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Thursday, March 10, 2011

LEETERS: Collpapse of the Housing Market Events

Dear Vesta,

The author of subject article had written, " was big business and the wealthy who gamed the deregulated financial system to make huge profits. Their speculation in the home mortage markets triggered the Great Recession..". But the collapse of the housing market need to rescue several banks was caused primarily by other events.

The four fundamental events that let to the housing bust of 2008, which spread to the financial markets and beyond are:

EVENT 1: In 1997 Congress passed the Community Reinvestment Act (CRA) to address alleged discrimination by banks in making loans to poor people and minorities. The Act required banks to meet credit needs of communities in which they are chartered. In 1989, Congress amended the Home Mortgage Disclosure Act requiring banks to collect racial data on mortgage applications. The Boston Federal Reserve Bank alleged systemic discrimination in loan making. Although the Boston Fed Reserve allegation was disproven by a University of Texas study and other studies, it became the standard on which government policy was based.

In 1995 the Clinton administration Treasury Department issued regulations tracking loans by neighborhoods, income groups, and races to rate the performance of banks. These ratings were used by regulators to determine whether the government would approve bank mergers, acquisitions, and new branches. Racial data collected and these regulations encouraged ACORN and other groups to file petitions with regulators to slow banks from conducting business and to extort huge pools of money for the purpose of ACORN home lending. Government, together with ACORN, forced banks to abandon traditional lending standards and to make “subprime” loans to people without sufficient incomes necessary to repay the loans. These became known as CRA-eligible loans; one estimate puts their total at $4.5 trillion.

EVENT 2: In 1992 the Department of Housing and Urban Development pressured Freddie Mac and Fannie Mae to purchase, or “securitize” large bundles of CRA loans for the purpose of diversifying risk and making even more money available to banks to make further risky loans. Congress also passed the Federal Housing Enterprise Financial Safety and Soundness Act, mandating that Fred and Fan purchase 45 percent of all loans from people of low and moderate incomes, creating a secondary market for these loans. In 1995 the Treasury Department established the Community Development Financial Institutions Fund, which provided banks with tax dollars to encourage even more risky loans. But this was not enough. Top Congressional Democrats, including Rep Barney Frank, Sen. Chris Dodd, and Sen. Charles Schumer, among others, repeatedly ignored warnings of pending disaster, insisting that they were overstated and opposed efforts to force Fred and Fan to comply with usual business and oversight practices. Top executives, including Franklin Raines and Jamie Garelick, resisted reform while they were cooking the books in order to reward themselves tens of millions of dollars in bonuses. Franklin Raines earned $90 million by inflating reported loan amounts.

EVENT 3: Fed and Fan reinvented the “derivative” for application to the subprime mortgage market to redistribute these risky loans to unsuspecting investors and thus further increase the market for these loans. The derivative would turn the subprime market into a ticking time bomb that would magnify the housing bust by orders of magnitude. A derivative is a contract where one party sells the RISK associated with the mortgage to another party in exchange for payments to that company based on the value of the mortgage. It was both a betting system and a form of insurance. The bet set the value. So long as the bet was covered, the mortgage was secured. Derivatives were a way to capitalize in an exponential manor on appreciating real-estate prices. But if derivatives ever collapsed, and since mark to market rules were resisted by government, the actual price of properties would fall out of proportion to what would have been the case had derivatives not existed. As bets on the underlying derivatives declined, banks were forced to devalue assets accordingly, placing banks in jeopardy of failing. Hedge funds, financial institutions and insurance companies, including American International Group (AIG) invested heavily in derivatives.

EVENT 4: The Federal Reserve Board slashed interest rates repeatedly starting in January 2001, from 6.5 percent until they reached a low in June 2003 of 1.0 percent. When the easy money policy became too inflationary for comfort, Fed Chairman Alan Greenspan (at the beginning) and Ben Bernanke (at the end) began to steadily raise the Fed rate back from 1.0 percent in June 2004 to 5.25 percent in June 2006. This artificial manipulation or the housing market contributed to destabilization of the economy.

Rod Hug
Santa Rosa

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