Constant Readers,
Allow me to apologize for taking so long with part two of what will almost certainly be a 57-part series. I don't know why I thought it would only take a few days to write about an issue that has people much smarter than me engaging in blood-vessel popping arguments.
These next few essays are dedicated to the causes of the crisis. Of course, Democrats blame Republican deregulation and Republicans say the Democrats gave too many loans to poor people. Or something like that.
You know that saying, "There are no athiests in foxholes"? Well, there are no Democrats or Republicans in the unemployment line. I'm too freaked out to care about political parties right now. I'd write about Count Chocula if I thought it would explain why the stock market is falling like boiling oil on us peasants. In other words: this series is an effort to understand major events, not to assign blame.
So, here we go. Today we look at the 1970's and 1980's:
1970 -The New York Stock Exchange changed its rules to allow investment banks to go public. Merrill Lynch was the first major firm to do so, in 1971. All the other large banks eventually followed suit: Bear Stearns (1985), Morgan Stanley (1986), Lehman Brothers (1994), and Goldman Sachs (1999).
The impact of allowing investment banks to go public was (at least) twofold:
(1) As partnerships or closely-held corporations, the investment banks were smaller and partners provided the investment capital and bore the risk of company investments. As publicly-traded companies, all of the risk shifted to shareholders. This allowed the (now enormous) banks to be more cavalier with the money at their disposal.
(2) If a Skittle-maker has a bad quarter, I will still buy Skittles. (Hells yeah, Skipper.) Investment banks are fundamentally different because they rely on short-term debt which requires confidence in the ability to cover losses. For investment banks, a bad quarter that leads to a lower stock price can send the bank into a kind of "death spiral" in which low stock prices drive away lenders, which lowers stock prices, which drives away lenders...this is what happened to Lehman Brothers. (Rumors about their crappy real estate holdings drove up borrowing costs, which drove down share prices, which dried up lending, which led to pffft.)
1977 - President Carter signed the Community Reinvestment Act (CRA) to address discriminatory lending practices commonly known as "redlining." The stated purpose of the Act is to "encourage [financial] institutions to help meet the credit needs of the local communities in which they are chartered..." by requiring federal regulatory agencies to consider a bank's efforts to serve low-income neighborhoods when deciding whether to grant permission for a bank charter, merger, etc. (12 USC secs. 2901, 2902.) With little teeth or detail, implementation of the Act was half-assed. But it did lay the groundwork for later low-income housing requirements.
Then there were a series of laws that encouraged the growth of subprime mortgages...
1980 - President Regan signed the Depository Institutions Deregulation and Monetary Control Act which prohibits states from setting caps on the rate of interest that can be charged on a mortgage.
1982 - Passage of the Alternative Mortgage Transaction Parity Act which allows banks to charge variable interest rates and require balloon payments.
1986 - The Tax Reform Act prohibited people from deducting interest on consumer loans from their taxes, yet allowed interest deductions on mortgages for a primary residence as well as one additional home. Which made even high-cost mortgage debt cheaper than consumer debt for many homeowners.
1989 - George Bush the Elder signed the Financial Institutions Reform Recovery and Enforcement Act. This Act requires federal regulatory agencies to publish information about the banks it evaluates pursuant to the Community Reinvestment Act (see above). According to Fed Chairman Ben Bernake, "With the requisite data becoming available, advocacy groups, researchers, and other analysts began to perform more-sophisticated, quantitative analyses of banks' records in meeting the credit needs of their communities." We'll see that this led to some low-income housing requirements for Fannie Mae and Freddie Mac.
Phew! So, that's the 1970 through 1989. You can see here the beginnings of an investment banking community eager to spend shareholder money and regulatory framework that allows for all sorts of creative mortgage finance. At the same time, there was growing pressure to address the needs of people with low incomes. As we'll see in the next installment (1990s to present) these forces (greed + deregulation + subsidy) led to the most recent unsustainable housing boom. If I left something out of this part, let me know!
-Melissa
Also, these TIN mortgages, mainly attractive to illegal immigrants. And if you get in trouble with the payment - leave the country where the law can not touch you. It's important to mention that the remove of the legal obstacles which allowed this practice to flourish -has contributed immensely to the mortgage crisis.
Posted by: kerthialfad | December 03, 2008 at 14:27