Collateralized Debt Obligation derivatives

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That is government for you. When they should not meddle they intervene and regulate. And when they should regulate and deter fraud, they pat their cronies on the back and wink.

ruveyn

They certainly encouraged it with their zero percent interest rates. With long term rates so low, more people wanted mortgages, causing home prices to increase and defaults to decrease as increased equity in homes allowed people to refinance. These low rates simultaneously caused investors to prefer riskier assets with higher rates of return.

The 0% interest rates you are referring to are overnight loans made between financial institutions.

Banks have to balance their books on a daily basis. They frequently need to borrow a little money for, oh, 18 hours or so. So that everything balances out. This happens thousands of times a day. Tens of thousands, probably. Hundreds of thousands likely.

The interest rates for this type of loan are very, very low. And the terms are very, very short.

Japan briefly set a slightly negative rate late one night during their financial crisis years ago.

These loans are a good thing because they keep banks liquid, and thus able to loan people money. Without them, the economy moves much, much slower.

Or did you mean to refer to interest-only mortgages, where the home buyer never actually pays any of the principal on the house, and has likely presumed that the market value will keep increasing at a pace that will make it easy to re-fi some day with equity that they never had to pay for?

Interest rates were extremely low across the board. This includes the federal funds rate in addition to long-term rates on mortgages. The fed doesn't explicitly set interest rates apart from the discount rate, but can still influence them through monetary policy. Asset purchases increase the price of treasuries (lowering yields) while creating large cash reserves at banks (increasing supply of loanable funds). Both of these effects put downward pressure on interest rates.

You are right that low interest rates was a major contributor to the destructive real estate bubble that has just burst in America but not quite right about how investors were essentially forced to seek riskier and thus higher yielding assets. Life insurance companies operate by offering some fixed or minimum return to their customers who then give them a monthly or lump sum payment in return. These companies make money by trying to create a spread or difference between their assets and liabilities.

A major component of the portfolio of all American insurance companies would be invested in U.S. Treasuries with a significant part holding short-term bills. When short-term interest rates fall the interest that these short-term bills offer will also decline and thus the overall returns on any portfolio which holds U.S. government debt gets compressed. So when Greenspan lowered interest rates to 1% post 9/11 and kept it there, many insurers found that they were unable to generate a meaningful spread between their assets and liabilities. In other words, when interest rates were pushed to record lows, the insurers were not profitable and thus had to seek out higher yielding assets.

It was in 2002 that the sub-prime mortgage market and the leveraged buyout market really got started. 1998 to 2001 were years of heartache and consolidation in the high yield markets as nobody wanted to touch riskier assets following Russia's default that was then compounded by Argentina's default. The sub-prime mortgage market had basically been eviscerated as funding evaporated. I would know, I was a small part of it

But 9/11 and Alan Greenspan's reaction to the attacks changed everything. Once insurers, which are far bigger players in the American financial system than most people realize, started to buy higher yielding assets, they could not stop. Bigger spreads meant more money and in the early years because the markets were recovering from a hollowed out crater, the risk-reward ratio was skewed heavily towards reward. It was like taking drugs - you become addicted and your judgment becomes impaired. He will deny it now but this was what Greenspan wanted. He believed that domestic players in the American financial system should take on more and not less risk.

The question that will occupy historians is this: Why did Alan Greenspan choose to do what he did? Certain people, like the leaders of Bear Stearns, were crowing and lauding the decision to lower interest rates because Bear at the time was the 800 lb gorilla in the sub-prime mortgage market and unreasonably low interest rates meant that the sub-prime market would see a major revival. I think the American people were betrayed. The people who were supposed to think for everyone chose instead to further private interests. It saddens me that after everything which has happened there has been no real inquiry or meaningful debate on why the mortgage meltdown happened or to hold the people responsible for it accountable. Believe it or not, like the Greeks, they just want things to go back to the way it was.

The fact the Federal Government applied consequences when Banks attempted to refuse to go along with the subprime mortgage scheme, is why I can say the Feds didn't just encourage these loans, they forced these loans.

The Central Government changed the rules so that investment houses could formulate schemes for laying off bets on shorting obligations. Read -The Big Short- by Michael Lewis. I am sorry to say the first such modern legalized betting scheme was invented by an Aspie. The predecessor to all this, of course, was Ponzi way back when.

In any case once the big money guys saw there was a bundle to be made in playing a legal casino they did it big time. We got a housing bubble that eventually popped. This is not much different than what happened back in the late 20's when the stock market was running on paper thin margins. Bubble, Bubble Bubble and Toil.

The government does not have to compel greed legally, and an eye for a money making angle comes naturally to the finance types.

You might be well advised to study the real history of economic bubbles and not accept the Fox News version of History so readily. The sort of nonsense we are experiencing now goes back to Holland and the Tulip Bulb craze and to Scotland and the Panama Scheme. Look it up.

ruveyn

I suggest you read again what I posted earlier on this topic, the bolded parts are especially important.



Denying banks the ability to expand because they were putting their foot down on CRA, is a way of attempting to force banks to go along with this. It isn't simply that incentives were used, there were fines, threats, etc. used, which makes what I am saying about the Government forcing banks to make these loans correct. While greed is a contributing factor, the fact remains Government forced the banks that didn't want to go along with this.

And the fact remains that loans made by banks enforced by CRA regulation have outperformed loans made by private, non-CRA regulated banks - you know, the HELOC's, piggy back loans, liar loans, etc.

What about the housing crisis in the UK and Australia? Were their banks "forced" by CRA regulators?

I'm not talking about the foreign banks, that part was pure greed on their parts unless they are affected by CRA enforcement too.

It was a rhetorical question. I'm pretty sure the CRA does not have international authority.

Okay then the fact the foreign banks got themselves caught up with this is their own fault, and I wasn't referring to them in the first place.

Why do you so easily accept greed as the primary cause elsewhere, but not here? The numbers do not support your little theory about CRA. If they did, then loans from CRA regulated banks would have the highest default rate. They do not. Foreclosure rate increases would be the highest in low income communities. They are not. Loan modification efforts are a massive fail because the majority of desperate homeowners do not qualify because they hold second mortgages (piggy backs, HELOC's, etc.).

It doesn't add up, Inuyasha.

Not once did the Bush administration take any step within its power, within the power of the SEC or within the power of the Federal Reserve to mitigate this crisis. There was plenty that they could have done--and they most assuredly failed to to.

I don't by the FNMA and FDMC argument at all. They were legally constrained from direct participation in the subprime marketplace, and the extent of their involvement was in the purchase of mortgage backed securities as part of their investing activities.

I'm not saying that greed wasn't a contributing factor, however it does not negate the fact that Banks faced retailiatory action from the Federal Government if they exercised better judgement and refused to make said loans. Therefore, the bulk of the blame is on the Government, not the banks. If it was just incentives from the Government and greed in play, then I would be agreeing with you that it was simply corporate greed. However, the Government was also retailiating towards banks that attempted to buck the trend and not go along with this, which is why I'm saying you can't chalk this up to simple greed, that the Government is effectively to blame for causing this mess.

But you are forgetting one extremely important fact: because of derivative instruments, these banks never had to accept any risk inherent in subprime mortgages, whether CRA or otherwise.

These are the self-same banks that were involved in an orgy of greed when it came to non-CRA mortgages. These banks couldn't give a toss whether the borrowers had jobs, assets or income. They couldn't care less about the realizable value of the property. They knew that within days of issuing the mortgage they could package it up into collateralized debt instruments and sell it on.