Want really happened Mr. Lagboltz was a failure of the government to exercise proper regulatory control over mortgage banking and securities. Between 2004 and 2006, banks and mortgage lenders made millions of high-risk, subprime loans (i.e., 100% "piggyback" loans with adjustable interest rates "ARMs", etc.) to borrowers that were unqualified for conventional financing and without due-diligence requirements for collateralization on the assumption that the real estate market could only go up and no one could lose. These loans were then packaged and sold as debt securities on the financial markets worldwide.
Then, predictably, things took a downturn. The interest rates on these loans went up, and borrowers started defaulting on their loans, precipitating a rash of foreclosures across the country. By August 2007, Countrywide Home Loans, the largest mortgage lender on the planet, was on the verge of bankruptcy; but was bought out by Bank of America in an effort to prevent its own equity position in the company from being extinguished. (Not a good move as it turned out, for in taking over Countrywide, it had to assume a large portfolio of very bad loans.) The disintegration, however, continued with millions of defaults followed by foreclosures as real estate values plummeted. This in turn precipitated bank failures, including Indymac Bank (the largest since the crash of 1929), which was followed by the collapse of some of the biggest investment firms like Bear Sterns, Morgan Stanley, and Lehman Brothers (the biggest bankruptcy in history), the federal "conservatorship" of Fannie Mae and Freddie Mac, and finally the outright takeover of AIG. It had a cascading effect necessitating a government bailout with taxpayer funds just to stabilize the financial markets and prevent widespread, systemic economic chaos.
It was the fault of deregulation. The FDIC, FSLIC, HUD and FTC failed in regulating the banks and mortgage lenders, and the SEC had failed to exercise proper oversight of the sale of mortgage-backed securities. (Even Alan Greenspan was forced to admit that he was wrong in thinking that the market could be left to its own devices.) And, it will happen again because the Congress lacks the political will to establish regulatory control over banking and financial markets. Dodd-Frank - which the banking lobby is working night and day to have Congress repeal - is not the answer. Regulation must be measured, but effective; and not so heavy-handed as to stifle economic growth. To work, there must at least be a level playing field, which requires more transparency that will promote value over speculation. Also, there needs to be accountability: if there are no penalties for failure - if executives are rewarded for running their companies aground - there is no incentive to exercise restraint over irresponsible action.
