Saturday, October 11, 2008

Simple Overview of the Crisis

This is a post from Barry Ritholtz's blog, The Big Picture. It was short and high quality, so instead of linking to it, I just copied it in to this site.

From a speech back in 2004 comes this telling quote:

"One other thing I've done, is I've called on private sector mortgage banks and banks to be more aggressive about lending money to first-time home buyers. And the response has been really good. There's a lot of people in this -- our communities around the country that deeply care about the issue of homeownership, and they've been responsive."

- George W. Bush, U.S. President, March 26, 2004.


Its important to understand how this situation occurred in the first place, if we want to be able to fix it. Blaming the CRA and Fannie/Freddie is a total misunderstanding of how the problem occurred, and what we need to do to fix it now, and avoid doing it again in the future.

To repeat my prior arguments, the proximate cause of the Housing crisis were 1) Ultra-low rates; and 2) Abdication of traditional lending standards, thanks to 3) originators ability to resell mortgages for securitization purposes, and hence, 4) not have to worry about loan defaults.

The credit crisis was caused by 1) the above securitized mortgage paper, that was 2) rated triple AAA by Moody's and Standard & Poors, which then 3) Which was then "insured" by credit default swaps (CDS) -- the unreserved for, shadow insurance products 4) whose exemption was made possible by the Commodities Futures Modernization Act. That legislation exempted these derivatives from any supervision or regulation. The lack of reserve requirements is why there is now $62 trillion in CDS, many of which will never pay their counter parties the promised insurance.

If you are going to blame Fannie/Freddie/CRA, or George Bush or Barney Frank, you are missing the big picture.

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