Financial Crisis Caused by Government-Not the Free Market

[Aryeh Jay]

Personally I wouldn't blame them too much. "Sure you can afford it! Look how low the payment is! And in a couple years the house will be worth significantly more so you can just refinance at a favorable rate or just sell the house for a nice profit!" And "Look how much your house has gone up in value. You can take out a second mortgage, that you can really afford, and get some awesome stuff. [fast foreward] Oh? The housing market crashed, you lost your job and can't make the payments now, and now that the value of your house is way down, you can't sell your house for enough to cover the loan? TOO BAD"

When you got the people who are supposed to be making sure you can actually afford the loan telling you that, and people you know doing the that exact thing (it worked for a while), you're going to come to believe it. Especially when the precise terms aren't totally clear.

This is almost word for word that happened to me in 2008, fast forwarding to 2013.

 

[Vylo]

This is almost word for word that happened to me in 2008, fast forwarding to 2013.

I met a couple in Maui. The man had gotten stranded as his house in Cali had its mortgage double while he was working on the Island. He couldn't keep up and eventually let it go. Guy fought in Iraq too, it was heartbreaking to hear about.

 

[jayem]

The other glaring lie is that the CRA caused the financial collapse. It was not just that bad loans - which were often predatory - were made, but that they were repackaged into derivatives that hid their junky nature such that E-rated loans were being sold as AAA-rated. It was the market for these derivatives, not the CRA, that drove bad lending frenzy

Exactly. The OP's article is from 8 years ago. Well before the market collapse could be fully investigated. Which took 3 years to do. This is pasted from the final majority report of the FCIC, in 2011. Only 6% of subprime loans were related to the CRA. And those loans were less likely to default than those made by lenders not subject to the law:

In conducting our inquiry, we took a careful look at HUD’s affordable housing
goals, as noted above, and the Community Reinvestment Act (CRA). The CRA was
enacted in 1977 to combat “redlining” by banks—the practice of denying credit to in-
dividuals and businesses in certain neighborhoods without regard to their creditwor-
thiness. The CRA requires banks and savings and loans to lend, invest, and provide
services to the communities from which they take deposits, consistent with bank
safety and soundness.

The Commission concludes the CRA was not a significant factor in subprime lend-
ing or the crisis. Many subprime lenders were not subject to the CRA. Research indi-
cates only 6% of high-cost loans—a proxy for subprime loans—had any connection to
the law. Loans made by CRA-regulated lenders in the neighborhoods in which they
were required to lend were half as likely to default as similar loans made in the same
neighborhoods by independent mortgage originators not subject to the law.

https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf

As you correctly note, the report also faults the credit rating agencies for negligently upgrading the safety of high-risk mortgage-backed securities.
.
Government does have some blame for the meltdown. But for inadequate regulation.

 

[[serious]]

Simple question:
Were boom bust cycles more or less common before the expansion of regulations of the stock/financial markets?

 

[Cearbhall]

Letting Leemann brothers crash was what the free market looks like, they had enough "free market" in about a week.

This guy thinks we've got the stones to laugh in the face of a burning economy for decades.

What actually happened was that the most ardent lip servers of the free market ran for the fire hose like we should expect them to.

And these types always seem so excited about fear-mongering regarding the economic doomsday...until it starts to come to fruition.

 

[Thursday]

Not about this.
Yeah, they were forced to stop redlining and discriminating based on race, gender and ethnicity and they were forced to reinvest a certain percentage of the money they took from the community back into the community. That's it.

Their standards had nothing to do with race. You are proving my point. Banks were forced to make loans that would not previously have been made because the applications came from minority neighborhoods.

 

[Thursday]

They were not forced to bundle those loans and lie about their nature to sell them, which is what caused the problem.

If somebody lied about the nature of a debt then they broke the law. What are you referring to?

 

[lesliedellow]

If somebody lied about the nature of a debt then they broke the law. What are you referring to?

He is referring to the way in which the rating agencies handed out AAA ratings like water.

 

[Thursday]

He is referring to the way in which the rating agencies handed out AAA ratings like water.

Could you be more specific?

 

[DaisyDay]

Their standards had nothing to do with race.

They had much to do with race; their redlining was predicated on race. This, not income level, was what was referred to as unacceptably "arbitrary".

You are proving my point. Banks were forced to make loans that would not previously have been made because the applications came from minority neighborhoods.

Aren't you contradicting yourself? The "minority neighborhoods" has something to do with race, does it not?

Your point was that banks were forced to throw out prudent lending standards such as income verification, job history, substantial down payments and credit history - which they most certainly were not. Instead, they could apply these standards to applicants from minority neighborhoods and could no longer arbitrarily reject these applicants simply because they were minorities or wanted to finance propertied in these neighborhoods; however, they could reject them for cause or, as was more common, simply charge them a higher rate on worse terms than they would a comparable non-minority person.

Your point was such loans caused the financial crisis, but that's contrary to fact. The CRA in no way asked or required no down payment loans, no interest for five years with ginoromous balloon payments, etc. that banks started shelling out to anyone to anyone who would sign on the dotted line, minority or not. They needed a growing volume of mortgages, quality be damned, to satisfy the demand for mortgage derivatives, which is where they were making their real money (until the bubble burst).

 

[Thursday]

Your point was that banks were forced to throw out prudent lending standards such as income verification, job history, substantial down payments and credit history - which they most certainly were not. I

No, my point was that they lowered standards, not that they threw out all standards.

 

[lesliedellow]

Could you be more specific?

Nobody is going to pay you to give their securities a D rating. You either have to give their risky securities a AAA rating, or have them take their custom elsewhere. And then the innocent investor thinks, "Ooh, a triple A rating eh? That must be good," when in fact it is junk, and full of mortgages which are almost guaranteed to go bad.

 

[DaisyDay]

Could you be more specific?

Mortgages were bought by the thousands from the original lenders and bundled into new debt instruments, Real Estate Investment Trusts (REITs). Mortgages are traditionally considered safe but bland investments, giving a steady reliable return over their life, averaging 30 years. Morningstar, for instance, is one of the bond rating companies - they rated the new instruments AAA based on the underlying mortgages. Which was fine, at first, but then more and more junk mortgages got bundled in to the point where many of the REITs were mostly junk, but still, the rating companies refused to change the rating from AAA to E, even after the defaults began as the balloon payments came due.

 

[DaisyDay]

No, my point was that they lowered standards, not that they threw out all standards.

This is from your own OP:

Note that these “arbitrary or outdated criteria” include most of the essentials of responsible lending: income level, income verification, credit history and savings history–the very factors lenders are now being criticized for ignoring.

While banks did ignore these essentials of sound lending, it was not because of CRA, it was because they wanted to generate as many mortgages as they could for their REITs. The only "arbitrary or outdated criteria" that the CRA removed was redlining and discrimination based on race, gender and ethnicity - they were certainly allowed to continue to discriminate based on income, job status, credit and savings history, they, in their drive for mortgages, any mortgages, chose not to and chose not to across the country, not just in minority neighborhoods.

 

[variant]

If somebody lied about the nature of a debt then they broke the law. What are you referring to?

Moodies, S&P and Fitch

Only one banker went to jail though...

Credit rating agencies (CRAs) — firms which rate debt instruments/securities according to the debtor's ability to pay lenders back — played a significant role at various stages in the American subprime mortgage crisis of 2007-2008 that led to the Great Recession of 2008-2009. The new, complex securities of "structured finance" used to finance subprime mortgages could not have been sold without ratings by the "Big Three" rating agencies — Moody's Investors Service, Standard & Poor's, and Fitch Ratings. A large section of the debt securities market — many money markets and pension funds — were restricted in their bylaws to holding only the safest securities — i.e securities the rating agencies designated "triple-A".[1] The pools of debt the agencies gave their highest ratings to [2] included over three trillion dollars of loans to home buyers with bad credit and undocumented incomes through 2007.[3] Hundreds of billions of dollars' worth of these triple-A securities were downgraded to "junk" status by 2010,[1][4][5] and the writedowns and losses came to over half a trillion dollars.[6][7] This led "to the collapse or disappearance" in 2008-9 of three major investment banks (Bear Stearns, Lehman Brothers, and Merrill Lynch), and the federal governments buying of $700 billion of bad debt from distressed financial institutions.[7]

https://en.wikipedia.org/wiki/Credit_rating_agencies_and_the_subprime_crisis

 

[variant]

Nobody is going to pay you to give their securities a D rating. You either have to give their risky securities a AAA rating, or have them take their custom elsewhere. And then the innocent investor thinks, "Ooh, a triple A rating eh? That must be good," when in fact it is junk, and full of mortgages which are almost guaranteed to go bad.

Many agencies like pension funds are required by bylaw or law to keep their investments in AAA rated securities. The reason for wanting the AAA rating is that it expands the pool of customers to the maximum, increasing the value of the financial instrument.

So, massive amounts of fraud caused the financial crisis, both on the "giving loans to people who you didn't think would be able to pay them back" side and the "securitizing risky debt and then calling it good so you had lots of buyers for your junk" side.

We can say without pause though that the cause wasn't the government forcing anyone to give out bad loans, but the private sector basically putting on an orgy of subprime loans, and defrauding investors to the max.

 

[Vylo]

If somebody lied about the nature of a debt then they broke the law. What are you referring to?

They did lie, very few went to jail. So there isn't a whole lot of sentiment for them to stop if they think they can do it again, so they are, just in the auto industry. Time will tell if they start doing it to homes again.

 

[Thursday]

Mortgages were bought by the thousands from the original lenders and bundled into new debt instruments, Real Estate Investment Trusts (REITs). Mortgages are traditionally considered safe but bland investments, giving a steady reliable return over their life, averaging 30 years. Morningstar, for instance, is one of the bond rating companies - they rated the new instruments AAA based on the underlying mortgages. Which was fine, at first, but then more and more junk mortgages got bundled in to the point where many of the REITs were mostly junk, but still, the rating companies refused to change the rating from AAA to E, even after the defaults began as the balloon payments came due.

I meant which specifice rating company intentionally skewed ratings?

 

[Thursday]

They did lie, very few went to jail. So there isn't a whole lot of sentiment for them to stop if they think they can do it again, so they are, just in the auto industry. Time will tell if they start doing it to homes again.

Who lied and didn't go to jail, besides Hillary?

 

[DaisyDay]

I meant which specifice rating company intentionally skewed ratings?

Morningstar Moody's was one. I forget the other...Standard & Poor's maybe?

Edited to reflect correction. See iluvatar5150's next post for details.