Mortgage crisis

I have written before on how the mortgage crisis had its beginning and I would like to expand on that in more detail. Recall that it all began in the 1970’s when it was discovered that mortgage companies were red lining. This means that in certain neighborhoods the income levels were so low that loans were not offered. Bankers would take a red pencil and draw lines around these neighborhoods and did not offer loans to those people. In order to rectify this apparent discrimination the government passed four laws during the 70’s and 80’s. The first was the Home Mortgage Disclosure Act (HMDA) which required banks to report on their loans. I use the term bank when in fact most home loans were provided by Savings and Loan Institutions which today are called bank. Because of this law by 1977 the government had all the information it needed to prove discrimination by banks against poor people. The second was the Community Reinvestment Act (CRA). This law required the banks to make loans to poor people and there were stiff penalties if they did not. In order for banks to comply without losing money they had to find a way to charge more for these loans. Third, the Deregulatory and Monetary Control Act (DIDMCA) was passed in 1980. This allowed banks to charge more for higher risk loans. Forth, in 1982 the Alternative Mortgage Transaction Parity Act (AMTPA) passed and it allowed banks to charge variable interest rates using balloon payments. And with the passage of these four Acts the sub-prime mortgage was born.
It seems that it never occurred to the law makers that banks could not afford to give loans to people who could not repay them. This is the result of law makers who have no business experience. Some of the same law makers who passed the above Acts are now saying that the banks are responsible for the crisis.
So what did the banks do with these loans? They sold them to someone else and said you worry about defaults. This led to the securitization of loans. This means that the loans were bundled together and sold as security investments like mutual funds. These bundles were called Collateralized Debt Obligations (CDO’s). These CDO’s can be bundles of any type but when they contain mortgages they are called Mortgage Backed Securities (MBS’s). In the days before the Acts a banker would meet with the borrower and set up a loan that was based on the ability to pay since the loan would stay in the bank and the bank had a long term interest in the safety of the loan. With the advent of CDO’s this all changed.
During the years when many of these variable loans were sold the interest rate on a 30 year mortgage held in the 5 to 7% range which was historically low and thus allowed many people to take on larger mortgages. Then in 2003 Greenspan started raising the fed fund rates and he raised them 17 times going from 1% to 5.25% which caused the variable home loans to increase by over 4%. What does this look do to the loan? Since the prime rate was 5% and the sub-prime was 10% this now increased each by 4% so the sub-prime went to 14%. You do the math and you will quickly understand why so many poor people had to default. Just another example of the unexpected consequences of good intentions. Isn’t government grand!