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The handwriting on the wall (street) - UPDATE
Posted by: McQ on Tuesday, September 23, 2008

This is a phenomenal article from the NY Times circa 1999. It lays out, in all of its rotten splendor, the reason we're having the financial fun we're having today.

The lede:
In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.
Yeah, I know, I've beaten this drum for quite a few posts now, but it is important to understand. What, if you were a bank or lender, would this say to you?

It says, "Hey, I can take risks I normally wouldn't take because Fannie is going to take the real risk off my hands by buying up dubious loans". So what do banks and lenders do then with an expanded market? They exploit it.

So why was Fannie Mae making this move of loosening credit requirements?
Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.
An economic issue becomes social policy which is worth far more than money to a politician (although that comes in a very close second). It means votes.

The stage is then set - the banks and institutions have been given a broad new market to exploit and been told it is essentially a risk free market - for them. Fannie and Freddie will take all the risk, and of course we know, with the backing of the full faith and credit of the US government, that's a pretty safe bet - or so they thought.

So the games began. And the naysayers? Oh they were out there, and they knew this was an catastrophe waiting to happen, but they were mostly ignored:
''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''
Of course what Wallison doesn't say is when they fail, the bailout is going to make the thrift bailout seem like a comparative walk in the park.

So here we have the 'free market', as some would like to claim, enacting social policy through a quasi-government company who has the backing of the government to do precisely what that government wanted it to do.
''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.''
And politically, we couldn't have that, could we Mr. Raines?

The rest, as they say, is history - repeating itself.

UPDATE: More of the history, via Hot Air:

 
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While not something I approved of, the easing of credit standards both in general and for Fannie Mae in particular was a relatively minor culprit in the current mess. Even if there hadn’t been a push to expand credit to less-than-desirable borrowers, we’d still have quite a mess on our hands. Or put another way, had only credit standards been relaxed, the bailout would be a whole lot less costly.

We’d still be having to deal with the fact that financial institutions were buying debt instruments that they had no understanding of the component pieces (remember, it’s the lack of understanding about the underlying value of these debt instruments that has led to the writeoffs and liquidity problems). And we’d still be dealing with the aftermath of the pop of the housing bubble that was created more by low interest rates than by relaxed lending standards.
 
Written By: steve sturm
URL: www.thoughtsonline.blogspot.com
What flavor of Kool-Aid do you prefer?
 
Written By: McQ2
URL: http://
weren’t those debt instruments created to pool high risk loans?
 
Written By: huh
URL: http://
steve sturm - We’d still be having to deal with the fact that financial institutions were buying debt instruments that they had no understanding of the component pieces (remember, it’s the lack of understanding about the underlying value of these debt instruments that has led to the writeoffs and liquidity problems). And we’d still be dealing with the aftermath of the pop of the housing bubble that was created more by low interest rates than by relaxed lending standards.

But don’t these problems stem from the root problem of the gov’t effectively ordering the banking industry to give large loans to people who, in normal circumstances, would be considered bad credit risks? Supply and demand would seem to dictate that, had the demand for houses not been artificially inflated by the gov’t magically creating potential homeowners, then the supply of houses would not have expanded at such a high rate and the cost of the houses would also not have risen as much as it did.

I also have to say that the idea that banks were "buying debt instruments that they had no understanding of the component pieces (remember, it’s the lack of understanding about the underlying value of these debt" is a damned scary idea... that sort of doesn’t make sense. Why would bankers, who are normally considered to be rather cold, calculating people concerned only with the bottom line, buy debts that they didn’t understand? Was it that the boom economy of the ’90s and the middle part of this decade led to a relaxation of the rules of common sense along with the rules for getting credit? Or was it exactly what the original NYT article cited by McQ says, i.e. that banks bought risky debts because they thought that, if things went bad, the feds would bail them out?

I’m not trying to put you on the spot: I want to understand better what you mean.
 
Written By: docjim505
URL: http://
So how does this explain Bear Stearns, Lehman Brothers, Countrywide, Morgan Stanley, AIG, dash dash dot dot? Where’s your grand Master Theory of Everything Is Fannie Mae’s fault? You haven’t even tried. You’re stuck at:

#1. Fannie Mae guaranteed some risky loans for poor people

#2. Financial System Meltdown!


Most of your readers are smart enough to observe the gaping lack of connective tissue between #1 and #2.



 
Written By: glasnost
URL: http://
So how does this explain Bear Stearns, Lehman Brothers, Countrywide, Morgan Stanley, AIG, dash dash dot dot? Where’s your grand Master Theory of Everything Is Fannie Mae’s fault? You haven’t even tried. You’re stuck at:

#1. Fannie Mae guaranteed some risky loans for poor people

#2. Financial System Meltdown!
Huh?

Have you bothered to read anything about this crisis?

When something is written about here it is assumed you have at least an modicum of knowledge about how the system works. Obviously, in your case, that’s not true.

This is about what Fannie an Freddie did and then repackaged and resold to third parties who resold them to 4th, 5th and 6th parties.

4,5 and 6 used them as "equity" to leverage even more borrowing.

It’s about leverage - rotten leverage - and its collapse. It started at the two institutions we’re talking about.
 
Written By: McQ
URL: http://www.QandO.net
Notice the choice of the word ’some’ to downplay the scope of ’risky loans to poor people’.

Screw Greenspan’s doom and gloom prediction of this crisis back in 2005.
 
Written By: looker
URL: http://
And between the allegations (more like fact) of McCain’s aide Davis’s firm taking a little piece, and Obama taking a little piece, Freddie and Fannie seem to be the pies everyone has a finger in.

 
Written By: looker
URL: http://
The fundamental problem is that the left—people like glasnost—want to engineer outcomes without any consideration of the resulting unintended outcomes.

You can’t just distort markets without some result, usually a bad result. The left just doesn’t get it.

 
Written By: Don
URL: http://
"The lede:"

You have been reading too much Beowulf and Chaucer.



"It’s about leverage - rotten leverage - and its collapse."

Yep. A textbook example of moral hazard.
Any child can tell you that when you play ’hot potato’ someone always gets burned. If you play the game so that everyone has a potato, everyone gets burned.
 
Written By: timactual
URL: http://
Excellent post and mostly excellent comments. In addition to the moral hazards involved in using taxpayer dollars to bail out the reckless behavior of these institutions, it seems to me that the big elephant in the room is Paulson and Bernanke’s insistance that this bailout take place without any real specifity. I understand their request, as there are a lot of unknowns and a lot of unforseen obstacles.. they will need flexibility if this plan goes through.. but allowing them to move forward on such a "don’t press me on details, just trust me" basis, leaves taxpayers incredibly vulnerable to having the plan changed and manipulated far differently then the way it’s being sold now to Congress and the American public.

For example, Sen. Bunning yesterday pointed out that he is already reading that student loans and credit card debt are going to be part of the bailout plan, not just mortgages. And once the plan passes, Dems, with a few Republican allies like McCain will see it as a cookie jar of money for the greater good, doing "whatever it takes" to keep Americans (and illegal aliens?) in their homes - subsidizing 1% interest loans, deferred payments and forgiveness of debt.. all of which will be paid for on the backs of taxpayers, most of whom did not overextend themselves. Details of the bailout matter greatly, but we’re given nothing but the vaguest of assurances. What do you think those assurances are worth with Obama in the White House and Paulson out the door? I don’t trust McCain much either.

Another recent example of the unpredictable nature of govt power grabs is the ban on financial short selling. That ban was extended to companies like GM and Hercules Technology, twisting the original intent of the shorting ban wildly out shape from how it was originally presented and sold, which was supposed to be a short term ban on shorting of a few selected number of financial companies. Given the degree of willful misrepresentation that we have seen in the early stages of this govt. power grab, it’s not such a leap to imagine a ban at some point in the future on the selling of stocks.. all for the common good of course.
 
Written By: Darrell
URL: http://
Published in 1993, this document from the Boston Fed on Equal opportunity lending is a good starting point for the origins of the current disaster.

Sample excerpts (emphasis mine):
While the banking industry is not expected to cure the nation’s social and racial ills, lenders do have a specific legal responsibility to ensure that negative perceptions, attitudes, and prejudices do not systematically affect the fair and even–handed distribution of credit in our society.

Fair lending must be an integral part of a financial institution’s business plan.The first step for financial institutions to take in narrowing the lending gap is to incorporate fair lending goals into their mission statements. By pledging to make fair lending a primary strategic goal of the institution, management and the board of directors set a standard for
loan production staff and other employees.
Credit History: Policies regarding applicants with no credit history
or problem credit history should be reviewed. Lack of credit history should not be seen as a negative factor. Certain cultures encourage people to “pay as you go” and avoid debt. Willingness to pay debt promptly can be determined through review of utility, rent, telephone, insurance, and
medical bill payments. In reviewing past credit problems, lenders should
be willing to consider extenuating circumstances. For lower–income
applicants in particular, unforeseen expenses can have a disproportionate
effect on an otherwise positive credit record.
Liberals in govt. used govt and quasi-govt institutions to enact back-door social policy in lending. As long as housing prices kept going up, the risks they took with taxpayer money didn’t come to light. But after the housing bubble burst, the dishonest left wants to point the finger at ’free markets’ as the problem.

 
Written By: Darrell
URL: http://
Bruce...

Well done. This is exactly the point I"ve been making for weeks, now.
 
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