In the late 1970s, Jimmy Carter and the Democrat congress passed the Community Reinvestment Act. The act was supposed to open the door for "redlined" areas in inner cities to let them buy houses. It was largely ignored because it was not funded.
Clinton enlarged the Community Reinvestment Act and gave it iron teeth in the 1990s. Banks were forced to give bad loans to “underserved” populations in “redlined” areas. This was reaction to an old story that the media had wailed about for years. ACORN and other groups were authorized to mau-mau banks to force them to make bad loans, even invading meetings and picketing in the bank lobby.
Beginning in 1992 Congress pushed Fannie Mae and Freddie Mac to increase purchases of mortgages going to low to moderate income people. In 1996 HUD gave Fannie and Freddie an explicit target: 42% of their mortgage financing had to go to borrowers with incomes below the median. This target was increased to 50% in 2000 and 52% in 2005. In 1996 HUD required that 12% of all mortgages purchased by Freddie and Fannie had to be “special affordable” loans, meaning loans to borrowers with income less than 60% of their area’s median. The 12% dictum was increased to 20% in 2000 and 22% in 2005.
The passage of Sarbanes Oxley in 2001 (a bill written in reaction to Enron’s failure) caused a massive amount of capital to flee the stock market looking for other ways to make a decent profit. The rules for Sarbox were not well understood, and the unpredictable penalties of not complying slowed down initial public offerings for new ventures. This made real estate very attractive as an alternative investment.
The Federal Reserve lowered interest rates in the wake of the 9/11 attacks, to try to encourage business and stop a stock market slump.
In the meantime, the CRA was generating a huge nationwide portfolio of risky home loans that were not truly credit-worthy. Yet with low interest rates from the Federal Reserve, the number of subprime loans was climbing with low teaser rates. So Congress authorized Fannie and Freddie to lower their standards so the banks could effectively unload their loans onto you and me, and turn around and make more CRA loans. That’s why Representative Barney Frank (on the House Banking Committee) and Senator Chris Dodd (on the Senate Banking Committee) fought against reforming the GSEs - if the CRA program were stopped or slowed down considerably, groups like La Raza and ACORN who were raking in commissions from the sub-prime applications would no longer be funded and it would hamper their ability to campaign for democrat candidates. In addition, Fannie and Freddie made substantial campaign contributions to many congressmen, including Obama, Dodd, Frank, and others.
The lowered GSE standards opened the door to a bonanza of sub-prime loans that the GSEs bought. Some banks kept the loans on their books. The loans made the banks’ books look very profitable and hid the danger of default. Banks made sub-prime loans even when customers could have qualified for regular mortgages, because the loans were rated as AAA and made the banks look like they were based on sound investments. The loans could always be packaged and sold to Fannie and Freddie. The general idea was that real estate never lost value.
But the banks still weren’t sure they could survive a general downturn in the economy that would lead to loan defaults, so they purchased insurance from companies like AIG, in the form of Credit Default Swaps. These instruments were purported to guarantee the sub-prime loans in case of default, but they weren’t backed by anything! Look up Joseph Cassano if you want to know how AIG went into this market after Hank Greenberg was forced out.
When this recession started, the effect of increased foreclosures was like setting gasoline on fire. Everything undergirding the housing market failed at the same time. The failure of the CDS market brought down Lehman, Bear-Sterns, AIG, JP Morgan, etc. The failure of the financial services companies rippled across the economy, in particular banks who held shares of these companies. Their loan-to-value balance was dramatically reduced, making many banks technically (or actually) insolvent.
At the same time, Sarbanes-Oxley came back with a vengeance, forcing banks to evaluate their assets at fire-sale prices, causing a downward spiral in financial companies bonds and stocks. This hurt all banks because, by regulation, they had only limited investment options (banks can’t buy most stocks, they can only buy financial company’s stocks, other bank’s stocks, or shares of Fannie and Freddie, which now are worthless).
Sound banking principles would have kept this from happening, but HUD, Fed, Fannie and Freddie, Congress and the rating agencies had all fallen prey to the idea of a great “untapped market” in poor areas (formerly called “redlining”) and immigrants (so called NINJA loans). Congress regulated social justice into the banking system, and it became a worldwide disaster.
