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These new loan types are credited with replacing the long-standing practice of banks making conventional fixed-rate, amortizing mortgages. Among the criticisms of banking industry deregulation that contributed to the savings and loan crisis was that Congress failed to enact regulations that would have prevented exploitations by these loan types.
Subsequent widespread abuses of predatory lending occurred with the use of adjustable-rate mortgages. This legislation established an "affordable housing" loan purchase mandate for Fannie Mae and Freddie Mac, and that mandate was to be regulated by HUD. This encouraged "subprime" mortgages.
See HUD Mandates, below.
So if we change Bank Rate we can influence prices and inflation. The government has taken a balanced approach to the public finances since , focusing on getting debt falling, while supporting public services, investing in the economy and keeping taxes low. The sum of all real payments, discounted back to date 0 at the real interest rate r , is declining in inflation; thus, a FRM benefits the borrower when inflation is high. This will address the current situation where recycling rates of plastic are too low, plastic producers use little recycled plastic and some problematic items are rarely recycled and often end up in the natural environment. Nonfinancial businesses are already starting to push back.
It separated commercial banks and investment banks, in part to avoid potential conflicts of interest between the lending activities of the former and rating activities of the latter. Economist Joseph Stiglitz criticized the repeal of the Act. Rivlin , who served as a deputy director of the Office of Management and Budget under Bill Clinton, said that GLB was a necessary piece of legislation because the separation of investment and commercial banking 'wasn't working very well.
It aligned the formerly competing investment and commercial banking sectors to lobby in common cause for laws, regulations and reforms favoring the credit industry. Economists Robert Kuttner and Paul Krugman have supported the contention that the repeal of the Glass—Steagall Act contributing to the subprime meltdown   although Krugman reversed himself several years late saying that repealing Glass-Steagall is "not what caused the financial crisis, which arose instead from ' shadow banks. The vast majority of failures were either due to poorly performing mortgage loans, permissible under Glass-Steagall, or losses by institutions who did not engage in commercial banking and thus were never covered by the act.
Peter J. Wallison points out that none of the major investment banks that were hit by the crisis, "Bear, Lehman, Merrill, Goldman, or Morgan Stanley — were affiliated with commercial banks" but were stand-alone investment banks allowable by Glass-Steagall.
The mortgage banks, Wachovia, Washington Mutual, and IndyMac, were also independent banks existing before the repeal of Glass. Capital requirements refer to the amount of financial cushion that banks must maintain in the event their investments suffer losses. Depository banks will take deposits and purchase assets with them, assuming not all deposits will be called back by depositors.
The riskier the assets the bank selects, the higher the capital requirements to offset the risk.
Depository banks were subject to extensive regulation and oversight prior to the crisis. Deposits are also guaranteed by the FDIC up to specific limits. However, depository banks had moved sizable amounts of assets and liabilities off-balance sheet, via complex legal entities called special purpose vehicles. This allowed the banks to remove these amounts from the capital requirements computation, allowing them to take on more risk, but make higher profits during the pre-crisis boom period.
When these off-balance sheet vehicles encountered difficulties beginning in , many depository banks were required to cover their losses. Unlike depository banks, investment banks raise capital to fund underwriting, market-making and trading for their own account or their clients; they are not subject to the same oversight or capital requirements. Large investment banks at the center of the crisis in September , such as Lehman Brothers and Merrill Lynch, were not subject to the same capital requirements as depository banks see the section on the shadow banking system below for more information.
FDIC Chair Sheila Bair cautioned during against the more flexible risk management standards of the Basel II accord and lowering bank capital requirements generally: "There are strong reasons for believing that banks left to their own devices would maintain less capital—not more—than would be prudent. The fact is, banks do benefit from implicit and explicit government safety nets. Investing in a bank is perceived as a safe bet.
Without proper capital regulation, banks can operate in the marketplace with little or no capital. And governments and deposit insurers end up holding the bag, bearing much of the risk and cost of failure. History shows this problem is very real … as we saw with the U. The final bill for inadequate capital regulation can be very heavy. In short, regulators can't leave capital decisions totally to the banks.
We wouldn't be doing our jobs or serving the public interest if we did. The non-depository banking system grew to exceed the size of the regulated depository banking system. However, the investment banks, insurers, hedge funds, and money market funds within the non-depository system were not subject to the same regulations as the depository system, such as depositor insurance and bank capital restrictions.
Many of these institutions suffered the equivalent of a bank run with the notable collapses of Lehman Brothers and AIG during September precipitating a financial crisis and subsequent recession. Yet, over the past plus years, we permitted the growth of a shadow banking system—opaque and laden with shortterm debt—that rivaled the size of the traditional banking system. Key components of the market—for example, the multitrillion-dollar repo lending market, off-balance-sheet entities, and the use of over-the-counter derivatives—were hidden from view, without the protections we had constructed to prevent financial meltdowns.
We had a 21st-century financial system with 19th-century safeguards. In a June speech, U. Treasury Secretary Timothy Geithner , then President and CEO of the NY Federal Reserve Bank, placed significant blame for the freezing of credit markets on a "run" on the entities in the "parallel" banking system, also called the shadow banking system. These entities became critical to the credit markets underpinning the financial system, but were not subject to the same regulatory controls.
Further, these entities were vulnerable because they borrowed short-term in liquid markets to purchase long-term, illiquid and risky assets. This meant that disruptions in credit markets would make them subject to rapid deleveraging , selling their long-term assets at depressed prices. Economist Paul Krugman described the run on the shadow banking system as the "core of what happened" to cause the crisis. Influential figures should have proclaimed a simple rule: anything that does what a bank does, anything that has to be rescued in crises the way banks are, should be regulated like a bank.
For example, investment bank Bear Stearns was required to replenish much of its funding in overnight markets, making the firm vulnerable to credit market disruptions. When concerns arose regarding its financial strength, its ability to secure funds in these short-term markets was compromised, leading to the equivalent of a bank run.
The securitization markets started to close down in the spring of and nearly shut-down in the fall of More than a third of the private credit markets thus became unavailable as a source of funds. The Economist reported in March "Bear Stearns and Lehman Brothers were non-banks that were crippled by a silent run among panicky overnight " repo " lenders, many of them money market funds uncertain about the quality of securitized collateral they were holding. Mass redemptions from these funds after Lehman's failure froze short-term funding for big firms.
The Commission found GSE loans had a delinquency rate of 6. The GSEs participated in the expansion of subprime and other risky mortgages, but they followed rather than led Wall Street and other lenders. The three  wrote:. Government entities held or guaranteed Wallsion publicized his dissent and responded to critics in a number of articles and op-ed pieces, and New York Times Columnist Joe Nocera accuses him of "almost single-handedly" creating "the myth that Fannie Mae and Freddie Mac caused the financial crisis".
Critics contend that Fannie Mae and Freddie Mac affected lending standards in many ways - ways that often had nothing to do with their direct loan purchases:. In Fannie and Freddie introduced automated underwriting systems, designed to speed-up the underwriting process. These systems, which soon set underwriting standards for most of the industry whether or not the loans were purchased by the GSEs greatly relaxed the underwriting approval process.
An independent study of about loans found that the same loans were 65 percent more likely to be approved by the automated processes versus the traditional processes. In a paper written in January , OFHEO described the process: "Once Fannie Mae and Freddie Mac began to use scoring and automated underwriting in their internal business operations, it was not long before each Enterprise required the single-family lenders with which it does business to use such tools. Some analysts believe that the use of AVMs, especially for properties in distressed neighborhoods, led to overvaluation of the collateral backing mortgage loans.
In some mainstream banks told the Wall Street Journal that Fannie and Freddie were promoting small, thinly capitalized mortgage brokers over regulated community banks,  by providing these brokers with automated underwriting systems. The Wall Street Journal reported that the underwriting software was "made available to thousands of mortgage brokers" and made these "brokers and other small players a threat to larger banks.
Many of the loan products sold by mortgage lenders, and criticized for their weak standards, were designed by Fannie or Freddie. For example, the "Affordable Gold " line of loans, designed by Freddie, required no down payment and no closing costs from the borrower. The closing costs could come from "a variety of sources, including a grant from a qualified institution, gift from a relative or an unsecured loan. Countrywide, a company reported to have financed 20 percent of all United States mortgages in , had a close business relationship with Fannie Mae. Estimates of subprime loan purchases by Fannie and Freddie have ranged from zero to trillions of dollars.
For example, in Economist Paul Krugman erroneously claimed that Fannie and Freddie "didn't do any subprime lending, because they can't; the definition of a subprime loan is precisely a loan that doesn't meet the requirement, imposed by law, that Fannie and Freddie buy only mortgages issued to borrowers who made substantial down payments and carefully documented their income. Critics claim that the amount of subprime loans reported by the two GSEs are wildly understated. The highest estimate was produced by Wallison and Edward Pinto, based on amounts reported by the Securities and Exchange Commission in conjunction with its securities fraud case against former executives of Fannie and Freddie.
The discrepancies can be attributed to the estimate sources and methods. The lowest estimate Krugman's is simply based on what is legally allowable, without regard to what was actually done. Other low estimates are simply based on the amounts reported by Fannie and Freddie in their financial statements and other reporting. As noted by Alan Greenspan, the subprime reporting by the GSEs was understated, and this fact was not widely known until "The enormous size of purchases by the GSEs [Fannie and Freddie] in — was not revealed until Fannie Mae in September reclassified a large part of its securities portfolio of prime mortgages as subprime.
The estimates of Wallison, Calomiris, and Pinto are based upon analysis of the specific characteristics of the loans.
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For example, Wallison and Calomiris used 5 factors which, they believe, indicate subprime lending. Those factors are negative loan amortization, interest-only payments, down-payments under 10 percent, low-documentation, and low FICO credit scores. When Fannie or Freddie bought subprime loans they were taking a chance because, as noted by Paul Krugman, "a subprime loan is precisely a loan that doesn't meet the requirement, imposed by law, that Fannie and Freddie buy only mortgages issued to borrowers who made substantial down payments and carefully documented their income.
However, some loans were so clearly lacking in quality that Fannie and Freddie wouldn't take a chance on buying them.
Nevertheless, the two GSEs promoted the subprime loans that they could not buy. He said that Freddie could usually find a way to buy and securitize their affordable housing loans 'through the use of Loan Prospector research and creative credit enhancements …. Miller added: 'But what can you do if after all this analysis the product you are holding is not up to the standards of the conventional secondary market? The GSEs had a pioneering role in expanding the use of subprime loans: In , Franklin Raines first put Fannie Mae into subprimes, following up on earlier Fannie Mae efforts in the s, which reduced mortgage down payment requirements.
At this time, subprimes represented a tiny fraction of the overall mortgage market. From forward, private lenders increased their share of subprime lending, and later issued many of the riskiest loans. However, attempts to defend Fannie Mae and Freddie Mac for their role in the crisis, by citing their declining market share in subprimes after , ignore the fact that the GSE's had largely created this market, and even worked closely with some of the worst private lending offenders, such as Countrywide.
In , one out of every four loans purchased by Fannie Mae came from Countrywide. Joseph Stiglitz . Countering Krugman's analysis, Peter Wallison argues that the crisis was caused by the bursting of a real estate bubble that was supported largely by low or no-down-payment loans, which was uniquely the case for U. Sanders reported in December : "We find limited evidence that substantial deterioration in CMBS [commercial mortgage-backed securities] loan underwriting occurred prior to the crisis.
Business journalist Kimberly Amadeo reports: "The first signs of decline in residential real estate occurred in Three years later, commercial real estate started feeling the effects. Gierach, a real estate attorney and CPA, wrote:. In other words, the borrowers did not cause the loans to go bad, it was the economy.
In their book on the crisis, journalists McLean and Nocera argue that the GSEs Fannie and Freddie followed rather than led the private sector into subprime lending. Just one year later, it dropped to There was no question about why this was happening: the subprime mortgage originators were starting to dominate the market.
They didn't need Fannie and Freddie to guarantee their loans As Fannie's market share dropped, the company's investors grew restless Among its key recommendations for increasing In a article on Fannie Mae, the New York Times describes the company as responding to pressure rather than setting the pace in lending.
By , "competitors were snatching lucrative parts of its business. Congress was demanding that [it] help steer more loans to low-income borrowers. Lenders were threatening to sell directly to Wall Street unless Fannie bought a bigger chunk of their riskiest loans" . According to Journalist McLean, "the theory that the GSEs are to blame for the crisis" is a "canard", that "has been thoroughly discredited, again and again.
The Government Accountability Office estimated a far smaller number for subprime loans outstanding than Pinto. Pinto stated that, at the time the market collapsed, half of all U. The GAO estimated in that only 4. Significantly, the SEC alleged and still maintains that Fannie Mae and Freddie Mac reported as subprime and substandard less than 10 percent of their actual subprime and substandard loans. By contrast, the national average was 9.
The Fannie and Freddie Alt-A default rate is similarly much lower than the national default rate. The only possible explanation for this is that many of the loans being characterized by the S. Still another criticism of Wallison is that insofar as Fannie and Freddie contributed to the crisis, its own profit seeking and not government mandates for expanded homeownership are the cause. The GSEs were far more concerned to maximize their profits than to meet these goals; they were borrowing at low rates to buy high-paying mortgage securities once their accounting irregularities were behind them.
Most disturbing about the GSEs, they refused to maintain adequate capital as a cushion against losses, despite demands from their own regulators that they do so. Nocera's contention notwithstanding, at least one executive at Fannie Mae had an entirely different viewpoint, stating in an interview:. Everybody understood that we were now buying loans that we would have previously rejected, and that the models were telling us that we were charging way too little, but our mandate was to stay relevant and to serve low-income borrowers.
So that's what we did. Wallison has cited New York Times columnist Gretchen Morgenson and her book Reckless Endangerment as demonstrating that "the Democratic political operative" Jim Johnson turned Fannie Mae "into a political machine that created and exploited the government housing policies that were central to the financial crisis and led the way for Wall Street".
Announcing the conservatorship on 7 September , GSE regulator Jim Lockhart stated: "To promote stability in the secondary mortgage market and lower the cost of funding, the GSEs will modestly increase their MBS portfolios through the end of Then, to address systemic risk, in their portfolios will begin to be gradually reduced at the rate of 10 percent per year, largely through natural run off, eventually stabilizing at a lower, less risky size. According to Jeff Madrick and Frank Partnoy , the GSEs ended up in conservatorship because of the sharpness of the drop in housing prices, and despite the fact that they "never took nearly the risks that the private market took.
It … was mostly associated with purchases of risky-but-not-subprime mortgages and insufficient capital to cover the decline in property values. The Act was set in place to encourage banks to halt the practice of lending discrimination. There is debate among economists regarding the effect of the CRA, with detractors claiming it encourages lending to uncreditworthy consumers    and defenders claiming a thirty-year history of lending without increased risk.
Many subprime lenders were not subject to the CRA. Loans made by CRA-regulated lenders in the neighborhoods in which they were required to lend were half as likely to default as similar loans made in the same neighborhoods by independent mortgage originators not subject to the law. The crisis can be explained without resorting to these factors. Detractors assert that the early years of the CRA were relatively innocuous; however, amendments to CRA, made in the mids, increased the amount of home loans to unqualified low-income borrowers and, for the first time, allowed the securitization of CRA-regulated loans containing subprime mortgages.
Economist Paul Krugman notes the subprime boom "was overwhelmingly driven" by loan originators who were not subject to the Community Reinvestment Act.
The banks were half as likely to resell the loans to other parties. And the fact is, the lending practices that are causing problems today were driven by a desire for market share and revenue growth However, research suggests that many banks felt heavily pressured. For example, Bostic and Robinson found that lenders seem to view CRA agreements "as a form of insurance against the potentially large and unknown costs Second, CRA-related loans appear to perform comparably to other types of subprime loans.
He also charged that "approximately 50 percent of CRA loans for single-family residences For that reason, the direct impact of CRA on the volume of subprime lending is not certain. They were convinced that they could safely fund the massive expansion of housing credit.
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