Who's Fault is this Financial Mess? Everybody's -- Part 3

What's a good bank to do?

Faced with increasing pressure and legal threats from the Federal Reserve, the federal government, and fringe organizations, banks and lending institutions did what they had to do: take on an increasing number of risky mortgages.

In 1994, for example, Bank Of America reported that 34% of its mortgage business (paragraph 2) went to low-income borrowers. Lenders tailored specific programs and educational platforms aimed at low-income borrowers. Banks created corporations to comply with the Community Reinvestment Act. The Clinton administration worked overtime to pass new government programs and goals, including simplifying the CRA, creating more empowerment zones, and tax incentives.

In addition to the subprime markets, financial institutions were drastically deregulated in many other areas. Most importantly, perhaps, was in the area of leverage ratios. Typically, banks are allowed to loan out $12 for every $1 in deposit. Lenders, investment banks, Fannie and Freddie, and subprime lenders started leveraging upwards of $30 to $40 per $1 in captial.

This paradigm, right or wrong, seemed to work "well" for years, undetected by and not concerning to the general public. Lenders would approve mortgages for people who normally would not qualify; Freddie Mac and Fannie Mae, if the loans were not repaid, would buy the bad loans -- principle and interest -- with no questions asked.

People got houses, banks got money, and politicians got to crow about helping the "little people."

However, when housing prices exploded in 1998/99, and wages did not follow, suddenly problems began to emerge.

That three-family in Boston that cost $200,000 in 1996 may have listed for $400,000 just a few years later. People who could barely afford to buy the house at the lower cost were priced out of a market that was artificially opened to them.

Enter the subprime mortgage.

Subprime borrowing is a completely artificial mechanism to get as many people into houses as possible. Low introductory teaser rates and zero down/zero fee agreements again provided access to home-buying for the borderline borrower.

Everything seemed to settle out and housing rates in the U.S. increased to record levels by 2004.

Fannie Mae was heavily involved in the drive to increase home ownership among the middle and low-income wage earners, pouring a staggering than $615 Billion in loans to 7.5 million families (roughly $82,000 per family) between 1994 and 1998 (paragraph 6, above link).

Then, as the subprime mortgages were designed, the interest rate on a loan jumped dramatically; facing 25 to 30% increases in mortgage payments (paragraph 10), the borrower who could barely afford the lower mortgage payment could no longer make payments without major sacrifice, if at all.

Enter the crisis.

The number of mortgages in default or late doubled; money stopped flowing to the lenders; Fannie and Freddie were forced to step in and buy out far more mortgages than they anticipated or could afford. People were being evicted; over-extended banks were losing money and closing; and Fannie and Freddie were drowning in debt.

With the initial vision of mainlining mortgages for low-income borrowers in trouble, public and private activists were sent scrambling for ways to keep people in their homes and to continue the dubious programs that put them there.

Activists lobbied/threatened/protested the "evil" banks, Fannie and Freddie were in trouble, and the lenders were seeking help.

Suddenly, we were plunged into a "credit crunch"; we entered the next Great Depression, subprime lending programs became "predatory" loans, and life as we knew it was over.

Enter the government.

In the face of only 4% of people unable to pay their mortgages on time, the U.S. government swept into action with a typically hysterical "solution" to the problem they created.

To be continued...