There have been many causes noted for the ongoing financial situation; we hear them repeated just about every day, so I will not dwell on those. However, there is one that seems to be forgotten that needs to be remembered.
This is that government interference in the housing market for political purposes also played a significant part. It traces its beginnings back to the Community Reinvestment Act of 1977.
This legislation addressed the problem of banks and lending institutions, which took in deposits from poor neighborhoods and yet did not offer any housing loans in those same neighborhoods, this was called “Redlining.”
The teeth to this legislation were that for any bank or other lending institution which wanted to merge or enter into these neighborhoods, they first had to prove to examiners that they did not indulge in “Redlining.” A noble, and most probably, a necessary piece of legislation.
This later became a threat. If banks and other lending institutions did not increase their lending to low and moderate-income areas, they could lose their federal charters. And they were encouraged to write these loans without means-testing, in other words, even if the borrower did not meet underwriting guidelines.
Thus undocumented loans started to become available to any borrower. To offset the increased risk of these loans, there was a higher interest rate associated with them. As interest rates fell the undocumented loan was affordable to most anyone even with the higher interest rate.
Then, in November of 2000, HUD required Fannie Mae and Freddie Mac to dedicate 50% of funds to low and moderate-income loans. Many people familiar with the mortgage market and industry, along with some politicians, including President Bush, began to voice their concern with the risk exposure, especially to Fannie Mae and Freddie Mac.
These concerns over the housing market and Fannie Mae and Freddie Mac were consistently denied by the government agencies in charge of their oversight, especially, the heads of the Senate and House committees, Rep. Barney Frank and Senator Chris Todd.
When the bubble finally burst, another government intervention had a significant influence on the free fall, the bank regulators insistence on “Mark to Market.” Mark to Market is when you assess the value of an asset on its estimated current market value instead of its value at the time of sale.
So banks and other financial institutions were forced to record losses in the value of their near-cash assets at current values, even though their income streams were still intact.
So the examiners would value at “Mark to Market,” the bank or financial institution would then be found to have not enough funds in reserve and be declared insolvent. And since there was now no agreed-upon value of these assets, MBS and CDO’s, the banks and financial institutions could not sell them on bringing up the cash reserves and had to turn to the government for short term loans.
However, then the Market would fall some more, and the whole cycle would repeat. Remember, these MBS and CDO’s income streams were intact and were profitable. The other effect this had was on those companies who sold derivatives and insurance to hedge or offset the possible losses of the MBS and CDO’s. As originally written, these were to cover any loses suffered at the maturity of the bonds.
However, with “Mark to Market” losses, this started a run on the financial institutions and insurance companies who wrote the policies funded by the derivatives that now had to cover the paper losses every month instead of paying off any actual loss of value incurred at the time of maturity.
Again remember, the vast majority of the bonds have their underlying payment streams intact and were profitable assets. (The bonds acquired by the government in the AIG takeover will make approximately $50 Billion in profits for the government).
Since these companies could not use possible raise that much cash, that quickly, these insurance policies became worthless, this set off another round of devaluations and bank insolvencies and added the need for the insurance companies to be bailed out.