To my thinking, it all began back in 1977, with the Community Reinvestment Act that began requiring banks to make bad loans. It continued with government bugling disguised as regulation, and as non-regulation.
This opinion piece from Forbes is a very brief explanation of how this "good intentioned" act created the by now predictable unintended consequences that legislation of markets is prone to. Also in this article, is information about how securitizing bad loans has absolved the lender from responsibility for the loan, by allowing loans to be bundled in to Securities that are sold, the beginning of the Derivatives problem, and the beginning of Freddie Mac and Fannie Mae's downfall- when the government put strong pressure on them to buy the securities backed by these questionable mortgages.
Then of course, to make sure there was more official support for these loans, the Government stepped in to emphasize its direction via Freddie and Fannie. We now know the unintended consequences of that action. From the NY Times of Sept 30, 1999 is an explanation of how Fannie Mae and Freddie Mac were compelled, in an act of "good intentions" to underwrite loans that had no business being made.
This issue was compounded by subsequent regulatory acts that next absolved those banks of the risk of loans by allowing them to be bundled into securities to be sold to investors "upstream". Those bundles became Derivatives, the financial instrument that made big banks around the world investors in our mortgages, providing more and more money and incentive to lend, which Warren Buffet and George Soros, the SEC and a Congressional Committee that reviewed them all condemned. Warren Buffet was warning about them in 2002, as you can read here, excerpted from his annual report. The column is long, but is the words of Mr. Buffet himself, and not too technical. Seems commons sense now, but his and other voices of concern were overruled by Robert Reich and Alan Greenspan, allowing the Derivative Market to go unregulated, thus leveraging bad loans on homes into bad investments of multiple times greater value in banks around the world. What other voices were warning against derivatives? George Soros, the man who hate Republicans, the SEC in the form a mere female regulator, and the report that congress commissioned to look into derivatives. But in 2002, Greenspan was considered to be a water-walker. I doubt history will continue to revere him as much as Bill Clinton and George Bush did.
From a blog by Professor Perry, and economist and the University of Michigan, a series of writing on the mortgage mess. This is more authoritative, wide ranging and expert thinking than mine, and is why I link to the Professor's blog on Exechobos.
My Editorial Opinion: My experience is that money will always find a way to grow, profits will always be made, whether the system is highly regulated like in China, or less regulated like in the US. Government regulations are like obstacles in the road, put there with the intent to manage traffic, but money flows around them, finding a way to go where it can best make more money.
In the case of the requirement to loan money to people who couldn't afford a home, whether in Detroit during the 80's or LA in 2006, banks figured out how to meet the requirements of these acts, and offset the added risk with balloon loans, etc., then sell these loans to other banks in the form of derivatives.
It leaves me thinking that the price of homes was driven up by the increased number of people who were able and wanting to buy homes, due to the ability to finance homes, even as prices went higher. The demand was unleashed by the ability to finance home ownership, and the prices went up as result. The spiral had to end, as they always do. Prices will come down, as they always do. Money has been made and will be lost.
Unfortunately, I think the derivative investments that were based on mortgages were eagerly shared by financial institutions all over the world, because the returns were good, and there was a perception that the US Government would always support Frannie and Freddie. Until they didn't, and panic set in. Then banks dried up credit, and companies as powerful as GE couldn't use the credit they depend on for everyday operations, so we have the start of a panic and meltdown, that governments around the world could not permit. The damage could not be confined to the housing market or mortgage lending business, it has been spread and leveraged too far. So, while I hate government bailing out banks, I can see it is a necessary evil.
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