Financial Crisis 2007-2008 Origin

In 1989, to address claims that banks discriminated against the economically weak and poor minorities in mortgage lending, Congress got the Home Mortgage Disclosure Act amended to force banks to collect data on mortgage applicants; this allowed various studies that seemed to validate the original accusation. In fact, poor minority mortgage applications were rejected more frequently than other applications. The overwhelming debate focused on two distinct answers: were the rejections because of racial discrimination, or because the minorities tend to have weaker finances.

In a "landmark" 1992 study from the Boston Fed concluded that mortgage-lending discrimination was systemic. It resulted in the Congressional resolution, "discrimination may be observed when a lender's underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants." Some of these "outdated" criteria included:the size of the mortgage payment relative to income, credit history, and savings history and income verification. For these applicants Fed advocated mortgage loan extension waiving criteria and providing only a credit-counseling program to ensure that they met their mortgage obligations.

Hence in 1994, the administration rewrote Community Reinvestment Act [CRA] with a view to help deserving minority families afford homes. In 1999 the President signed a bill into law overhauling banking laws, relaxing 1930's era regulations, encourging Banks to end red lining and relax lending requirements to poor credit risks. Government Sponsored Entities [GSEs] FNMA and Freddie Mac became the main vehicle for the multicultural housing policy and were authorized to buy such securitized mortgages not meeting historical underwriting norms.

The Sub-prime mortgage crisis is the unintended direct consequence of an intentional loosening of underwriting standards— initiated to achieve the social objective of ending documented discrimination. Unscruplous, Avaricious, Greedy, Irresponsible mortgage intermediaries and Wall Street Wizzards used this loophole as a Vechicle to create the current sub-prime crisis for personal profits at the expense of the system. At the crisis' core, mortgage loans were made with virtually nonexistent underwriting standards—no verification of income or assets with little consideration of the applicant's ability to make payments and mostly with no down payment. Banks and Loan originators could securitize such mortgages and pass the risk of default to the ultimate borrowers with out any consequences. This Moral Hazard situation was exploited.

All investors understand that such loans are unsound and problematic. But how did the heavily-regulated banking industry end up engaging in such a foolish practice? Banks argue that it was NOT them that created this mess. In fact, it was the regulators who relaxed these standards and permitted this. Historically, the "outdated" standards and norms existed to limit defaults. But bank regulators loosened underwriting standards, with pressure from various vested interests.

Hence, banks expanded flexible lending programs even though they had higher default rates than loans with traditional standards. "100 percent financing . . . No credit scores . . . undocumented income . . . even if you don't report it on your tax returns" became possible. Credit counseling was the only required action given to prospective applicants to prevent defaults. Fannie Mae congratulated Countrywide Financial Corporation [CFC], as it worked with community activists and followed "the most flexible underwriting criteria permitted." CFC's $1 billion commitment to low-income loans in 1992 had grown to $80 billion by 1999 and $600 billion by early 2003. In a news story extolling the virtues of relaxed underwriting standards, Countrywide's CEO stated, to approve minority applications that would otherwise be rejected "lenders have had to stretch the rules a bit."

For years, between 2000 and 2006, rising house prices [25% per year] hid the default problems since quick refinances and restructuring of loans were possible for individuals unable to make payments. But when that house prices stopped increasing and reversed course in 2006, it created and precipated the major crisis. Many homeowners, sub-prime and otherwise were "upside down" or ‘Negatively amortized" or "under water" owing more that the house was worth. Many had purchased homes using adjustable or variable rate mortgages and when these rates were re-set, their monthly commitments increased five-fold and were unable to restructure or re-finance. The subprime loans increased from $35 billion in 1994 to $1.2 trillion in 2008 threatening the banking system's survival. Many homeowners were prepared