Absolutely right and that was true throughout, at its peak mortgage based securitization accounted for less than 20% of the market? By far the majority was corporate debt and credit cards which had nothing to do with Government.
Interesting that you think Government was involved to such an extent. I was of the oppinion that no one in government would have been able to come up with the vehicles that were traded in the markets as the complexity of the vehicles were beyond even most bankers understanding! Even the credit rating agencies did not understand them which led to them mis-pricing risk. Governments real problem was that they allowed trading and innovation because they could not understand the transactions and allowed the bankers to self-regulate.
First, credit card debt, and other forms of debt, are irrelevant since they were not part of the problem.
Other than news reporters and commentators, as well as government know nothings... I have yet to find a banker or someone in the banking industry that didn't know how it worked.
Moreover, it was government regulation that pushed for sub-prime loans. People in the mortgage industry overwhelmingly say there is tons of regulations. Not only in reports, but also first hand accounts of people in my community today that are in the mortgage business, say there is tons of legal paper work that must be done.
No, the answer is really simple. Through Fannie Mae and Freddie Mac, the government securitized sub-prime loans. What better way to make money, than to sell sub-prime loans, and when they default, let a government sponsored company take the hit.
If you look at sub-prime originations, the market really takes off in the late 90s. Before that, you don't see the sub-prime market being anything other than a fraction of the market. Yet, here for you to read is the actual press release from one of the first adopters of the sub-prime market specifically to meet minority lending requirements under the CRA. Please read.
This is from October 1997.
1. Notice, they focused on CRA loans, targeted to low and moderate income borrowers and neighborhoods. These are sub-prime loans, or there would be no need to do it because the CRA says to.
2. Notice also, they are guaranteed by Freddie Mac. Of course the point here is, the bank would not make the loans otherwise, because Sub-prime loans are horribly risky.
3. Notice finely, they have an "implied" AAA rating. The only reason they must have an implied AAA rating, is because they were not AAA loans. It was implied because Freddie Mac, the government sponsored company, was securitizing them. The biggest holder of mis-rated risky mortgages is Fannie Mae.
How did Fannie Mae get mis-rated risky mortgages? Easy. In 2001 or 2002, Fannie Mae, under the direction of the HUD department, allowed mortgage companies to package sub-prime loans in with regular loans. As a result, say you sell 100 loans, and have 15 sub-primes. You package them all together, and are allowed to sell them all to Fannie Mae with an "implied" AAA rating, just like Freddie Mac did. Surprise! Mis-priced risk.
Again, what better way to make money than to make risky loans, keep the profit, and let the government through Freddie Mac take the risk. This is specifically where the mis-pricing risk came from.
One problem...
Freddie Mac went bankrupt, along with Fannie Mae. What happened to First Union Corporation? They merged with Wachovia, which went bankrupt after sucking down billions in tax money. The other key player in this deal, was also the very first bank to fail. Namely Bear Stearns.
So the two original banks that engaged in securitizing sub-prime loans with the blessing of the government through Freddie Mac, were also the first couple of banks to fail. Shocking eh? Not really.
Private Mortgage Lenders
Now, you would be correct in pointing out that the rest of the industry also engaged in sub-prime loans. Yes, you are right. But again, the sub-prime originations only happened AFTER the government legitimized the market. Before the late 90s, originations were very small, and fringe market.
But suddenly, after the government showed the way by securitizing sub-prime loans, the rest of the industry said "we want in on that party!" and followed suit. Again, why wouldn't you want in on this? Put yourself in that market. You can loan me $1,000, and charge me whatever interest floats your boat (because my credit rating sucks), and at the same time have the federal government through Fannie or Freddie, securitize it.
So if I pay up the loan, you get your money back with an amazing interest rate. If I default, Fannie or Freddie pays off my debt, and you get to pocket whatever payments I made up to that point. In either case, you break even or make a profit. And you are surprised the private market followed suit? This is obvious.
Private Securitization
But you say... Fannie and Freddie were not in on every single loan. That's true. They didn't securitize every loan. But consider, let's say your a private insurance company, that deals in securitizing financial securities. You look over at Fannie and Freddie, and see they are securitizing millions of sub-prime loans through package securities.
Well hey, if the two biggest mortgage brokers in the entire nation are doing it, and making money... why can't we? So suddenly AIG is securitizing mortgage backed securities too. Of course, Fannie and Freddie go bust, and AIG goes bust too.
Who Started It
No matter how you cut it... you have to go back to who got the ball rolling. Who started the land slide. Because sub-prime mortgages existed for 80 years. Why all of a sudden, in the late 90s did it take off? Perhaps you might try and blame credit default swaps that you eluded too. Sorry but CDSs didn't exist until 1999-2000. The spike in sub-prime loans began before that. 1997 to be exact.
Moreover, if CDSs where the cause, then why have they not caused any problems in any of the other markets? Why only the sub-prime mortgage market has CDSs reeked havoc, and not in any other? Answer: They had nothing to do with it.
It was government regulation that got us into this mess.
