PART 1: How Did We Get To This Pointby Tim Manni
It all boils down to one simple problem: low-income borrowers, and borrowers with poor credit, applied for and were issued loans they could not afford. How did this happen?
Starting in 1992, Congress demanded that Fannie Mae and Freddie Mac increase the amount of mortgages they buy which were made available to low-and moderate-income borrowers. By 2000, HUD, Fannie and Freddie’s regulator at that time, had required that the two dedicate 50% of their loan portfolio to accommodate low and moderate income borrowers. In order to reach that goal, lenders were forced to relax their lending standards. “You went from subprime loans being 2% of total loans in 2002 to 30% of total loans in 2006,” said Steven Schwarzman, the chairman of Blackstone Group. According to Wayne Barrett of the Village Voice, in 2003 alone, Fannie and Freddie spent $81 billion on subprime mortgages.
-Subprime loans were bundled into securities, given better ratings by rating agencies, and sold to investors around the world.
-Over time various types of new products with very low initial payments were introduced to borrowers. Subprime borrowers soon began to fall behind on their monthly payments, and eventually defaulted on their loans, sending their homes into foreclosure.
-As more and more mortgage loans began to default, investment banks and other holders were forced to decrease the value of their holdings, and take additional steps since a large percentage of the mortgage investments they held were failing. All of a sudden, there were vastly different values for the same type of investment throughout the worldwide marketplace. Certain banks that invested more heavily in these mortgage securities were forced to devalue not only the investment itself, but their total earnings and overall market value. Investment banks were also forced to set aside increasing amounts of cash to cover loan losses.
-In turn, investment firms found themselves in, as Schwarzman puts it, “a structurally impossible situation.” What happened was, investment banks had to raise money in order to generate fresh income. But the end result was that it cost these investment banks more to raise the money to generate the extra income than they would have gotten back from lending it. They went bust.
Coming Soon: Part 2 — “What’s Being Done To Solve It?”