in the U.S. also played a significant role. The average household’s ratio of debt to disposable income rose from a level of roughly 77% in the year 1990 to 127% as 2007 ended, and a substantial part of this debt was directly related to mortgages.

As the prices of U.S. homes peaked in the middle of 2006 and promptly began their near nosedive, refinancing homes became a far more difficult prospect than it had previously been. When the large number of adjustable rate mortgages began resetting at higher rates of interest, demanding larger monthly payments, the number of delinquent mortgages skyrocketed. Securities that were backed by mortgages, particularly those composed of subprime mortgages that banks held large amounts of, lost a great deal of their value. Around the world, investors dramatically reduced the amount of mortgage debt and related securities as the willingness and capacity of the private financial sector to continue such lending practices all but imploded. Abundant concerns developed regarding how sound the U.S. credit and financial markets were, leading to dramatically tighter credit worldwide. This slowed both Europe and the U.S.’s economic growth.

The Background and Timeline

The most immediate causative factor at work within the crisis was the bursting of what was known as the United States housing bubble, which had peaked at some point within the years of 2005 or 2006. As this period ended, adjustable rate and subprime mortgages defaulted in large numbers. Between the years of 2004 and 2007, lenders originated extraordinarily high numbers of these types of mortgages. Those years produced mortgages which display a substantially higher default rate than those produced either before or subsequently.

As the increasingly large number of incentives including those of simple early terms and a fairly long term rate of continuously higher prices for housing continued to encourage borrowers to take on the most difficult mortgages possible, many people continued to believe that all they would need to do was refinance at a more favorable rate at a later time. In addition to this, the larger degree of marketing power that loan originators creating subprime mortgages and the smaller role of Government Sponsoring types of enterprises played in gatekeeping further grew the number of subprime mortgage obligations that came about for consumers. Because of all of these factors, more consumers who could have potentially qualified for more traditional and conformist loans took on the subprime variety.

Out of all of the most underperforming loans, the majority of these came about through the securitization of private investment banking organizations. These were the types of companies that mostly lacked the GSE or Government Sponsoring Entity level of market clout and additional level of influence within the mortgage originating market. Over the time where interest rates on mortgages started to rise and the growing prices of houses began to drop to a moderate extent in 2006 and 2007 across several different areas within the U.S., it became more difficult for many people to refinance their loans. As this occurred, so did a growing number of both foreclosures and defaults, as the easier terms that had characterized the early loans began to expire. Coupling this with the fact that home prices did not continuously rise as many people had expected them to, adjustable rate mortgages or ARMs found higher reset interest rates. As the prices of houses dropped, roughly 23% of U.S. homes ended up being worth less than the mortgage liens that were attached to them by September of 2010, which provided a further monetary incentive for a borrower to simply go into foreclosure. As this foreclosure problem turned into a full blown epidemic, with the subprime loan being a major factor and a healthy part, the later part of 2006 marked the beginning of a trend which is continuing to this day. As the U.S. keeps on being one of the largest factors in the financial crisis that grips the world, the mortgage issue continues to drain wealth and the perception of wealth from consumers while it simultaneously undermines the financial power of the banks that made these types of loans.

During the years which led up to the subprime mortgage crisis, there were a huge amount of foreign funds that flowed both into and through the U.S. from all kinds of different companies and even entire economies that leveraged their fast growth for high levels of profitability. These economies were primarily based in oil producing countries and those in Asia. When this rapid influx of funding coupled with the low level of interest rates in the U.S. between the years of 2002 and 2004, the easy conditions of credit both powered a housing bubble and a credit bubble. As the various different types of loans, with the most prevalent being auto, credit card and mortgage became more easily obtained by the average person, the average consumer began to take on a truly massive and unprecedented level of debt.

Among the various different parts of both the credit boom and the housing boom, the degree of financial agreements that were known as mortgage backed securities or MBSs also grew to a dramatic extent. These were the types of investments that essentially boiled down to deriving their value from the payments of a pool of mortgages and from the housing prices that supported those mortgage payments. While this was a financial innovation of sorts that allowed a financial institution or an investor that was located anywhere in the world to place a significant investment into the housing market of the United States, this carried a serious disadvantage when house prices did not continue to rise. As the prices for houses declined across the country, a large number of significant financial institutions all around the globe that had substantially borrowed in order to invest a large amount of money into MBSs produced and had to report dramatic levels of financial loss as a result of this type of investment. As the losses and default level of the other loan types also grew to a dramatic extent with the expanding level of the crisis, the housing market itself could not contain the full breadth of the financial damage it was doing to the economy. Across the entirety of the world, it is estimated that the total loss of wealth this cascade effect produced is estimated to have been trillions of dollars of U.S. currency or equivalent foreign wealth.

During the time when both the housing bubble and the credit bubble were expanding, several different kinds of factors caused an increasing level of fragility within the entire system of finance. As the policymakers who did not recognize the incredibly important role that both investment banking companies and hedge funds played in the entire system ignored this role, which became known as a system of shadow banking, that role still continued to grow further. A shadow bank is able to mask its level of leverage from those who invest in and through it, also tricking regulators in the same way. Using a large number of extremely complex and off balance sheet derivatives and securitizations, these shadow banks were able to hide tremendous amounts of debt.

Through the use of these sorts of instruments, it became as close to impossible as anything else for such a financial institution to be fixed by way of a reorganization or a typical bankruptcy, which contributed greatly to a need for the receipt of a government bail out. These bail outs became a large and unpopular trend due to the widespread nature of such shadowy financial tactics. Among those who are expert in financial matters, it is believed that such institutions had grown to be as important to the economy as the commercial type of depository bank in the provision of credit to both people and businesses within the U.S. economic system, but that these types of organizations did not work within the same level of tight and careful regulation as the other kind of banks. Such institutions, and even a number of different properly regulated banks, had also taken on a very significant degree of debt burden with they provided others with the types of loan that are described in the above paragraphs. In addition to producing such unsustainable loans, these kinds of businesses did not maintain the levels of financial cushioning that are typically considered sufficient to absorb significantly high losses from both the massive loan defaults and the losses due to MBS failure.

As these huge losses mounted still further, the entire capacity of the financial institutions to produce loans eroded away, which further slowed the economic activity that drives the economy. As the concerns about the general stability of such highly important financial companies drove the central banking organizations to provide funding for the encouragement of lending, the commercial paper markets also required boosting. The commercial paper markets are integral to keeping business operations properly funded, and the faith investors had placed in them had been shattered. Many governments took great steps to bail out the key financial companies which had overextended themselves and crushed investor confidence, with the governments themselves taking on a large amount of additional commitment financially.

While the risks that took on and threatened the main part of the larger economy created through the housing market’s level of risk taking and its subsequent downtown created a crisis, the central banks began to take action. The central banks got into a large number of important financial decisions as far as what level to which they should cut interest rates and produce stimulating economic packages that would hopefully stir new growth. The overall impact on the different stock markets around the world have been tremendous as a result of the global financial crisis. During the time between the 1st of January and the 11th of October in 2008, the owners of stock within companies based in the U.S. suffered through a roughly $8 trillion level of losses, with the total level of these holdings moving downward in value from a level of roughly $20 billion down to a level of around $12 billion. Along with the losses within the U.S. itself, the losses in other countries around the world also took on an average of around 40%.

The losses within the various stock markets and the values associated with housing and those declines placed even more downward pressure on the spending that consumers practiced, which is a major engine of economic growth and prosperity that fed the cycle of the subprime mortgage mess. As the leaders of the more developed world with larger economies to protect met with emerging nations with less developed economies during the periods of November of 2008 and March of 2009 to discuss and mull over strategic plans for managing this crisis, they produced a number of different potential solutions to it all. As the brainstorming went on, government officials, bankers from central banks, economic experts and executives from major businesses all chimed in. For example, one piece of American legislation that took hold and was signed into law was the Wall Street Reform and act that protects consumers that was nicknamed Dodd-Frank. This became a law in the official sense in July of 2010, and it was designed to help the global economy and particularly the U.S. economy to cope with this crisis from a causative point of view.

The Market for Mortgages as a Whole

The borrowers who take on subprime mortgages have an increased tendency to have weaker credit scores and histories than other borrowers do, which also tends to reduce their level to repay their loans. As a result of this tendency, a subprime loan has a far more substantial risk of going into default than a loan that is made to a borrower in the prime range. If such a borrower becomes delinquent through not making their payments in a timely manner to the servicer of the loan, such as a bank or any other type of financial company, the lender is able to possess the property itself through a process that is known as foreclosure.

As of the month of March in 2007, the American value of the different subprime mortgages was estimated to be in the vicinity of $1.3 trillion. As the number of first lien mortgages in the subprime range was numbered 7.5 million, this was a dramatically high percentage of the total. During the years of 2004 through 2006, the share of these types of lower performing mortgages compared to the total number of originations became as high 18 to 21 percent, as opposed to a level of lower than 10 percent during the years of 2001 through 2003 and again in 2007. As this boom in mortgage lending and particularly in subprime lending expanded, it was driven still further on by a rapid expansion of independent originators of mortgages that were not affiliating with banks. Despite the smaller share possessed by these smaller types of institutions, which was roughly 25% in the year 2002, they were able to contribute on the order of 50 percent to the total growth of mortgage credit during the years of 2003 through 2005. As the third quarter in 2007 arrived and progressed, the subprime ARMs which happened to only make up 6.8 percent of all of the outstanding mortgages in the USA coincidentally accounted for 43% of all of the foreclosures that started up during the same quarter.

By the time October of 2007 rolled around, roughly 16 percent of all of the subprime mortgages with adjustable rates or ARMs were either in the 90 days late range or had already begun the foreclosure process by the lender’s decision. This was triple the percentage that had gone this way in 2005. As January of 2008 happened, this delinquency rate had risen even further, to 21 percent, and it had reached 25 percent by May of 2008.

Judging by the figures quoted by RealtyTrac, the values of every outstanding residential mortgag that the various U.S. households owed through the purchase of residences that housed four families or less was a total of $9.9 trillion USD as of the end of 2006, with this amount growing still further to $10.6 trillion USD by the middle of the year in 2008. Through the year 2007, the foreclosure process had been initiated by lenders in almost 1.3 million of their properties, which was an increase of 79 percent versus the year 2006. This number grew still further in 2008, to 2.3 million properties, which was an 81 percent increase over 2007. This growth level was 21 percent over 2008 during 2009, as this year found 2.8 million properties being foreclosed upon.

By the month of August of 2008, 9.2 percent of every outstanding mortgage in the United States was either delinquent to some extent or actively in the process of being foreclosed upon. By the month of September in 2009, this level had reached that of 14.4 percent. Between the months of August in 2007 and October in 2008, more than 930,000 residences within the United States completed a foreclosure. Granted, these foreclosures were concentrated in certain states, and this concentration concerned both the rate of foreclosure filings and total number that were filed. A total of 74 percent of all of the foreclosure filings during 2008 were only in ten states, with the highest two among them representing a total of 41 percent of all foreclosures. The states of California and Florida scored more highly in foreclosures than nearly every other state in the country put together. While the national average of foreclosures was roughly 1.84 percent, nine of the states in the Union were over this national rate.

The Underlying Causes

As a whole, this crisis can be largely boiled down to a select group of different factors that revolved around both the housing and credit issuing markets, despite the fact that both of these factors took several years to emerge. Among the proposed causes were the lack of capability among homeowners to properly pay their mortgages, with a large amount of that being caused by the resets of adjustable rate mortgages. However, there were other factors such as speculation in the housing market, lending practices that have been called predatory and the general overextension of the average borrower. Some other factors were mortgage products that unnecessarily risky, a period of extreme building that exceeded demand, the unmitigated power that mortgage originating companies wielded, extraordinary levels of both private and corporate debt, and products within the financial industry that in some cases concealed and in many cases distributed the likelihood of a default on mortgages. Still other contributing factors included imbalances within national level trade, a lack of effective regulations by the government and ineffective general policies about money and housing related to personal economic fitness.

In addition to this, three significant catalysts that formed the subprime crisis and its subsequent mess were a huge amount of private money through various corporations and other investors, banks that got into the mortgage lending business through issuing bonds related to mortgage loans and the practices of some mortgage lending companies that have been deemed predatory in nature. These dishonorable lending practices were particularly flagrant in adjustable rate mortgages or ARMs and the related 2-28 loans that a large number of lenders that originated mortgages then subsequently sold through the use of mortgage brokers in either a direct or indirect sense.

The Group of 20 posited that there may have been several causes to this entire crisis. In their declaration regarding their summit on the financial world and the total global economy that came about on the 15th of November in 2008, they declared:

While the world was going through a time of exceptionally high growth and a prolonged period of relative stability during the early part of this century’s first decade, the participants in the various markets sought to gain higher levels of yield without truly appreciating the substantially higher levels of risk they would face. In many cases, these same parties failed to put forth a proper level of due diligence. While this was going on, the underwriting standards were fairly weak, there was an unsound trend in the managing of risk, the financial products that were on offer were more and more opaque and complicated, and the excessively high level of leverage present in the system all mixed together to make the entire situation a very volatile and vulnerable one. As the supervisors, the policy makers and those in charge of regulations, even in the most advanced countries, did not care enough about or truly appreciate the risks that were steadily building up within their own financial systems, regulatory activities within these countries did not keep up with the financial innovations that were taking place or consider the ramifications that were happening throughout the system.

As the month of May of 2010 occurred, both Paul Volcker and Warren Buffett happened to independently question the assumptions and judgments that were going into the U.S. economic and financial systems that led into the crisis itself. These assumptions could essentially be broken down as follows: 1. The prices of houses could not and would not fall with any speed; 2. When a financial market is free, open and under the support of sophisticated financial engineers, it would be very likely to properly support both a stable market and an efficient one, with the direction of funds primarily going to the most productive and profitable uses humanly possible; 3. The concepts that were embedded into the systems of physics and mathematics could just as effectively and directly apply to the dynamics of the market environment, particularly with regard to the different financial models that the experts used in the evaluation of borrowing and lending risks; 4. The economic imbalances such as the massive deficits in trade and the low rates of savings, while indicating a level of over-consumption, were somehow sustainable; finally, 5. There was no need to more strongly or thoroughly regulate either the banking system operating in a shadowy fashion or the derivatives market.

According to a report that was put forward by the U.S.’s Financial Commission concerned with the Crisis Inquiry, there was the potential to have avoided the crisis if the world’s financial system had been treated differently. Through an increased level of regulation in the nation’s finances, particularly through the Federal Reserve properly reducing the number and percentage of mortgage toxicity in the housing market. Another way that the entire crisis could have been prevented would have been if the level of corporate governance had not included so many financial companies that took on an excessive level of risk without mitigating it somehow. Still another way that the crisis could have at least been reduced would have been if the excessively high level of borrowing that the average homeowner took on during the early part of the century had been less than it was. With the highest ranking and most important policy makers being unable to anticipate or unwilling to prepare for the possibility of a financial issue of this nature, as they lacked a proper understanding of the system of finance that they were ostensibly in charge of protecting and guarding, it was inevitable that problems would inevitably occur. Ultimately, there were a number of different breaches within the system itself that ultimately led to a lack of accountability and an essential breaking down of ethical constraints at every level. With so many things able to go wrong that fed into one another, a breakdown was bound to happen sooner or later.

Booming and Busting Within the Housing Market

Going with the low levels of interest rates and the massive inflows of funding from a number of foreign countries, there was a very easy market for credit and the conditions favored those who wanted to borrow for several years before the crisis began. Because of all of this potential for borrowing, a great deal of debt financed consumption and a massive boom in the housing market were actively encouraged. Whereas between the years of 1980 and 1994, the home ownership rate within the US had been 64 percent, it reached a high for all time of 69.2 percent in the year 2004. A large contributing factor to the increase in the rate of home ownership could be traced directly back to the prominent level of subprime lending. Coupled with subprime lending’s prominent role, the prices of houses rose even higher because of a large level of demand for this housing.

Between the years of 1997 and 2006, pricing for the standard American single family house rose by a level of 124 percent. Through the two decades that ended in the year 2001, the median house price across the nation stayed within the range of 2.9 and 3.1 times the household median income level. However, this ratio of income to house pricing grew all the way up to four times the median income level in the year 2004, even rising as high as 4.6 times the income level in the year 2006. As this housing bubble continued, the result was that a very large number of homeowners refinanced their houses at a lower rate of interest. Similarly to this, this level of financing capability also led to a large degree of second mortgage origination to finance their consumer spending. The level of debt for the average US household grew as a percentage of annual personal disposable income from the level of 77 percent in 1990 to a high of 127 percent of their annual income by the end of 2007.

During the time period when the prices of houses were growing on a regular basis, the average consumer was saving far less of their income, which meant that they were both borrowing at a larger level and spending a greater amount of money. As the level of debt in the average household went from $705 billion at the end of the year in 1974, which represented 60 percent of personal disposable income, all the way to $7.4 trillion by the end of the year in 2000, the debt level exploded to $14.5 trillion by the middle of the year in 2008. This figure represented 134 percent of the average household’s personal disposable income. In the year 2008, the average household in the USA possessed a total of 13 credit cards, and 40 percent of those households carried a balance on their cards. By contrast, during the year 1970, only 6 percent of the households in the U.S. carried a balance.

The level of free cash that these consumers derived from their home equity extractions doubled from a level of $627 billion in the year 2001 to that of $1,428 billion in the year 2005, with the housing bubble building steadily as consumers used a total of nearly $5 trillion during that period of history. The debt level even began to approach the level of the GDP, with the average moving upward from 46 percent of the GDP across the 1990s all the way up to 73 percent during the year 2008, all the way up to $10.5 trillion. Between the years of 2001 and 2007, the level of mortgage debt in the U.S. nearly doubled, with the amount of this type of debt per the average household climbing more than 63 percent. This meant an increase from $91,500 all the way up to $149,500, as wage growth was virtually nonexistent.

This explosion in the level of both house prices and credit availability led up to a boom in the building trades and also led, in turn, to a dramatic surplus in the number of homes that were not sold. This brought about a leveling off of the prices of houses in the U.S. as they peaked, with a decline beginning in the middle of the year 2006. With the easy level of credit people could attain, a belief that the prices of houses would continue to rise indefinitely, a large number of subprime borrowers felt encouraged to obtain a mortgage with an adjustable rate. This type of mortgage enticed the borrower with a lower than market level of interest along a set period of time, and this “teaser period” was subsequently followed up by a market interest rate that would last for the remainder of the term of the mortgage.

Many of these types of borrowers, who could not make the higher levels of payments after the early grace period had expired, had planned to refinance their loans after they had gone through a couple of years of appreciating. However, as the prices of houses began to first stagnate and then decline over several parts of the U.S., these borrowers found that it was increasingly difficult to both pay back their mortgages and to refinance at the lower rates that they had initially assumed they could garner. Because they could no longer get away from their higher payments through refinancing their mortgages, many of these borrowers began to default on their loans.

This crisis is an ongoing one, with ever increasing numbers of borrowers no longer paying their mortgages as time goes by. the supply of houses and the number of foreclosures has gone up still further. As the number of mortgage payments itself continues in decline, the existing value of mortgage backed securities also reduce in turn. This further erodes the overall wealth and both net worth and cash flow of banks, other lenders and other investors that own these types of securities. At the heart of the entire crisis lies this vicious cycle.

By September of the year 20088, the average price of a house in the U.S. had gone downward by more than 20 percent versus the peak level that happened in the year 2006. This was an extremely large and unanticipated decline in the prices of houses, which means that a large number of borrowers possess absolutely no equity in their homes. In some cases, they are upside down or have what is known as negative equity in their homes, which means that they actually owe more for their mortgages than their houses are actually worth. In the month of March 2008, it was estimated that roughly 8.8 million mortgage borrowers, which amounted to roughly 10.8 percent of all the homeowners in the country, had some degree of negative equity in the houses they lived in. By the month of November in 2008, this number of people is suspected to have grown to the point of 12 million people. By the month of September in 2010, it is estimated that roughly 23 percent of all of the homes in the U.S. had a value of less than their mortgage loans.

As a typical part of this type of situation, the borrower has a powerful incentive to default on the mortgage from a financial perspective. As a typical rule, this type of loan is a nonrecourse type of debt that is only secured by the property itself. As an economist known as Stan Leibowitz proffered in an issue of the Wall Street Journal, while only about 12 percent of houses had a level of negative equity in them, this group made up roughly 47 percent of all of the foreclosures that occurred during the second six months of the year 2008. His conclusion was that the level of equity in an individual’s house was the primary factor that influenced the decision to go into foreclosure. This factor trumped what type of loan the home had on it, the credit worthiness of the buyer and even the ability to pay off the loan over time.

As the rates of foreclosures increased, so did the level of inventory of houses that were on the market waiting to be sold. There were 26.4 percent less new houses sold in the year 2007 than were bought in 2006. As January of 2008 rolled around, this level of inventory of homes that were not sold was at a level 9.8 times higher than the volume of sales in the month of December in 2007. The month of January 2008 was higher than any other ratio of unsold homes to sold homes since 1981. Beyond this, more than 4 million homes that were already existent were up to be sold, and 2.9 million of those houses had no one living in them.

This level of overhang among the unsold home market drove the prices of all houses lower still. When the prices went down further still, an even greater number of homeowners hovered in the at risk range of either defaulting on their mortgages or going into a foreclosure situation. This inventory of houses that are not sold is continuing to drive down the prices of all houses declines to a level that can be called normal, which is simply an excessive level of supply in economics terms. In a report that came out during the month of January 2011, the values of houses in the U.S. fell by about 26% versus their peak level during the month of June in 2006 down to their lowest level in the month of November in 2010, which was even greater than the 25.9% drop that occurred between the years of 1928 and 1933 as the Great Depression was in its deepest stage of economic decline.

The Speculation of Homeowners

The Main Thrust of Speculation

The level of speculation present in the borrowing level in the residential market for real estate has been attributed greatly to being a major cause within the crisis of subprime mortgages. During the year 2006, 22 percent of all of the houses that were purchased were for the purpose of investing in them. This was 1.65 million properties in total. An additional 14 percent of the properties purchased were to be used as vacation residences, which totaled up to 1.07 million properties. In the year 2005, by contrast, these percentages were a respective 28 percent and 12 percent. Said in another way, what amounted to a record breaking volume of roughly 40 percent of the houses that people purchased were not intended to be lived in on a regular basis. According to a man named, David Lereah, who was the NAR’s principal economist at that point, the decline during the year 2006 in the purchasing of these investment properties was an expected one. The speculators essentially abandoned the entire market during the year 2006, and this brought about a rapid drop of sales in the investment real estate category above and beyond any decline in the overall market for real estate.

The prices of houses on the whole all but doubled in between the years of 2000 and 2006, which was a dramatically different overall trend from that of the historical level of appreciation that house prices experience, which essentially mirrors that of the standard inflationary rate. Even though houses have not always been treated as a form of investment that is subject to the speculative fever any asset can experience, this became a relevant part of the process during the boom in house prices. In the media, it became popular to report that people were purchasing condominiums while they were being constructed and then flipping them, which means rapidly selling them. This typically occurred so quickly that the seller never lived in the property at all, and often it happened before anyone had lived in the condo. Early on, there were mortgage companies that determined that there was a level of risk that was built into this practice, with the identification happening as early as the year 2005, when some mortgage companies identified that some investors took on extremely leveraged mortgage positions in several properties at one time.

According to Nicole Gelinas, working in the Manhattan Institute, there were some negative repercussions of not adjusting the policies present in the mortgage and tax areas to adapt to this shift in the house from a conservative hedge against inflation to an investment with a heavy speculative edge. According to an economist known as Robert Shiller, the speculation that bubbles up is further edged onward by the contagious level of optimism, which would seem to be totally immune to any sort of contradictory facts, which can easily take hold when the price of any kind of asset is steadily rising. A bubble is essentially a social phenomenon. Without a complete understanding and properly addressing the psychology that drives a bubble, these types of bubbles will continue to form. According to a Keynesian economist known as Hyman Minsky, there is a specific method to how speculative borrowing has contributed to a substantial rise in the debt level, and this ultimately leads to the collapsing of any kind of asset’s value.

According to Warren Buffett’s testimony before the Commission that inquired on the Financial Crisis, there was a tremendously large bubble. He even described the bubble as the largest that he had ever seen in his entire life. According to Buffett, the public in the U.S. was completely caught up in the belief that there was absolutely no possibility of a substantial drop in the prices of houses.

The practices of lending and borrowing and their impact on mortgage loans with high risk levels

As the years led up to the financial crisis, lenders began to substantially alter their behavior. As borrowers were piling up, lenders began to offer loans to increasingly high risk borrowers that even included immigrants who were in the country without any kind of documentation. The standards of lending deteriorated with complete abandon in the years between 2004 and 2007, while the GSE’s saw their market share greatly declining and the private securitizers were making up a greater than 50 percent volume of all of the mortgage securitizations.

The level of mortgages in the subprime range made up roughly $35 billion, or a total of 5 percent of all originations in the year 1994. In 1996, this represented 9 percent, while in 1999 it was $160 billion or 13 percent of them. By the year 2006, however, this number was $600 billion or 20 percent of the pie. During a study conducted by the Federal Reserve, it was discovered that on the average, the difference between a subprime loan and a prime mortgage’s rate of interest, otherwise known as the subprime markup, dropped considerably between the years 2001 and 2007. This coupling of a lower premium placed on risk and the lessening standards for credit is a common occurrence during a boom phase of the booming and busting cycle.

Adding to the level of the more high risk borrowers who got involved in this boom, the lenders themselves also offered an increasingly high risk level of options for loans and more incentives for the borrowers to take. In the year 2005, the down payment median for a buyer getting involved in their first home purchase was roughly 2 percent. Out of all of these buyers, roughly 43 percent of them put down absolutely nothing as their down payment at all. In comparison to this, in China the necessary level of down payment is in excess of 20 percent, and for a property that is not one’s primary residence the required amount is even higher than that.

The analysis by the US Treasury Department regarding higher levels of fraud in mortgage lending practices

The guidelines required to qualify for a mortgage started changing over time. In the early days, a person’s stated level of income and verified asset level or SIVA loan was a new possible deal on the table. It was no longer necessary for an individual to prove his or her level of income for a mortgage. All a borrower needed to do in this context was to “state” the level of income and demonstrate that he or she had some level of money in a bank account. After this became a common practice and its newness wore off, the NIVA or no income, verified asset loan became a new option. A lender did not even need to see any kind of proof that the potential borrower was even employed in this type of arrangement. All a borrower needed to demonstrate was that there was a minimum amount of money within their bank account. Such guidelines necessary to qualify into a mortgage became increasingly looser so that more mortgages could be produced and more securities initiated, simply because of the huge level of hunger from the investment community for such assets. Because of this, the NINA was created. NINA is an acronym which stands for No Income and No Assets, and this is sometimes colloquially known as the Ninja loan. In essence, a NINA loan is a loan product that allows an individual to borrow money without any kind of proof or even a statement of owning any assets at all. The only thing that such a loan requires to be initiated for a mortgage is that the potential borrower have a credit score.

Still one more option for the borrower was the interest only adjustable rate mortgage or ARM. This type of loan lets a homeowner pay nothing more than the interest on their mortgage during the initial portion, and pay absolutely none of the principal for a specified amount of time. Beyond this, another option for the homeowner is the payment option type of loan, which allows the borrower to pay a variable amount. The only caveat in this type of loan is that any interest which is not paid is simply tacked onto the original principal amount. Roughly one out of ten people who took out a mortgage in the year 2005 and year 2006 applied for and received such an option ARM loan, which allowed them to decide on how much of a payment they made on a given month. These borrowers could even choose to pay so little toward their mortgages that they actually ended up owing more money each month than they had the month beforehand. It is estimated that approximately one out of three of the ARMs that came about between the years 2004 and 2006 had a sort of teaser rate that was below four percent, and this rate rose substantially higher once a certain period had been reached. In some cases, the month payments would even double versus their original levels.

The percentage of ARM loans that fit the subprime level that mortgage lenders originated for people who had reasonably high credit scores rose considerably over the early part of the century. During the period between the years 2000 and 2006, the percentage of people whose credit scores would have been sufficiently high to get a more conventional type of mortgage but opted instead for an ARM went from roughly 41 percent in the year 2000 up to 61 percent in the year 2006. Although, a substantial number of other factors also come into play beyond one’s credit score when it is time to take out a loan. Beyond this, a mortgage broker can often receive an incentive from a lender to offer a subprime ARM to those who did not need such a loan, including people who had sufficiently high credit ratings to receive a standard, conforming loan that was anything but subprime.

The standards that were used to underwrite mortgage loans also went down sharply during the period of time known as the boom phase. As lenders used increasingly automated approval methods on loans, there was no perceived need for a human being to properly review any of the documentation associated with such loans. In the year 2007, for example, roughly 40 percent of all of the subprime loans that were originated came about as a result of an automated underwriting process. The Mortgage Bankers Association’s chairman even issued the claim that while a mortgage broker does earn a profit from the booming level of home loans, did not properly examine the extent to which a potential borrower was able to pay for their loans. Partially as a result of this near total lack of oversight from without or from within, the level of fraud brought about by both the lenders and the borrowers involved in mortgages grew by an exponential factor.

The commission which analyzed the financial crisis came about in January of 2011 with a report that claimed that a large number of mortgage lending companies took the qualifications of overly eager borrowers on nothing more than faith, with what was often a willful disregard of the ability a borrower would bring about to pay. Out of all of the mortgage that lenders originated in the first half of the year 2005, roughly 25 percent of them were of the interest only variety. Along the same year’s duration, 68 percent of the different option ARM loans which came about through Washington Mutual and Countrywide Financial had either very little documentation required of them or absolutely no documentation necessary whatsoever.

It is curious why the standards for loan origination declined so much. At least a single study came up with the hypothesis that this lowering of the standards used in lending came about because of a new order in the mortgage securitization process. As this business went from a highly controlled duopolistic scheme to a more competitively set up marketplace wherein the different originators of mortgages carried a great deal of sway, the entire game changed considerably. The lowest levels of mortgage quality standards happened to occur during the period in which the GSEs or Government Sponsored Enterprises happened to be at their least strong, while the originators of the mortgages and the securitizers operating under private labels had the largest amount of strength.

It stands to reason that one might question why there was such a tremendous market for such a poor quality level of securitized private label loan bundles. In a program that was awarded a Peabody Award, correspondents who were affiliated with National Public Radio debated that a purported gigantic pool of wealth, which represented a total of $70 trillion of investments around the world that were in fixed income assets desired a higher level of financial yields than those that they were being offered with treasury bonds that the U.S. was offering during the earlier parts of the decade. Above this, such a tremendous pool of wealth essentially doubled itself in pure mass during the period of time between the years of 2000 and 2007, while there was a relatively stable and flat growth curve for the more safe and reliable income generating asset classes. The Wall Street investment banking world responded to this record demand through creating innovative financial programs, which included the MBS or mortgage backed security and the CDOs or collateralized debt obligations. These actually earned safe ratings from the largest credit ratings companies.

Simply put, Wall Street’s wisdom put this massive pool of wealth within the structure of the U.S.’s mortgage marketplace, with incredibly large fees coming about through the entirety of the supply chain of new mortgages. This came all the way from the front line brokers who sold these types of loans, through the smaller sized banks that financed these types of brokerage transactions, all the way through to the massive investment banks that stood behind the smaller banks. By around the year 2003, this mortgage origination supply level which had come about through more traditional levels of lending standards were all thoroughly exhausted. Despite this, there was a continuously strong demand level present for both MBSs and CDOs, which continued to push down the standards that lenders used, so long as there was the capability to sell mortgages along the chain that supplied them. As these things tend to go, however, such a speculative bubble was unable to last indefinitely. As NPR described how the situation unfolded:

The ultimate problem came about because even though the prices of houses were rising dramatically, the people involved in actually buying the houses had static levels of earned income. Between the years of 2000 and 2007, the average levels of income in an American household remained essentially flat. Regardless of the level to which the standards that lenders used got lax, and without any regard to how many different exotic types of mortgages the lenders could create for the purpose of shoehorning people into houses that they had absolutely no hope of ever being able to afford, and without any regard to what methods the machine that originates mortgages attempted to put forward, the people involved in the entire deal simply were not capable of handling the responsibility that came their way.  By the time late 2006 came around, on the average a house was priced at a level of roughly four times that of what an average family took in. Across the historical averages, this level was roughly two to three times that of what the family made during the year. Even the mortgage companies began to notice a trend that they had almost never witnessed at any point in the past. Individuals would close on their home loan, making sure to sign all of the paper work for it, and promptly default on the loan without making their first loan payment. They had not lost their jobs, nor had they experienced any sort of medical emergency, either. These were simply people who were underwater on their mortgages before they even began to pay on them. While this was not the kind of thing that anyone could literally hear, this was essentially the moment at which one of the most massive bubbles of speculation in the history of American business popped explosively.

Fraud in the mortgage business

In the year 2004, the FBI issued a warning about what it referred to as an epidemic within the mortgage industry, as the fraud level was likely to skyrocket. This was among the larger risks within the nonprime mortgage industry because it was projected to have a great deal of potential repercussions. The Bureau even suspected that the credit risk level present within subprime mortgages could have as much potential fallout as the S&L crisis had had.

This commission, which addressed the financial crisis and inquired deeply about its underlying causes, released a report in January of 2011 which stated that the level of mortgage fraud flourished in such an environment, as the lax level of regulation mixed with an almost total collapse of standards for lending. As the level of activities reported that were suspicious, including reports of what could have been financial crimes that depository banks and companies affiliated with them reported grew dramatically. Between the time between the year 1996 and the year 2005, the level of reports that were filed related to fraud within the mortgage industry grew by a factor of twenty. From that level, the rate once again doubled between the year 2005 and that of 2007, reaching $112 billion. The lenders issued loans which they already knew that the borrowers were not able to afford, even with the knowledge that such loans would potentially cause a massive level of losses to anyone who invested in the securities that these mortgage loans went into.

The prosecutors in the state of New York continue to examine the possibility that eight different banks might have actually intentionally fooled the agencies that rate credit worthiness, simply in the interest of inflating the grade levels of investments that are linked to subprime mortgage loans. Many organizations such as the SEC, the Department of Justice, the attorney’s office of the United States and others are in the process of examining precisely how these banks created, then subsequently rated, then sold and went on to trade the securities that were based on mortgages and that ended up being among the worst of all investments that have ever been devised. Within the year 2010, out of all of these investigations, which range from the civil all the way up to the criminal level, remain at the earliest of stages.

The practices involved with securitization

Borrowing within the structure of the securitization framework

More information: the mortgage backed security and its securitization

With a traditional mortgage, the business model was based on a bank that originated the loan to a borrower or homeowner and then retained the resulting credit risk, which was essentially the risk that the borrower would subsequently default on the loan. However, the process of securitization is one in which a loan or any other kind of asset that generates an income stream is bundled in a group to create a sort of bond, and this bond can then be sold to investors. However, the more modern method of the securitization of mortgages within the U.S. began in the 1980s with GSEs or Government Sponsored Enterprises starting to pool together large numbers of the reasonably safe conventional types of conforming mortgages together. These mortgages were guaranteed by bonds, which the GSE’s would subsequently sell to investors as a sort of hedge against default.

The riskier method of securitization also came about in time. This method allowed private banking institutions to pool their non-conforming types of mortgages, and this did not typically involve guaranteeing their bonds against any of the default on the mortgage that underlie them. Put another way, the former type of GSE securitization method only transferred the risk of the interest rate to the ultimate investors, while the latter private label type of securitization that the investment banks and the commercial banks used transferred both the interest rate risk and the risk of default.

As securitization has been invented and become popular, the formerly popular model has essentially been replaced by what is known as the origination and subsequent distribution business model.  This is a method by which a bank basically sells the various mortgages that it originates, while it distributes the risk of credit default to the investors through the collateralized debt obligations and or the mortgage backed securities that it creates. This type of selling of the default risk to the various investors has buit a moral hazard where a larger emphasis on processing ever increasing numbers of mortgages and transacting more of them became the more incentivized strategy, while making certain that the credit quality of the loans themselves was deemphasized.

By the time the mid 2000s rolled around, the process of GSE securitization in the mortgage industry had largely faded away in its overall share of the total number of securities produced. By contrast with this, the level to which private labels securitized the loans went up to a dramatic extent. The vast majority of the growth in these types of securities came about through the use of far higher risk Alt-A and subprime types of mortgages. While the private label securitization grew in its market share and GSE market share diminished, the overall quality of the mortgages that came about dropped to a large extent. The worst of all mortgages by performance metrics were the ones that were securitized by private banking institutions, while the mortgages that were originated by GSEs kept on performing better than the average level within the market. This even included the mortgages that banks did not securitize and kept within their own portfolios, signifying an overall drop in mortgage vetting.

During the 1990s, the process of securitization grew in both prevalence and in its level of efficiency. The overall volume of the securities backed up by mortgages that were issued during this time period all but tripled between the year 1996 and the year 2007, moving all the way up to $7.3 trillion. The portion of the subprime mortgages that were securitized, such as those that got passed along to the MBS investing third parties, grew from the level of 54 percent in the year 2001 all the way up to being 75 percent in the year 2006. A random sampling of 735 deals that resulted in CDOs that were originated between the year 1999 and the year 2007 demonstrated that all of the both subprime and under prime types of mortgages made up and stood for a growing extent of assets based in CDOs, which rose from 5 percent in the year 2000 to 36 percent in the year 2007.

The consumers, the homeowners and the corporate entities that used these services owed a total of somewhere in the vicinity of $25 trillion in the year 2008. The banks in America kept roughly $8 trillion out of this total in the direct sense, as the traditional type of mortgage loan group. The bondholders and the other traditional sorts of lending entities chipped in an additional $7 trillion. Out of the $10 trillion that was left over, it came out of the markets of securitization. These types of securitization markets began to shut down during the spring of the year 2007, and almost closed down altogether during the fall of the year 2008. Greater than one third of the privately operating credit marketplaces became completely unavailable as a result of this, rending them unsuitable sources of further funding. In the month of February in 2009, Ben Bernanke observed that the markets for securitization stayed shut for all intents and purposes, even though the exception to this was for the conforming type of mortgages. These types of mortgages were able to be sold to Freddie Mac and Fannie Mae.

The closer and greater directness of the connectivity among the securitization and the crisis of subprime mortgages ultimately relates more directly to the fundamental faultiness in the methods by which the underwriters, agencies in charge of ratings and the investors themselves determined the model of correlation between their risks within the different loans that made up the pools of securitized assets. This process, which is known as correlation modeling, allows an individual to determine how the risk that one loan may default and how that risk is related from a statistical standpoint to the risk that any other loan within the group would default, is based on what is known as a Gaussian copula method that was created by the statisticion known as David X. Li. This method, which became extremely wide in its adoption as a method by which people can manage their level of risk that comes bundled in with any kind of securitization transaction, utilized what ended up being an overly simplified and even simplistic way to approach this correlation. To the detriment of all, the flaws that were present in this technique were not immediately or obviously apparent to the people who participated in the markets until its use became a part of losing a massive a mount of money, to the tune of hundreds of billions of dollars. This occured through backing CDO and ABS assets with subprime loans which had received ratings prior to their sale based on this method. When investors had finally had their fill of purchasing the securities that were backed up by the subprime loans this method evaluated, it was already too late. This only stilted the capacity of mortgage originators to extend the processing of lending in the subprime realm, even as the first effects of this subprime crisis were starting to take shape in an obvious way.

A Nobel Prize laureate known as Dr. A Michael Spence at one point stated that the innovation of finance, while it may be intended to either redistribute the risk or reduce it, seems to have done little more than hide it away from the public view for a time. Among the important challenges that are involved in moving forward is to increase the understanding of the dynamics which form the intellectual base of some kind of early diagnostic or forecasting system for maintaining financial stability.

The inaccuracy of credit ratings

The agencies that rate credit and the crisis of subprime loans

With each quarter, the credit ratings of MBSs downgrade even further.

The agencies that monitor and rate the creditworthiness of other entities are under a level of scrutiny for their role in giving a rating of investment grade quality to the MBS class of investments that had high risk subprime mortgage loans underlying them. Such high rating levels facilitated the sale of these MBSs to investors, which essentially financed the boom in house prices. Such ratings carried a belief in their justification due to the practices that reduced risk, with some being what was known as insurance on credit default and the investors in equity who were willing to take the earlier losses. Notwithstanding this, indications surfaced early enough that a few of the agencies that got into the act of rating the securities that were related to subprime mortgages were aware at the time that the process used to rate these loans and the securities based upon them was a faulty one.

The critics of these agencies suggest that the agencies themselves suffer from a sort of conflicted interest, as they receive compensation from the various firms such as investment banks that used to sell the securities they had structured to various investors. On the 11th of June in 2008, the Securities and Exchange Commission proposed that some new rules might mitigate some of this perceived conflict of interest between the agencies that rate creditworthiness and the companies that issue securities that are structured. On December 3rd of 2008, the SEC went ahead to approve of some measures that were designed to increase the strength of oversight above the credit ranking agencies, which came about because of a ten month long investigation finding that there was a significant level of weakness within the rating practices that these agencies practiced. This weakness included but was not limited to a conflict of interest on the parts of the agencies.

In between the periods of the third quarter of the year 2007 and the second quarter of the year 2008, the agencies that provide ratings reduced the levels of ratings on approximately $1.9 trillion of the securities backed up by mortgage loans. The institutions of finance believed that they were in need of lowering the values of the MBS holdings they possessed and take on more capital so that they could retain effective ratios of capital. In the cases where this involved selling some additional shares of stock, the existing value of shares that were already outstanding became lower as a result of this dilution. As a result of this, the downgrades in company ratings lowered the prices that many of these financial companies’ stocks commanded.

The commission that was tasked with inquiring into the financial crisis reported during the month of January in the year 2011 that out of the three agencies that rate the credit worthiness of others, all were major enablers of this financial crisis and its resulting meltdown. The securities that were mortgage related, which were very important to forming the crisis in the first place, could not have been so easily and effectively put on the market and sold if they had not contained the seals of approval that these companies gave them. As investors depended in the ratings bureaus, often with a level of blind faith, their trust was punished. There were even cases in which there was an obligation to use these agencies because of the capital standards that regulators imposed and the extreme importance that so many in the capital markets place on these ratings. Furthermore, the report also said that these ratings were specious because there was the use of flawed models in their computer programs, there was a great deal of pressure coming out of the various firms that paid to receive the ratings, and an unrelenting drive to gain more share in the market. Beyond these reasons, there were also very few resources dedicated to properly completing the work in spite of record levels of earnings and profits, and finally there was a genuine absence of any real oversight from the public sector.

Policies of the government

The policies of the government and how they led up to the subprime mortgage crisis

The dramatic level of expansion within the years of 2004 to 2006

The overly regulated nature of some things by the government, the failed types of regulations in others and the deregulation of still other areas have all had their turn to be blamed as the causative factors within the crisis. During the presentation of testimony in front of Congress from both the SEC or Securities and Exchange Commission and its former chief, Alan Greenspan, both accepted a large degree of responsibility for bringing on the crisis through allowing the investment banking industry to regulate itself.

During the year 1982, Congress had passed an Act known as the Alternative Mortgage Transaction Parity, which became shortened in vernacular to AMTPA. This allowed the housing creditors who were not chartered by the federal government to write mortgages that had adjustable rates to them. With the types of loans that were new because of this allowance, several became very popular during the early part of the 1980s. These types of loans included the standard adjustable rate, the option adjustable rate, interest only type and balloon payment type of mortgages. Out of all of these types of loans, all are attributed a portion of the blame for subverting the old fashioned and formerly standard method by which banks issued conventional and fixed rate mortgages that had the purpose of amortizing over a period of time known at their beginning. There were many criticisms that were issued regarding the level of deregulation that the banking industry experienced, as well as how these all contributed to the crisis in the savings and loan business. One of the most major of these criticisms came ffrom how Congress did not properly regulate any sort of exploitation that could easily occur in an environment where these types of loans are available. Subsequently to this, there were incredibly widespread levels of abuse in the form of predatory practices in lending, which came about in the realm of adjustable rate mortgage issuance. During the year 2006, around 90 percent of all of the subprime mortgages that were originated had adjustable rates built into them.

While there were a number of different political leaders, pundits and think tanks who are funded by the financial industry who perceive that the government’s policy decisions that were originally intended to make housing more affordable to people were ultimately in part responsible for the financial crisis’s cause, a more detailed level of analysis brought forth from the data on mortgages by the commission that inquired into the financial crisis, as well as economists working for the Federal Reserve and other researchers that operated independently within academia have the notion that such assertions carry very little validity or truth to them. Examples of how such claims are false involve how the loans which were formed by the Community Reinvestment Act did far better than the mortgages that are classified as subprime, and as well the mortgages that were initiated by GSEs fared far better than those that came about and were securitized by the private label companies.

The higher levels of ownership of homes have also been targets for many presidents to hit, and these presidents included George W. Bush, Bill Clinton, Ronald Reagan and the Roosevelts. In the year 1995, GSEs such as Fannie Mae started to receive taxation incentives from the federal government for the purpose of buying the securities formed from mortgages. These securities also had loans that had been made to lower income individuals as their underlying components. In the year 1996, the Department of Housing and Urban Development put forth a goal that Fannie Mae along with Freddie Mac should have no less than 42 percent of the securities within their portfolios should have loans within them that had been issued to individuals whose income levels were below the median range within their geographic regions. The target of having a certain degree of relatively impoverished loans within the MBS portfolio was later amended to be 50 percent in the year 2000, with the amount further raised to 52 percent during the year 2005.

During the years between 2002 and 2006, the subprime market within the U.S. grew by a percentile of 292 percent versus the prior series of years. During this time, as Freddie Mac and Fannie Mae coupled their acquisitions of securities that featured subprime loans in their structures, the total amount grew from roughly $38 billion to about $175 billion in the average year prior to plummeting to roughly $90 billion in the average year. This featured $350 billion in Alt-A types of securities, as well. In the early 90s, Fannie Mae had discontinued the practice of purchasing products that contained Alt-A characteristics due to their above average level of risk of defauting. By the year 2008, however, the two federal agencies owned in some form or another a significant pool of these types of mortgages. Through a combination of direct ownership of the securities and the various pools of mortgages that they held sponsorship over, more $5.1 trillion worth of mortgages the two companies owned in the residential sector had these characteristics, which totaled nearly 50 percent of every mortgage within the U.S. market at that time.

GSE companies have always carried a large degree of leverage by their very natures, and on the date of June 30th 2008 the net worth of these companies was only $114 billion. During September of the year 2008 brought about a large number of concerns about how effectively the GSEs could effectively keep up their promises and guarantees, the Federal Government had to step in and take the companies under its conservatorship. In essence, this nationalized both Fannie Mae and Freddie Mac at a cost which the taxpayers had to take on.

The commission which inquired into the financial crisis issued a report during the year 2011 that both Freddie and Fannie played a role in building up the crisis, but they were not among its most major causes. The securities that the GSE companies had originated basically kept their levels of value during the entire crisis, and they did not place any substantial losses onto the balance sheets of the financial companies nor place any downward pressure during the financial crisis. The GSE companies did play a role in growing the riskier types of mortgages such as subprime loans, although their method was to follow instead of walk at the vanguard of Wall Street and the many lenders which proceeded into the realm of lending in the subprime market.

An Act which was known as Glass-Steagall happened as a result of and immediately following the Great Depression’s end in the 1930s. Glass Steagall provided a level of separation between the lending activities of commercial banks and the ratings activities that investment banks carried out, among its other benefits. However, repealing this Act has been called the ultimate product of a $300 million effort to lobby the government by both the financial services industry and the banking industry, and the repeal of the Act was spearheaded within Congress by a senator who was known as Phil Gramm. Many have suggested that the repeal of Glass-Steagall was a major contributor to the crisis due to the inherently high risk and very risk tolerant culture which pervades the investment banking world. This culture was able to easily dominate the more conservative culture of the commercial banking industry, and this led to a far higher level of risks being taken and leverage being employed during the period of the boom.

Both libertarians and conservatives have carried on a debate regarding how the CRA or Community Reinvestment Act may have affected the crisis and the conditions that led up to it. Some detractors have suggested that this Act only gave further encouragement to those who wished to extend credit to borrowers who had no worthiness for it. Defenders of this Act, however, claim that during a 30 year history of lending with it in force did not grow the level of risk that is always present in lending. Some detractors have also issued the claim that during the middle of the 1990s, some amendments that were made to the CRA increased the level of mortgage issuance to people who had insufficient income levels and not enough credit worthiness to pay hem back. Furthermore, the detractors also claim that the CRA allowed the mortgages it regulated to be securitized, despite the fact that a reasonable number of these types of loans were of the subprime variety.

The governor of the Federal Reserve, known as Randall Kroszner, along with the Chairwoman of the FDIC, Sheila Bair, have openly expressed their belief that this Act did not play a significant enough role in the crisis for blame to be placed on it.

An economist known as Paul Krugman offered up the debate in January of the year 2010 that while the residential and commercial bubbles in the prices of properties grew at the same time, this fact lessens the level of the case that can be made by individuals who suggest that the CRA, Freddie Mac and Fannie Mae or even the predatory methods of lending were the causes most contributive to the crisis. Said in a different way, such a bubble as those that occurred in both of these markets happened in spite of the fact that the residential market was the one that actually contained all of these factors.

According to the report that was released in the month of January 2011 by the inquiry commission in charge of researching the financial crisis, the CRA did not play a substantial role in either the crisis or the subprime lending that itself contributed to the crisis. Given that a large number of the lenders that produced subprime mortgages were not even under the dictation of the CRA and that the most relevant research indicates that one of the best proxies for subprime loans, the higher cost variety, were largely unaffected, the connection between the CRA and the subprime loans themselves seems to be tenuous at best. In fact, it is suggested by the research that only about 6 percent of all higher cost loans had possible connection to the CRA. As well, lenders that were regulated by the CRA and chose to operate in areas where lending was required only had one half of the likelihood of producing loans that went into default as essentially similar notes that came from the very same areas from independent companies that originated mortgages without being subjected to this law at all.

There were accusations stating that the presidential administration of George W. Bush blocked the investigations led by the state into the potentially predatory practices that were associated with lending during the growth phase of the housing bubble. In spite of this, in the year 2003 when President Bush requested a probe into and a greater level of control over both Freddie Mac and Fannie Mae, a congressman named Barney Frank objected to this with a statement essentially saying that the two companies in question were not moving into any sort of serious financial difficulties. Congressman Frank even went on to state that with a greater level of exaggeration present regarding the problems, there was more pressure on both of the companies, which would result in a lower level of afforably priced housing for Americans. Congressman Frank has dodged any sort of blame over using more insight over the two companies, citing the fact that his was the minority party during the year of 2003. Frank has also stated that while he was incorrect at the time, he was also not in a position of power suitable to produce substantial influence. As the opposing party had been in power between the years of 1995 and 2006, Congressman Frank’s role was primarily that of vocal minority.

According to a Republican by the name of Mike Oxley, who used to be in charge of the committee in charge of the House of Representatives’s financial services section, the House had actually passed a law that had caused a strengthening of the GSE businesses in the form of the Housing Finance Reform Act during the year of 2005. However, the White House had destroyed this bill during President Bush’s tenure, not allowing it to reach the status of a full blown law. As Oxley described the situation, the worries and the public demonstrations of fear all continue unabated without any memory of how the White House had contributed to the entire issue. He even went so far as to suggest that the House had gotten nothing more than a “one fingered salute” from the White House.

During the month of December in 2011, the SEC actually charged the former executives of the companies Freddie Mac and Fannie Mae with the accusation that these executives had misled their investors regarding the risks that were associated with mortgage loans of the subprime variety. As one analyst put it, the facts drew a picture of not being a matter of highly intellectual mandates from the government not being what went wrong with the GSEs, but instead the intentional focus from the management of the companies to further grow their level of ownership within the marketplace. As this market share grew, there were large bonuses. These bonuses, in turn, stimulated these executives to take even further risks, whether they understood that this was what they were doing or not.

Central banking policy decisions

The rates of federal funding and the rates of the various types of mortgages

The monetary policies that are present in and regulated by the central banks are intended to target the rate that the currency is inflated. With this authority over how commercial banks a several others types of institutions of finance operate, there is less of a concern with staying away from bubbling up the prices of the various asset types, with things such as the dot com bubble and the housing bubble being only of a secondary level of concern to the central banks. In accordance with this, the general modus operandi of central banking authorities has been to react when such a bubble bursts in a manner which will prevent as much of the inevitable collateral damage to the entire economy as is humanly possible, with a definite de-emphasis on preventing such a bubble from forming up in the first place. This occurs due to the fact that the identification of asset bubbles and the determination that the most effective policy with regard to money and deflating such a bubble is something that is best debated by groups of economists.

As has been observed by some people both inside and outside of the market, there is concern that the Federal Reserve may end up taking actions that could potentially cause moral hazards to form. According to the office for government accountability, New York’s bank that is connected to the Federal Reserve rescued capital management in the year 1998, which could have helped to create this hazard. Because of this rescue in 1998, there was a certain level of encouragement among the larger of the financial companies that they could take risks due to their being, as many have put it, too large for failure. These companies believed that due to their size and their overall importance to the economy that they would be rescued from any serious damage by the Federal Reserve.

One of the most major factors that was involved in the rising levels of housing prices was the reduction of the interest rate by the Federal Reserve during the early part of the decade. Between the years of 2000 and 2003, the Federal Reserve had reduced the targeted rate of federal funds from the 6.5 percent interest rate down to the 1 percent interest rate. This action was partially taken so that the overall impact of the dot com bubble’s bursting could be softened somewhat, with an additional reason being to ease concerns that arose after the 2001 terrorist attacks. Beyond those two more overt reasons for the drop in interest rates, the Fed also lowered them so dramatically because there was a perception that deflation could occur otherwise.

The Federal Reserve’s belief that there was a degree of safety inherent in lowering the interest rate came largely from the fact that the inflationary rate was a low one. While there were other factors that were also of importance, the Fed decided to ignore these. According to the President and CEO of the Fed in Dallas, Texas, Richard W. Fisher, the policy that the Fed decided upon in the early part of the first decade in the 2000s came about due to a misguided understanding of where inflation was at that time. The inflation that was measured at that point in history was lower than the level of standard inflation that is considered true, and this led to a level and type of policy with regard to money that led into the bubble in housing prices. As Ben Bernanke stated during his tenure as the chairman of the Fed, there was a glut in the overall savings of the world that had pushed a massive amount of money into the U.S. Beyond the actions of the Central Bank, Mr. Bernanke has asserted that this massive amount of money was the other factor that kept the level of the interest rates at a fairly low level.

After that point, the Fed expanded the rate of Fed funds to a dramatic extent during the years between July of 2004 and the month of July in 2006. This action led in part to a growth level of the one year and five year ARM rates, which made the interest rates resetting in ARMs a far more expensive prospect for many homeowners. This decrease certainly substantially aided the deflation of the bubble in house prices, in no small part because of the fact that the prices of most asset types tend to move at an inverse rate compared to the dominant rates of interest. This increase in the rates of interest subsequently caused the speculation risks of housing to grow considerably.

The incentivization and levels of debt within the financial institutions

The generalized increase in the ratios of leverage within investment banks between 2003 and 2007

According to the commission’s report from the month of January 2011, there was a marked increase in the level of debt that the financial sector held between the 1970s and the latter part of the 21st century’s first decade. Between the years of 1978 and 2007, this debt level skyrocketed from a relatively small $3 trillion to the comparatively massive level of $36 trillion. In addition to the raw growth the numbers indicate, as a percentile of the GDP, this debt level greater than doubled. Due to an intrinsic change in the entire structure of how many companies operating on Wall Street operated, moving from the fairly secure and steady types of private partnerships that they had been to being corporations that were publicly traded and engaged in ever riskier levels of activity, the entire game had changed dramatically.  By the year 2005, the ten biggest commercial banks in the U.S. owned 55 percent of all of the assets within the industry. This was greater than twice the level of holdings possessed during the year 1990. As the crisis loomed silently in the year 2006, the profit levels within the financial industry were 27 percent of every cent of corporate profit within the U.S. By contrast, this had only been 15 percent in the year 1980.

A very large number of financial companies, with a particular emphasis on the investment banks in the mix, released huge amounts of loans during the years of 2004 to 2007. These companies used a substantial portion of this newly acquired debt to invest in MBSs or mortgage backed securities. This was in essence a bet that the prices of houses would continue to go up. This significant investment also signified a belief that most households would continue to make the payments on their mortgages. When a company or individual borrows money at a fairly small rate of interest and invests those proceeds into something that pays a higher level of interest, it is known as making use of financial leverage. In roughly the same way, a regular person could take out a second mortgage on his or her home in order to buy stocks. While the housing boom was going strong, this strategy seemed to work very well However, as the prices of houses declined and the levels of mortgage default began to rise, this strategy led to massive losses. In the year 2007, the first of the incredibly large losses that befell the companies and private individuals who held MBSs in their portfolios began as the defaults within the MBSs lowered their value.