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The statistics provided by these samples, according to Mr. Johnson and Vicki Beal, a senior vice president at Clayton who also testified before the inquiry commission, indicated that only 54 percent of the loans met the lenders’ underwriting standards, regardless of how stringent or weak they were.

Some 28 percent of the loans sampled over the period were outright failures — that is, they were unable to meet numerous underwriting standards and did not have positive factors that compensated for their failings. And yet, 39 percent of these troubled loans still went into mortgage pools sold to investors during the period, Clayton’s figures showed.

At Goldman Sachs, 19 percent of loans failed to make the grade in the final quarter of 2006 and the first half of 2007, but 34 percent of those loans were still sold by the firm. Throughout this period, Goldman Sachs was also betting against the mortgage market for its own account, according to documents provided to government investigators.

A Goldman Sachs spokesman said the percentage of deficient loans that went into its pools was smaller than Clayton’s average, indicating that the firm had done a better job than its peers. Because these loan samples were provided to the Wall Street investment banks that commissioned them, they could see throughout 2006 and into 2007 that the mortgages they were financing and selling to investors were becoming increasingly sketchy.

A more proper procedure, analysts said, would have been for lenders like these — New Century Financial and Fremont Investment and Loan among them — to buy back the problem loans and replace them with higher-quality mortgages. But because these companies did not have enough capital to do that, they were happy to sell the troubled mortgages cheaply to the brokerage firms.

• 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.

In the United States, homeowners' net equity as a percentage of home value has plummeted from around 65% to 45% over the last two decades. with more than half that drop coming since 2000. In Canada, on the other hand, this ratio has remained stable at between 65% and 70% since the 1980s.

Less off-balance-sheet mortgages. The frenzy of mortgage securitization that gripped the United States in recent years (famously explained/satirized in this comic strip) never really took off here. According to Scotiabank "The majority of mortgages are held on balance sheet in Canada, with only 24% having been securitized." That's huge, because it is the radioactive quality of these securities — many of which contain a tangled welter of mortgages of varying quality — that has really sunk the U.S. credit market: Since no one knows how much these complex instruments are really worth, they still haven't established an equilibrium price level, thereby freezing the credit market for any entity that has a large number of them on their books. (What's more, even those 24% have mostly been securitized through the CMHC, a Crown corp. with government backing.)

Finally, there is the fact that Canada simply has a different — and more prudent — banking culture:

Canada banks continue to apply prudent underwriting standards. In other words, they have always checked, and continue to check, incomes, verify job status, asks for sales contracts, etc.,

On average, Canadian home prices are roughly 200% what they were in 1989. In the United States, the corresponding ratio peaked at 260% before crashing down to 220%.

This is the most shocking stat of all. In the United States, a full 4.5% of mortgages are in 90-day arrears (i.e. the local sheriff is ready to move in and tack a notice to the door). In Canada, the figure is one 20th that level — just 0.27%.

All in all, what do these figures show? A prudent, risk-averse, well-regulated Canadian real estate and mortgage community that — on both the seller, mortgagor and buyer sides — has avoided the pitfalls swallowing up the United states.

one blemish

significant imbalances were building up at various levels in the global economy and the global financial system

exuberant real estate prices and an ebullient securitisation business which facilitated huge credit growth

developments were unsustainable and would only need a spark to cause turmoil in the financial markets and the world economy

US mortgage market provided that spark.

Rising delinquencies and foreclosures revealed the exuberance in the housing market, and brought the sub-prime business to a sudden halt. Securitisation markets froze, banks had to bring assets from special purpose vehicles back onto their balance sheets, and confidence in the financial markets started to crumble. The crisis rapidly spread through the financial sector and spilled over to other industrialised and emerging market economies.

Central banks became the first line of defence, responding to the emerging crisis by injecting liquidity into the financial system. When the liquidity crisis became a solvency crisis that threatened the stability of the financial system, governments initially resorted to traditional measures to rescue individual institutions: liquidity lines were granted to insolvent institutions which in many cases were then sold and merged with a partner presumed to be stronger.

inancial system stood on the brink of disaster in autumn 2008 after the collapse of Lehman Brothers on 15 September. Its failure sent a shock wave through the global financial system, largely due to its importance as a counterparty in the credit derivatives market.

Conditions in interbank markets and other short-term funding markets deteriorated sharply. Credit risk spreads rose to new highs, and equity prices fell sharply. And financial markets in emerging market economies came under pressure as a flight to safety reversed capital flows.

The bad news is that there are even worse bets out there. There are credit default swaps written on subprime mortgage securities. It's bad enough that these subprime mortgage pools that banks, investment banks, insurance companies, hedge funds and others bought were over-rated and ended up falling precipitously in value as foreclosures mounted on the underlying mortgages in the pools. What's even worse, however, is that speculators sold and bought trillions of dollars of insurance that these pools would, or wouldn't, default! The sellers of this insurance (AIG is one example) are getting killed as defaults continue to rise with no end in sight.

What happened to AIG is simple: AIG got greedy. AIG, as of June 30, had written $441 billion worth of swaps on corporate bonds, and worse, mortgage-backed securities. As the value of these insured-referenced entities fell, AIG had massive write-downs and additionally had to post more collateral. And when its ratings were downgraded on Monday evening, the company had to post even more collateral, which it didn't have.

increasing pressure from Bill Clinton's administration on Fannie Mae and Freddie Mac to increase lending quotas to minorities and middle and low-income home buyers in so- called "under-served" areas (usually inner cities).

being pushed by the Federal Housing initiatives Fannie & Freddie, private banks and the rest of the players in the housing and mortgage industry jumped on sub-prime bandwagon seeing only big profits ahead.

answer is correct destructive and dangerous housing practices and introduce more transparency and accountability for the banking sector.

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.

some investors bought insurance policies called Credit Default Swaps, issued by companies such as AIG.  A CDS guaranteed an investor would not lose money, even on the riskiest asset, assuring a payment even if the underlying security defaulted.

Flush with billions, hedge funds and sovereign wealth funds gobbled up these CDOs.

One former Moody’s analyst says it was easy to “turn crap into Triple A.”

So Fannie and Freddie lowered their standards, just as the lenders had done. They began buying lesser-quality mortgages, including subprime loans, exactly the kind they avoided years earlier.

Lehman Rocks Wall Street, Declares Bankruptcy

The Treasury Department and Federal Reserve watched Lehman implode, unable to predict the scope of the global financial damage that would follow.

While Lehman Brothers failed to find a buyer, Merrill Lynch succeeded

Merrill’s CEO Stan O’Neal was so fixated on the revenue generated by the mortgage business, he didn’t just want to securitize them, he wanted to originate them, too. So, in 2007, Merrill bought mortgage lender First Franklin.

Bank Of America Rescues Merrill From ExtinctionBy September 2008, Merrill Lynch was suffering huge mortgage-related losses.

Although Bank of America’s purchase of Merrill ultimately saved the company, the transaction later came under intense scrutiny because of larger-than-expected losses and controversial year-end bonuses paid to Merrill executives.

Fed Accused Of 'Cover Up' In BofA, Merrill Deal

“Too Big To Fail,” Feds Take Control Of AIG

Paulson And Bernanke Issue Dire Warning

Paulson requested $700 Billion from Congress for a program intended to buy toxic assets from banks and infuse financial institutions with capital

contained no rules and standards for oversight. Infuriated politicians

Washington Mutual, weighed down by mortgage-related losses, was seized by federal regulators and sold to JPMorgan Chase.

largest bank failure in U.S. history, caused by an old fashioned, Depression-like run on WaMu’s deposits, following rumors about the bank’s ability to survive. 

Dow Jones Industrial Average plunged a record 778 points, its biggest drop in history.

Congress acted again. This time, lawmakers  approved the package, known as the Troubled Asset Relief Program. It included significantly greater oversight of the $700 Billion and more specific details on how it would be used to bolster the U.S. banking system.

Paulson’s “tough love” was a bitter pill for some bank bosses to swallow.

Residential construction has plunged and house prices have fallen. Mortgage defaults have soared, particularly among the least credit-worthy subprime borrowers. Home-owners who took out mortgages at cheap introductory rates face sharply higher payments as these loans reset. There have been plenty of financial-market casualties. The latest was American Home Mortgage Investment, a largish lender which this week said it would no longer fund home loans.

Ever since the demise of Long-Term Capital Management in 1998, regulators have worried that banks might lend too much to individual funds. But the Bear Stearns debacle shows that banks may also have to stump up capital to rescue hedge funds within their own stable. Bear had to promise an additional $1.6 billion of collateral to the funds' prime brokers.

The problems at Bear Stearns triggered the current market decline. Investors were surprised by the scale of the losses and the time it took for them to emerge.

There, the deadly combination of loose lending practices and higher interest rates has created a prolonged, and ever-deepening, bust.

Credit spreads, the premium that riskier borrowers must pay over government debt, have surged since June. That is a problem for companies and banks in the middle of doing deals.