Understanding the Mortgage Crisis


By David Ruggles




Preface: The following is the culmination of over 4 years of research. At one time I thought the mortgage crisis was due to “an unholy alliance between RW and LW forces. That was before I discovered that during the bubble period only 15% of mortgages and equity lines of credit (ELOCs) were made by Community Reinvestment Act lenders, and of those, only a small percentage were actual CRA loans. Further, according to the Federal Reserve study on the matter, those CRA loans have performed better than the overall mortgage loan market. The “fall back” position of the Republican Party when faced with the actual facts is to say, “There is certainly plenty of blame to go around.” This seems to be an attempt to equally apportion blame to both parties when it is clear that RW ideology is what caused the problem regardless of whether it was practiced by Republicans or the very few Democrats involved, Bill Clinton or Larry Summers, to name a couple.



I know it is RW orthodoxy to believe that Fannie Mae and Freddie Mac played a large role. The two Government Sponsored Enterprises (GSEs) were guilty of excessive lobbying, misstating their balance sheet based in a rather complicated legal case, and excessive executive compensation. But for those who want to know the truth and read further it will become clear that that Fannie and Freddie were victims of what RW ideology unleashed, not perpetrators. Had I seen “The Warning” earlier, I would have come to my conclusion earlier. As it was, I watched hours of Congressional testimony, the most entertaining being when Congress got again Hank Greenburg, retired CEO of AIG in front of them. So I studied AIG and Joe Cassano, head of AIG’s London Financial Products division. Then came, “All the Devils are Here,” by Bethany McLean and Joseph Nocera. I later waded through the highly partisan “Financial Crisis Inquiry Report” published by the panel entrusted to analyze the mortgage crisis. I then got my hands on the Federal Reserve documents issued by the Minneapolis Federal Reserve, link provided.




What Is The Mortgage Crisis? –


In short, the Mortgage Crisis is what is stymying the U.S. economy.

Easy credit by Wall Street lenders and artificially low interest rates fueled a real estate bubble. These lenders had been enabled by an anti-regulatory environment that allowed risky mortgages to be rated as an investment much higher than they deserved. Mortgages had been bundled into complex Mortgage Backed Securities, “insured” by “policies” (Credit Default Swaps) that lacked reserves to pay potential claims, and sold around the world. Because they had been rated AAA by the ratings agencies, these securities were held by traditional depository banks, Fannie Mae and Freddie Mac, pension funds, and other conservative investments vehicles. When the bubble burst, these trillions of dollars in securities became valueless virtually overnight because suddenly no one knew what real estate as worth. The MBSs were no longer backed by the asset values that supported them. Those who held mortgage backed securities couldn’t turn them into cash. In fact, all asset backed securities seized up and the world found itself in a credit crisis. Banks couldn’t lend because their cash was tied up in worthless MBSs and ABSs. The worldwide credit system froze up. The stock market fell like a rock. In the U.S., consumers instantly lost a minimum of 38% of their household net worth and at least 50% of their stock portfolio value. Many around the world lost their pensions, or a portion thereof. Panic set in and a worldwide lack of consumer confidence threw the global economy into deep recession. Tax revenues dropped precipitously. By late 2008 the American economy began shedding jobs at the rate of 800K per month. Governments around the world ran huge deficits as they tried to deal with the drop off in tax revenue at a time when they needed to prop up their economies to keep from slipping into Depression.


While things have improved and consumer confidence is on the rise, millions of Americans have to deal with a damaged credit report and the loss of the household net worth. Even though there is tremendous pent up demand, millions are without jobs or underemployed.


The Community Reinvestment Act (CRA)


The Community Reinvestment Act was passed by Congress and signed by Jimmie Carter in 1977. Its purpose was to ban discrimination in lending and insurance markets. A common practice of the day was “red lining.” Insurance companies and lenders frequently made decisions on whether or not to do grant credit or issue insurance to a consumer based on whether or not they lived inside or outside a “red lined” neighborhood. The CRA is frequently blamed by the Right Wing for causing the mortgage crisis as it did morph over the years into method to “persuade” lenders to include a true cross section of consumers in their loan portfolios. The CRA had no real force of law to accomplish this. There were/are no jail sentences or actual fines involved in the Act. However, lenders who did not meet the target percentage could have their names published on a list, which could impact their being granted charters by regulators to buy other banks and expand their business. This could have consequences to a lender.


HOWEVER, the mortgage crisis was not caused by banks regulated by the CRA. During the mortgage crisis, 85% of all mortgages and Home Equity Lines of Credit (ELOCs) were granted by NON CRA regulated lenders. This information is easily accessible via Google. One needs to understand the distinction between depository banks and investment banks to understand this.


Even depository banks, regulated by the CRA, really had NO PRESSURE on them to make “risky CRA loans.” Why? During the bubble period they often functioned as mortgage brokers. They could “approve” all sorts of risky mortgages, but they had no risk. WHY? Because they had NO REQUIREMENT to hold the paper “in house.” They could get CRA credit and immediately sell the “risky” mortgages upstream to a mortgage backed security assembler (Wall Street Investment Bank) who could include it in one of their mortgage backed securities, which were rated AAA because of the complex formula used to assemble them and the credit default swaps purchased to “insure” the risk.


CRA regulated banks were a non factor in causing the mortgage crisis. Out of the 15% or so of mortgages approved by CRA regulated depository banks during the bubble period, only a small percentage of those were CRA caliber mortgage loans. And they have performed well.



CRA Regulated depository banks WERE impacted by the mortgage crisis and the bubble created by the Wall Street Investment Banks. One day they woke up to realize that the collateral that supported the mortgages they had made and still held didn’t support the money they had outstanding. This is essentially the same thing that happened to Fannie and Freddie. F&F had no real role in creating the bubble that burst. They were prohibited by law from buying the kinds of mortgages Wall Street routinely approved, packaged, and sold. There are a few anecdotes where F&F bought some bad mortgage paper from CRA regulated lenders, one of which is playing out now in the $1 billion law suit filed by F&F against BOA for misrepresentation. The transgressions were actually committed by Countrywide, an infamous NON CRA regulated lender. The lawsuit will be interesting as the purchase of Countrywide by Bank OF America was a true “shotgun marriage” arranged by the Feds. There will most certainly be an accommodation of sort made by Federal regulators.


The situation is further complicated by the fact that certain banks had BOTH CRA regulated and NON CRA regulated operations under their roof. The repeal of Glass Steagall via the Gramm-Leach-Bliley Act took care of this. GLBA was essentially the CitiBank/Travelers Insurance Merger Facilitation Act.


Credit Default Swaps (CDS)


The first CDS was invented by Blythe Masters of JP Morgan in 1989. Masters hadn’t reached the age of 30 at the time, and is a remarkable woman born, raised, and educated in the UK. JP Morgan had extended a $4.8 billion credit line to Exxon. The Exxon Valdez had just run aground. Exxon came to JP Morgan to tap their line of credit. JP Morgan had to oblige. Masters exchanged sold risk on the loan to the European Reconstruction and Development Bank in return for a healthy fee, and the CDS was born. There was no mechanism to make sure the European bank had the means to pay a claim of the size they had just “insured.” Once the rest of Wall Street got wind of this, the free for all was on. Once they figured out how to parlay the mortgage backed security, assembled as a “tranched” collateralized debt obligation and insured with a CDS, they could now get the coveted AAA rating from Moody, S&P, and Fitch, and sell mortgage backed securities around the world. In fact, to be able to offer attractive higher yields, they often needed to buy really risky mortgages that carried higher interest rates.





At one time, F&F used Wall Street to securitize their own mortgages. Wall Street sold the mortgage backed securities “backed with the full faith and credit of the U.S. government” and collected fees for doing so. The process provided an endless supply of capital to support the U.S. housing market. Wall Street appreciated the business they had with F&F but had always been envious of their “big brothers.” Once Wall Street firms became public companies and had been enabled by unregulated credit default swaps, which allowed for the AAA rating, Wall Street became F&F’s biggest competitor. Wall Street routinely approved and purchased mortgages that F&F were prohibited by law from purchasing.


The Commodities and Futures Trading Commission, Brooksley Born, and the Commodities and Futures Modernization Act.


What a mouthful! Of all the events responsible for the mortgage crisis, the blocking of regulation of credit default swaps is the critical piece. During the Clinton administration, Brooksley Born was appointed to the chairmanship of the CFTC (Commodities and Futures Trading Commission). An extremely bright person, she quickly figured out the danger to the global economy associated with un-backed credit default swaps. The inherent danger came as a result of issuers not being required to reserve capital to pay potential claims. Issuers could collect fees for “insuring” others’ risk with no associated cost or reserve. The “Fees” would drop straight to the bottom line, on which huge bonuses would be paid, instead of establishing reserves to pay claims. Worse yet, in the complex world of derivatives trading, players could make bets n other’s “bets.” Really complex hybrid derivatives appeared with securities of mortgages, car loans, credit card debt, and student loans all bundled into the same security and “insured” with an un-backed credit default swap.


When Born moved to force issuers of CDSs to reserve capital to pay potential claims, she was met by a daunting opposition force. Brooksley Born lost the ensuing battle. The American taxpayer, voter, citizens and their offspring lost. The “winners” at the time were Wall Street, Alan Greenspan, the Fed Chairman and the economic rock star of the day who was appointed by Ronald Reagan, and the RW ideologues. Of course, Greenspan’s his star has been somewhat tarnished and he has been disavowed by his fellow Ayn Rand sycophants and Austrian Economics School theorists. In fact, he is in ideological exile with George W. Bush. To his credit, he has publicly copped to the errors of his thinking.



Greenspan was, no doubt, sincere in what he did. He led the pack which included people like Phil Gramm, Republican Senator from TX, Arthur Leavitt, Chairman of the SEC at the time, Robert Rubin, Treasury Secretary, Tom DeLay, Republican from TX, and a host of other RW “laissez faire ideologues. They succeeded in the forcing Born out of her job and in blocking her move to force issuers of CDSs to reserve capital to pay potential claims. Since Larry Summers was a part of the “pack,” there WAS a Democrat involved in this, but the entire affair was a result of RW “laissez faire markets self- regulate” ideology. This incident is chronicled in the PBS documentary “The Warning.” Excerpts can be seen at YouTube, including the tearful “mea culpas” of Greenspan and Leavitt. Another documentary on the subject is “Inside Job,” by Charles Ferguson. Featured on this film is Glen Hubbard, currently Mitt Romney’s chief economic advisor. Hubbard has been musing publicly of late on whether or not he would prefer to be Treasury Secretary or wait to be appointed Chairman of the Fed. This is NOT a good guy.


In the middle off all of this, Long Term Capital Management, a highly leveraged hedge fund collapsed and threatened to drag the world’s economy along with it. High risk arbitrage trading including credit default swap speculation, was the culprit.



Greenspan and his crew needed to take time out of their effort to block the CFTC to deal with this. I guess they didn’t learn any lessons from their experience. Indeed, regulation is all about “an ounce of prevention is worth a pound of cure.” Greenspan and his pack of ideologues have cost us dearly. Almost 40% of household net worth is gone and the credit reports of millions of consumers have been badly damaged. Credit is required to buy the kind of high ticket items that create high paying manufacturing jobs. Fortunately, almost $23 Trillion in wealth has been restored through the rebound of the stock market, but the current administration is paying a high political price for the fact that their predecessors damaged the economy so thoroughly.


Also on YouTube is the late Jack Kemp scoffing at the idea that the CRA caused the mortgage crisis.




In 2000, Congress passed the Commodities and Futures Modernization Act. The most important part of this bill was written in at the last minute by RW ideologue Phil Gramm. He inserted language ensuring that credit default swaps would NOT be regulated as insurance “because no insurable risk” exists. Bill Clinton signed the bill, so here is another area where a Democrat could shoulder some blame.


I find the fall back position of the RW after facing the insurmountable mountain of evidence that proves “liberals did NOT force banks to make risky loans,” is to claim, “There is plenty of risk to go around.” While this is technically true, the preponderance of evidence of guilt is clearly on the part of RW ideology. Technically, when I took a leak in the ocean I contributed to the Japanese tsunami.


Barney Frank and Chris Dodd


It is said Barney lied to the American people when he made the statement that “Fannie and Freddie are fine.” As the Chairman of the House Banking Committee Barney is prohibited from making statements that could devastate markets. But then, so are other government officials like the Fed Chairman, the Treasury Secretary, and the President of the United States. These people make the wrong statement and they could be creating a self-fulfilling prophecy. Imagine the Chairman of the House Banking Committee saying, “There is a bubble in the housing market that will burst and render mortgage backed securities valueless?” In minutes, the value of pension funds worldwide takes a dump as economies seize up. Give it a rest. Besides, F&F had little or nothing to do with the making of the bubble and were victims of what Wall Street did, NOT perpetrators. Having said this, it is absolutely true that the quasi-private industry companies (GSEs, Government Sponsored Enterprises) paid huge salaries and bonuses to executives based on incentives provided to them by Congress.


While it is true that their compensation incentives included objectives for low income (CRA) mortgages, every time they were given a new target they were already exceeding it? There was nothing that compelled F&F to buy and hold CRA mortgages. In fact, they sold most of them upstream to Wall Street and bought them or similar mortgages back as mortgage backed securities. Yes, F&F held hundreds of trillions of these toxic assets. AND like the home owner who wakes up one day to find that his house isn’t worth anything near what he/she owes against it, F&F awoke to find that the money they had extended wasn’t supported by the collateral they held, PLUS they were out of cash and couldn’t liquidate assets to generate any. This had nothing to do with Barney Frank or Chris Dodd.


Alan Greenspan


Greenspan was the longest serving Federal Reserve Chairman in history, appointed by Ronald Reagan. Greenspan was Ayn Rand’s favorite and highest profile protégé, and used to be a firm believer that markets would “self-regulate.” Some of his exploits have already been chronicled in this piece. A link to the YouTube video where he admits the error in his previous thinking has been included above. But Greenspan’s Fed played an additional role in creating the mortgage bubble that blew up in our face. After the September 11, 2001 terrorist attacks, Greenspan’s Fed lowered interest rates in an effort to bolster the American economy, which had been shocked by the attacks and was in the doldrums. This was probably a good thing at the time, but the Fed held the rates at record lows for much too long. Once addicted to the low interest punch the Fed was afraid to take the risk of raising rates. After all, so many mortgages were ARMs, and an upward reset could have triggered a chain reaction of defaults and deficiencies. Well, we know what happened. And the current administration inherited an economic mess and the Fed lacked the most helpful tool of all, the one Paul Volcker used to bring recovery to the Reagan era recession, that of lowering interest rates. When they are already at low ebb, there is no place to go. It’s like trying to fix a car with an empty tool box and no parts. 


George W. Bush



According to David Frum, Bush 43’s speech writer, the administration worried about the overheated housing sector but made the conscious decision not to touch it, as it was the single bright spot supporting the economy. We really needed someone with the will power and authority to take away the punch bowl just as the party is getting well underway.


Risky Mortgages and ELOCs


There are many lenders who PREFER to make riskier loans. The key is whether or not the risk is properly priced. In most cases, those who are making riskier loans add in a little extra for themselves so they are more than covered from loss through default and deficiency. Even if liberals DID make lenders make risky loans, which is not the case, the issue would be whether or not the loans were properly priced NOT that they were made in the first place.


Wall Street Goes Public


Not often discussed as a role in the mortgage crisis is the fact that Wall Street investment banks went from being closely held partnerships, where the partners watched each other like hawks, to pubic companies without the same level of motivation to properly manage risk. This occurred about twenty years ago. Complicated Value At Risk (VAR) calculations were developed which failed to account for the impact of a slide by all elements at once. Previously, partners had personal liability and would have never allowed the kind of risk taking which became routine after the partners had cashed out and no longer held the same level of risk. It’s one thing to lose on an investment, and quite another when they throw you out of your house, take your vehicles, and you are forced to call your kids home from college and move in with your in laws. In other words, there are different degrees of being “wiped out.”


Gramm Leach Bliley Act


Passed in 1999 and designed to facilitate the merger of Travelers Insurance and CitiBank into the huge conglomerate it became, it made “Too Big to Fail” a reality. It repealed the Glass Steagall Act of 1933, which was designed to provide regulation that was sorely lacking at the time. Many believe it was the Glass Steagall Act that had prevented more serious economic downturns since the Great Depression. A part of the new Dodd Frank Act, designed to reinstall safeguards that could prevent another serious meltdown like the one we are trying to recover from, is called the Volcker Rule, named for ex Fed Chairman and Obama administration advisor Paul Volcker. The Volcker Rule is currently being blocked by a cadre of RWers. I guess they believe that privatizing profits while socializing risk is a good thing. The electorate needs to know what they are doing and why they are doing it. Unfortunately, this is a well-kept secret.


If everything is not clear to this point, all you need to know is that the 85% of mortgages and ELOCS approved during the bubble period, the mortgages and ELOCS that actually inflated the bubble, were made by NON CRA regulated lenders. And those lenders had NO MANDATE forced on them by anyone. All they had driving them was the profit motive and a group of RW ideologues running interference for them.


Research resources include the PBS documentary “The Warning,” the Oscar winning documentary “Inside Job, “by Charles Ferguson, “Too Big to Fail,” by Andrew Ross Sorkin, “Overhaul,” by Steve Rattner, “All the Devils are Here,” by Joe Nocera and Bethany McLean, “The Big Short, Inside the Doomsday Machine,” by Michael Lewis, “The Financial Crisis Inquiry Report,” by the appointed presidential panel that included Brooksley Born, hours of watching CSPAN, scores of Federal Reserve conferences, supplemented by 40 plus years of experience in the financial sector.


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