Group items tagged

• Competitors were "snatching lucrative parts" and market share away; • Between 2001-04, the subprime mortgage market grew from $160 to $540 billion • Between 2005-08, Fannie purchased or guaranteed at least $270 billion in loans to risky borrowers.  • By 2004, Fannie had lost 56% of its loan-reselling business to Wall Street; • Angelo Mozilo, Countrywide Financial CEO, the nation’s largest mortgage lender, threatened to end their partnership unless Fannie started buying Countrywide’s riskier loans; • Congress was pressuring for more loans to low-income borrowers; • Hedge fund managers and other investors pressured Fannie executives that the company was not taking enough risk in pursuing profits; • Like many other firms, Fannie’s computer systems did a poor job of analyzing risky loans; • Between 2005-07 -- afte rthe market's peak -- Fannie's acquisitions of mortgages with less than 10% down payments almost tripled; • Fannie expanded in hot real estate areas like California and Florida; • From 2004-06, Fannie operated without a permanent chief risk officer;

According to modern financial theory, the probability of default of the top tranche of even subprime mortgages was very small, indeed. However, the theory failed to take account of the possibility that the defaults might be correlated. If underwriting standards deteriorated, all the mortgages written during a bubble might be of extra-poor quality. If house prices declined nationwide, all the riskier subprime mortgages would be in trouble.

The theory underlying the calculations of default risk was rubbish, so the ratings were rubbish. Yes, rating agencies were in a conflict of interest, and allowed the investment- bank quants to"help" them in their analysis. But the investment bank quants - who were paid only if deals got done - also did not think hard enough about possible flaws in the theory.

That was the catalyst for the collapse of the U.S. housing market. From late 2007, AAA-rated tranches of subprime mortgages started defaulting. Double securitizations, in which securitized assets were re-securitized (for example, BBB-rated tranches of mortgage bonds were packaged together and tranched again) were even more screwy than ordinary securitizations, because the errors in the calculation were doubled. Needless to say, rating agencies became pretty discredited. But they haven't been successfully sued, because they were able to claim that their ratings were just like a novel really - artistically elegant, but pure fiction.

Second, the increased demand from the GSEs and the competition with private-label issuers drove up the value of sub-prime and Alt-A mortgages, reducing the risk premium that had previously suppressed originations. As a result, many more marginally qualified or unqualified applicants for mortgages were accepted.

Since these mortgages aggregate more than $2 trillion, this accounts for the weakness in bank assets that is the principal underlying cause of the current financial crisis.

state-based residential finance laws give homeowners two free options that contributed substantially to the financial crisis. First, any homeowner may, without penalty, refinance a mortgage whenever interest rates fall or home prices rise to a point where there is significant equity in the home, enabling them to extract any equity that had accumulated between the original financing transaction and any subsequent refinancing.

The homeowner’s opportunity to walk away from a home that is no longer more valuable than the mortgage it carries exacerbates the effect of the cash-out refinancing.

From 2005 to 2007, Fannie and Freddie bought approximately $1 trillion in sub-prime and Alt-A loans.

interest on home equity loans is deductible no matter how the funds are used. As a result, homeowners are encouraged to take out home equity loans to pay off their credit card or auto loans or to make the purchases that would ordinarily be made with other forms of debt.

Bank regulatory policies should also shoulder some of the blame for the financial crisis.

Bank assets are assigned to different risk categories, and the amount of capital that a bank holds for each asset is pegged to the asset’s perceived riskiness.

These rules provided an incentive for banks to hold mortgages in preference to commercial loans or to convert their portfolios of whole mortgages into an MBS portfolio rated AAA, because doing so would substantially reduce their capital requirements.

U.S. housing policies are the root cause of the current financial crisis. Other players--greedy investment bankers; incompetent rating agencies; irresponsible housing speculators; shortsighted homeowners; and predatory mortgage brokers, lenders, and borrowers--all played a part, but they were only following the economic incentives that government policy laid out for them.

our first order of business should be to correct the destructive housing policies of the U.S. government.