Change the channel and join the rest of the world. The audience of Fox, Rush, Rev. Moon etc, (the Pub Propaganda Network) are hopelessly misled. Read this- it's NOT communist...Wiki. You can't fake all the findings of neutral observers and financial institutions referred to, dittoheads.
Late-2000s financial crisis
From Wikipedia, the free encyclopedia
Jump to: navigation, search
The TED spread (in red) increased significantly during the financial crisis, reflecting an increase in perceived credit risk.
World map showing real GDP growth rates for 2009. (Countries in brown are in recession.)Part of a series on:
Late-2000s financial crisis
Major dimensions[show]
2000s energy crisis
Late-2000s recession
Automotive industry crisis of 20082010
DoddFrank Wall Street Reform and Consumer Protection Act
European sovereign debt crisis
Financial Crisis Inquiry Commission
Subprime crisis impact timeline
Subprime mortgage crisis
United States housing bubble
United States housing market correction
Countries[show]
Belgium
Greece
Iceland
Ireland
Latvia
Russia
Spain
Ukraine
Summits[show]
34th G8 summit (July 2008)
2008 G-20 Washington summit (November 2008)
APEC Peru 2008 (November 2008)
2009 G-20 London Summit (April 2009)
Legislation[show]
Banking (Special Provisions) Act 2008
Economic Stimulus Act of 2008
Emergency Economic Stabilization Act of 2008
Housing and Economic Recovery Act of 2008
Term Asset-Backed Securities Loan Facility
Troubled Asset Relief Program (TARP)
2008 European Union stimulus plan
2008 United Kingdom bank rescue package
Chinese economic stimulus program
ChinaJapanSouth Korea trilateral summit
Anglo Irish Bank Corporation Act 2009
American Recovery and Reinvestment Act of 2009
Green New Deal
Company bailouts[show]
American International Group (AIG) (US$150B)
Chrysler (US$4B)
Company failures[show]
(listed alphabetically)
ABC Learning
Allco Finance Group
American Freedom Mortgage
American Home Mortgage
Babcock & Brown
BearingPoint
Bernard L. Madoff Investment Securities LLC
Charter Communications
Chrysler
Chrysler Chapter 11 reorganization
Circuit City Stores
General Motors
General Motors Chapter 11 reorganization
Icesave
Kaupthing Singer & Friedlander
Lehman Brothers
Bankruptcy of Lehman Brothers
Linens 'n Things
Mervyns
NetBank
New Century
Saab Automobile
Sentinel Management Group
Terra Securities
Terra Securities scandal
Tweeter
Washington Mutual
Waterford Wedgwood
Yamato Life
Causes[show]
Causes of the late-2000s financial crisis
Causes of the late-2000s recession
Causes of the United States housing bubble
Credit rating agencies and the subprime crisis
Government policies and the subprime mortgage crisis
Solutions[show]
20082009 Keynesian resurgence
Emergency Economic Stabilization Act of 2008
Economic Stimulus Act of 2008
American Recovery and Reinvestment Act of 2009
Federal Reserve responses to the subprime crisis
Government intervention during the subprime mortgage crisis
National fiscal policy response to the late 2000s recession
Regulatory responses to the subprime crisis
Subprime mortgage crisis solutions debate
Arab spring
Indignados
Occupy movement
v · d · e
The late-2000s financial crisis (often called the Global Recession, Global Financial Crisis or the Credit Crunch) is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s.[1] It resulted in the collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. In many areas, the housing market had also suffered, resulting in numerous evictions, foreclosures and prolonged vacancies. It contributed to the failure of key businesses, declines in consumer wealth estimated in the trillions of U.S. dollars, and a significant decline in economic activity, leading to a severe global economic recession in 2008.[2]
The financial crisis was triggered by a complex interplay of valuation and liquidity problems in the United States banking system in 2008.[3] The collapse of the U.S. housing bubble, which peaked in 2007, caused the values of securities tied to U.S. real estate pricing to plummet, damaging financial institutions globally.[4] Questions regarding bank solvency, declines in credit availability and damaged investor confidence had an impact on global stock markets, where securities suffered large losses during 2008 and early 2009. Economies worldwide slowed during this period, as credit tightened and international trade declined.[5] Governments and central banks responded with unprecedented fiscal stimulus, monetary policy expansion and institutional bailouts. Although there have been aftershocks, the financial crisis itself ended sometime between late-2008 and mid-2009.[6][7][8]
While many causes for the financial crisis have been suggested, with varying weight assigned by experts,[9] the United States Senate issuing the LevinCoburn Report found "that the crisis was not a natural disaster, but the result of high risk, complex financial products; undisclosed conflicts of interest; and the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street."[10]
Critics argued that credit rating agencies and investors failed to accurately price the risk involved with mortgage-related financial products, and that governments did not adjust their regulatory practices to address 21st-century financial markets.[11] The 1999 repeal of the GlassSteagall Act of 1933 effectively removed the separation that previously existed between Wall Street investment banks and depository banks.[12] In response to the financial crisis, both market-based and regulatory solutions have been implemented or are under consideration.[13]
Contents
1 Background
1.1 Subprime lending
1.2 Growth of the housing bubble
1.3 Easy credit conditions
1.4 Weak and fraudulent underwriting practice
1.5 Predatory lending
1.6 Deregulation
1.7 Increased debt burden or over-leveraging
1.8 Financial innovation and complexity
1.9 Incorrect pricing of risk
1.10 Boom and collapse of the shadow banking system
1.11 Commodities boom
1.12 Systemic crisis
1.13 Role of economic forecasting
2 Impact on financial markets
2.1 US stock market
2.2 Financial institutions
2.3 Credit markets and the shadow banking system
2.4 Wealth effects
2.5 European contagion
3 Effects on the global economy
3.1 Global effects
3.2 U.S. economic effects
3.2.1 Real gross domestic product
3.2.2 Distribution of wealth
3.3 Official economic projections
4 Government responses
4.1 Emergency and short-term responses
4.2 Regulatory proposals and long-term responses
4.3 United States Congress response
5 Stabilization
6 Media coverage
7 Emerging and developing economies drive global economic growth
8 See also
9 References
10 External links and further reading
[edit] Background
Main article: Causes of the late-2000s financial crisis
The immediate cause or trigger of the crisis was the bursting of the United States housing bubble which peaked in approximately 20052006.[14][15] Already-rising default rates on "subprime" and adjustable rate mortgages (ARM) began to increase quickly thereafter. As banks began to give out more loans to potential home owners, housing prices began to rise.
In the optimistic terms, banks would encourage home owners to take on considerably high loans in the belief they would be able to pay them back more quickly, overlooking the interest rates. Once the interest rates began to rise in mid 2007, housing prices dropped significantly. In many states like California, refinancing became increasingly difficult. As a result, the number of foreclosed homes also began to rise.
Share in GDP of U.S. financial sector since 1860[16]Steadily decreasing interest rates backed by the U.S Federal Reserve from 1982 onward and large inflows of foreign funds created easy credit conditions for a number of years prior to the crisis, fueling a housing construction boom and encouraging debt-financed consumption.[17] The combination of easy credit and money inflow contributed to the United States housing bubble. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load.[18][19]
As part of the housing and credit booms, the number of financial agreements called mortgage-backed securities (MBS) and collateralized debt obligations (CDO), which derived their value from mortgage payments and housing prices, greatly increased. Such financial innovation enabled institutions and investors around the world to invest in the U.S. housing market. As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime MBS reported significant losses.[20]
Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter foreclosure. The ongoing foreclosure epidemic that began in late 2006 in the U.S. continues to drain wealth from consumers and erodes the financial strength of banking institutions. Defaults and losses on other loan types also increased significantly as the crisis expanded from the housing market to other parts of the economy. Total losses are estimated in the trillions of U.S. dollars globally.[21]
While the housing and credit bubbles built, a series of factors caused the financial system to both expand and become increasingly fragile, a process called financialization. U.S. Government policy from the 1970s onward has emphasized deregulation to encourage business, which resulted in less oversight of activities and less disclosure of information about new activities undertaken by banks and other evolving financial institutions. Thus, policymakers did not immediately recognize the increasingly important role played by financial institutions such as investment banks and hedge funds, also known as the shadow banking system. Some experts believe these institutions had become as important as commercial (depository) banks in providing credit to the U.S. economy, but they were not subject to the same regulations.[22]
These institutions, as well as certain regulated banks, had also assumed significant debt burdens while providing the loans described above and did not have a financial cushion sufficient to absorb large loan defaults or MBS losses.[23] These losses impacted the ability of financial institutions to lend, slowing economic activity. Concerns regarding the stability of key financial institutions drove central banks to provide funds to encourage lending and restore faith in the commercial paper markets, which are integral to funding business operations. Governments also bailed out key financial institutions and implemented economic stimulus programs, assuming significant additional financial commitments.
The U.S. Financial Crisis Inquiry Commission reported its findings in January 2011. It concluded that "the crisis was avoidable and was caused by: Widespread failures in financial regulation, including the Federal Reserves failure to stem the tide of toxic mortgages; Dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk; An explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis; Key policy makers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; and systemic breaches in accountability and ethics at all levels."[24][25]
[edit] Subprime lending
Intense competition between mortgage lenders for revenue and market share, and the limited supply of creditworthy borrowers, caused mortgage lenders to relax underwriting standards and originate riskier mortgages to less creditworthy borrowers.[26] Prior to 2003, when the mortgage securitization market was dominated by regulated and relatively conservative Government Sponsored Enterprises, GSEs policed mortgage originators and maintained relatively high underwriting standards. However, as market power shifted from securitizers to originators and as intense competition from private securitizers undermined GSE power, mortgage standards declined and risky loans proliferated.[26] The worst loans were originated in 2004-2007, the years of the most intense competition between securitizers and the lowest market share for the GSEs.
U.S. subprime lending expanded dramatically 2004-2006The term subprime refers to the credit quality of particular borrowers, who have weakened credit histories and a greater risk of loan default than prime borrowers.[27] The value of U.S. subprime mortgages was estimated at $1.3 trillion as of March 2007,[28] with over 7.5 million first-lien subprime mortgages outstanding.[29]
As well as easy credit conditions, there is evidence that competitive pressures contributed to an increase in the amount of subprime lending during the years preceding the crisis. Major U.S. investment banks and government sponsored enterprises like Fannie Mae played an important role in the expansion of lending, with GSEs eventually relaxing their standards to try to catch up with the private banks.[30][31]
Subprime mortgages remained below 10% of all mortgage originations until 2004, when they spiked to nearly 20% and remained there through the 2005-2006 peak of the United States housing bubble.[32]
Some long-time critics of government and the GSEs, like American Enterprise Institute fellow Peter J. Wallison,[33] claim that the roots of the crisis can be traced directly to risky lending by Fannie Mae and Freddie Mac, which are government sponsored entities. Although Wallison's claims have received widespread attention in the media and by policy makers, the majority report of the Financial Crisis Inquiry Commission, several studies by Federal Reserve Economists, and the work of independent scholars who have carefully and scrupulously analyzed the data suggest that Wallison's claims are not supported by the data.[26] In fact, the GSEs loans performed far better than loans securitized by private investment banks, and even than loans originated by institutions that held loans in their portfolios.[26] On the whole, the GSEs appear to have had a conservative influence on mortgage underwriting.
Wallison has been widely criticized for attempting to politicize the investigation of the Financial Crisis Inquiry Commission, and his critics include fellow Republican Commissioners.[34]
On September 30, 1999, The New York Times reported that the Clinton Administration pushed for more lending to low and moderate income borrowers, while the mortgage industry sought guarantees for sub-prime loans:
Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits. In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers... In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s.[35]
In the early and mid-2000s, the Bush administration called numerous times[36] for investigation into the safety and soundness of the GSEs and their swelling portfolio of subprime mortgages. On September 10, 2003 the House Financial Services Committee held a hearing at the urging of the administration to assess safety and soundness issues and to review a recent report by the Office of Federal Housing Enterprise Oversight (OFHEO) that had uncovered accounting discrepancies within the two entities.[37] The hearings never resulted in new legislation or formal investigation of Fannie Mae and Freddie Mac, as many of the committee members refused to accept the report and instead rebuked OFHEO for their attempt at regulation.[38] Some believe this was an early warning to the systemic risk that the growing market in subprime mortgages posed to the U.S. financial system that went unheeded.[39]
A 2000 United States Department of the Treasury study of lending trends for 305 cities from 1993 to 1998 showed that $467 billion of mortgage lending was made by Community Reinvestment Act (CRA)-covered lenders into low and mid level income (LMI) borrowers and neighborhoods, representing 10% of all US mortgage lending during the period. The majority of these were prime loans. Sub-prime loans made by CRA-covered institutions constituted a 3% market share of LMI loans in 1998.[40] Nevertheless, only 25% of all sub-prime lending occurred at CRA-covered institutions, and a full 50% of sub-prime loans originated at institutions exempt from CRA.[41]
An analysis by the Federal Reserve Bank of Dallas in 2009 concluded unequivocally that the CRA was not responsible for the mortgage loan crisis, pointing out that CRA rules have been in place since 1995 whereas the poor lending emerged only a decade later.[42] Furthermore, most sub-prime loans were not made to the LMI borrowers targeted by the CRA, especially in the years 2005-2006 leading up to the crisis. Nor did it find any evidence that lending under the CRA rules increased delinquency rates or that the CRA indirectly influenced independent mortgage lenders to ramp up sub-prime lending.
Others have pointed out that there were not enough of these loans made to cause a crisis of this magnitude. In an article in Portfolio Magazine, Michael Lewis spoke with one trader who noted that "There werent enough Americans with [bad] credit taking out [bad loans] to satisfy investors appetite for the end product." Essentially, investment banks and hedge funds used financial innovation to enable large wagers to be made, far beyond the actual value of the underlying mortgage loans, using derivatives called credit default swaps, CDO and synthetic CDO. As long as derivative buyers could be matched with sellers, the theoretical amount that could be wagered was infinite. "They were creating [synthetic loans] out of whole cloth. One hundred times over! Thats why the losses are so much greater than the loans."[43]
Economist Paul Krugman argued in January 2010 that the simultaneous growth of the residential and commercial real estate pricing bubbles undermines the case made by those who argue that Fannie Mae, Freddie Mac, CRA or predatory lending were primary causes of the crisis. In other words, bubbles in both markets developed even though only the residential market was affected by these potential causes.[44]
As of March 2011 the FDIC has had to pay out $9 billion to cover losses on bad loans at 165 failed financial institutions.[45]
[edit] Growth of the housing bubble
Main article: United States housing bubble
A graph showing the median and average sales prices of new homes sold in the United States between 1963 and 2008 (not adjusted for inflation)[46]Between 1997 and 2006, the price of the typical American house increased by 124%.[47] During the two decades ending in 2001, the national median home price ranged from 2.9 to 3.1 times median household income. This ratio rose to 4.0 in 2004, and 4.6 in 2006.[48] This housing bubble resulted in quite a few homeowners refinancing their homes at lower interest rates, or financing consumer spending by taking out second mortgages secured by the price appreciation.
In a Peabody Award winning program, NPR correspondents argued that a "Giant Pool of Money" (represented by $70 trillion in worldwide fixed income investments) sought higher yields than those offered by U.S. Treasury bonds early in the decade. This pool of money had roughly doubled in size from 2000 to 2007, yet the supply of relatively safe, income generating investments had not grown as fast. Investment banks on Wall Street answered this demand with the MBS and CDO, which were assigned safe ratings by the credit rating agencies.[49]
In effect, Wall Street connected this pool of money to the mortgage market in the U.S., with enormous fees accruing to those throughout the mortgage supply chain, from the mortgage broker selling the loans, to small banks that funded the brokers, to the giant investment banks behind them. By approximately 2003, the supply of mortgages originated at traditional lending standards had been exhausted. However, continued strong demand for MBS and CDO began to drive down lending standards, as long as mortgages could still be sold along the supply chain. Eventually, this speculative bubble proved unsustainable.[50]etc etc etc
Late-2000s financial crisis
From Wikipedia, the free encyclopedia
Jump to: navigation, search
The TED spread (in red) increased significantly during the financial crisis, reflecting an increase in perceived credit risk.
World map showing real GDP growth rates for 2009. (Countries in brown are in recession.)Part of a series on:
Late-2000s financial crisis
Major dimensions[show]
2000s energy crisis
Late-2000s recession
Automotive industry crisis of 20082010
DoddFrank Wall Street Reform and Consumer Protection Act
European sovereign debt crisis
Financial Crisis Inquiry Commission
Subprime crisis impact timeline
Subprime mortgage crisis
United States housing bubble
United States housing market correction
Countries[show]
Belgium
Greece
Iceland
Ireland
Latvia
Russia
Spain
Ukraine
Summits[show]
34th G8 summit (July 2008)
2008 G-20 Washington summit (November 2008)
APEC Peru 2008 (November 2008)
2009 G-20 London Summit (April 2009)
Legislation[show]
Banking (Special Provisions) Act 2008
Economic Stimulus Act of 2008
Emergency Economic Stabilization Act of 2008
Housing and Economic Recovery Act of 2008
Term Asset-Backed Securities Loan Facility
Troubled Asset Relief Program (TARP)
2008 European Union stimulus plan
2008 United Kingdom bank rescue package
Chinese economic stimulus program
ChinaJapanSouth Korea trilateral summit
Anglo Irish Bank Corporation Act 2009
American Recovery and Reinvestment Act of 2009
Green New Deal
Company bailouts[show]
American International Group (AIG) (US$150B)
Chrysler (US$4B)
Company failures[show]
(listed alphabetically)
ABC Learning
Allco Finance Group
American Freedom Mortgage
American Home Mortgage
Babcock & Brown
BearingPoint
Bernard L. Madoff Investment Securities LLC
Charter Communications
Chrysler
Chrysler Chapter 11 reorganization
Circuit City Stores
General Motors
General Motors Chapter 11 reorganization
Icesave
Kaupthing Singer & Friedlander
Lehman Brothers
Bankruptcy of Lehman Brothers
Linens 'n Things
Mervyns
NetBank
New Century
Saab Automobile
Sentinel Management Group
Terra Securities
Terra Securities scandal
Tweeter
Washington Mutual
Waterford Wedgwood
Yamato Life
Causes[show]
Causes of the late-2000s financial crisis
Causes of the late-2000s recession
Causes of the United States housing bubble
Credit rating agencies and the subprime crisis
Government policies and the subprime mortgage crisis
Solutions[show]
20082009 Keynesian resurgence
Emergency Economic Stabilization Act of 2008
Economic Stimulus Act of 2008
American Recovery and Reinvestment Act of 2009
Federal Reserve responses to the subprime crisis
Government intervention during the subprime mortgage crisis
National fiscal policy response to the late 2000s recession
Regulatory responses to the subprime crisis
Subprime mortgage crisis solutions debate
Arab spring
Indignados
Occupy movement
v · d · e
The late-2000s financial crisis (often called the Global Recession, Global Financial Crisis or the Credit Crunch) is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s.[1] It resulted in the collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. In many areas, the housing market had also suffered, resulting in numerous evictions, foreclosures and prolonged vacancies. It contributed to the failure of key businesses, declines in consumer wealth estimated in the trillions of U.S. dollars, and a significant decline in economic activity, leading to a severe global economic recession in 2008.[2]
The financial crisis was triggered by a complex interplay of valuation and liquidity problems in the United States banking system in 2008.[3] The collapse of the U.S. housing bubble, which peaked in 2007, caused the values of securities tied to U.S. real estate pricing to plummet, damaging financial institutions globally.[4] Questions regarding bank solvency, declines in credit availability and damaged investor confidence had an impact on global stock markets, where securities suffered large losses during 2008 and early 2009. Economies worldwide slowed during this period, as credit tightened and international trade declined.[5] Governments and central banks responded with unprecedented fiscal stimulus, monetary policy expansion and institutional bailouts. Although there have been aftershocks, the financial crisis itself ended sometime between late-2008 and mid-2009.[6][7][8]
While many causes for the financial crisis have been suggested, with varying weight assigned by experts,[9] the United States Senate issuing the LevinCoburn Report found "that the crisis was not a natural disaster, but the result of high risk, complex financial products; undisclosed conflicts of interest; and the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street."[10]
Critics argued that credit rating agencies and investors failed to accurately price the risk involved with mortgage-related financial products, and that governments did not adjust their regulatory practices to address 21st-century financial markets.[11] The 1999 repeal of the GlassSteagall Act of 1933 effectively removed the separation that previously existed between Wall Street investment banks and depository banks.[12] In response to the financial crisis, both market-based and regulatory solutions have been implemented or are under consideration.[13]
Contents
1 Background
1.1 Subprime lending
1.2 Growth of the housing bubble
1.3 Easy credit conditions
1.4 Weak and fraudulent underwriting practice
1.5 Predatory lending
1.6 Deregulation
1.7 Increased debt burden or over-leveraging
1.8 Financial innovation and complexity
1.9 Incorrect pricing of risk
1.10 Boom and collapse of the shadow banking system
1.11 Commodities boom
1.12 Systemic crisis
1.13 Role of economic forecasting
2 Impact on financial markets
2.1 US stock market
2.2 Financial institutions
2.3 Credit markets and the shadow banking system
2.4 Wealth effects
2.5 European contagion
3 Effects on the global economy
3.1 Global effects
3.2 U.S. economic effects
3.2.1 Real gross domestic product
3.2.2 Distribution of wealth
3.3 Official economic projections
4 Government responses
4.1 Emergency and short-term responses
4.2 Regulatory proposals and long-term responses
4.3 United States Congress response
5 Stabilization
6 Media coverage
7 Emerging and developing economies drive global economic growth
8 See also
9 References
10 External links and further reading
[edit] Background
Main article: Causes of the late-2000s financial crisis
The immediate cause or trigger of the crisis was the bursting of the United States housing bubble which peaked in approximately 20052006.[14][15] Already-rising default rates on "subprime" and adjustable rate mortgages (ARM) began to increase quickly thereafter. As banks began to give out more loans to potential home owners, housing prices began to rise.
In the optimistic terms, banks would encourage home owners to take on considerably high loans in the belief they would be able to pay them back more quickly, overlooking the interest rates. Once the interest rates began to rise in mid 2007, housing prices dropped significantly. In many states like California, refinancing became increasingly difficult. As a result, the number of foreclosed homes also began to rise.
Share in GDP of U.S. financial sector since 1860[16]Steadily decreasing interest rates backed by the U.S Federal Reserve from 1982 onward and large inflows of foreign funds created easy credit conditions for a number of years prior to the crisis, fueling a housing construction boom and encouraging debt-financed consumption.[17] The combination of easy credit and money inflow contributed to the United States housing bubble. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load.[18][19]
As part of the housing and credit booms, the number of financial agreements called mortgage-backed securities (MBS) and collateralized debt obligations (CDO), which derived their value from mortgage payments and housing prices, greatly increased. Such financial innovation enabled institutions and investors around the world to invest in the U.S. housing market. As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime MBS reported significant losses.[20]
Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter foreclosure. The ongoing foreclosure epidemic that began in late 2006 in the U.S. continues to drain wealth from consumers and erodes the financial strength of banking institutions. Defaults and losses on other loan types also increased significantly as the crisis expanded from the housing market to other parts of the economy. Total losses are estimated in the trillions of U.S. dollars globally.[21]
While the housing and credit bubbles built, a series of factors caused the financial system to both expand and become increasingly fragile, a process called financialization. U.S. Government policy from the 1970s onward has emphasized deregulation to encourage business, which resulted in less oversight of activities and less disclosure of information about new activities undertaken by banks and other evolving financial institutions. Thus, policymakers did not immediately recognize the increasingly important role played by financial institutions such as investment banks and hedge funds, also known as the shadow banking system. Some experts believe these institutions had become as important as commercial (depository) banks in providing credit to the U.S. economy, but they were not subject to the same regulations.[22]
These institutions, as well as certain regulated banks, had also assumed significant debt burdens while providing the loans described above and did not have a financial cushion sufficient to absorb large loan defaults or MBS losses.[23] These losses impacted the ability of financial institutions to lend, slowing economic activity. Concerns regarding the stability of key financial institutions drove central banks to provide funds to encourage lending and restore faith in the commercial paper markets, which are integral to funding business operations. Governments also bailed out key financial institutions and implemented economic stimulus programs, assuming significant additional financial commitments.
The U.S. Financial Crisis Inquiry Commission reported its findings in January 2011. It concluded that "the crisis was avoidable and was caused by: Widespread failures in financial regulation, including the Federal Reserves failure to stem the tide of toxic mortgages; Dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk; An explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis; Key policy makers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; and systemic breaches in accountability and ethics at all levels."[24][25]
[edit] Subprime lending
Intense competition between mortgage lenders for revenue and market share, and the limited supply of creditworthy borrowers, caused mortgage lenders to relax underwriting standards and originate riskier mortgages to less creditworthy borrowers.[26] Prior to 2003, when the mortgage securitization market was dominated by regulated and relatively conservative Government Sponsored Enterprises, GSEs policed mortgage originators and maintained relatively high underwriting standards. However, as market power shifted from securitizers to originators and as intense competition from private securitizers undermined GSE power, mortgage standards declined and risky loans proliferated.[26] The worst loans were originated in 2004-2007, the years of the most intense competition between securitizers and the lowest market share for the GSEs.
U.S. subprime lending expanded dramatically 2004-2006The term subprime refers to the credit quality of particular borrowers, who have weakened credit histories and a greater risk of loan default than prime borrowers.[27] The value of U.S. subprime mortgages was estimated at $1.3 trillion as of March 2007,[28] with over 7.5 million first-lien subprime mortgages outstanding.[29]
As well as easy credit conditions, there is evidence that competitive pressures contributed to an increase in the amount of subprime lending during the years preceding the crisis. Major U.S. investment banks and government sponsored enterprises like Fannie Mae played an important role in the expansion of lending, with GSEs eventually relaxing their standards to try to catch up with the private banks.[30][31]
Subprime mortgages remained below 10% of all mortgage originations until 2004, when they spiked to nearly 20% and remained there through the 2005-2006 peak of the United States housing bubble.[32]
Some long-time critics of government and the GSEs, like American Enterprise Institute fellow Peter J. Wallison,[33] claim that the roots of the crisis can be traced directly to risky lending by Fannie Mae and Freddie Mac, which are government sponsored entities. Although Wallison's claims have received widespread attention in the media and by policy makers, the majority report of the Financial Crisis Inquiry Commission, several studies by Federal Reserve Economists, and the work of independent scholars who have carefully and scrupulously analyzed the data suggest that Wallison's claims are not supported by the data.[26] In fact, the GSEs loans performed far better than loans securitized by private investment banks, and even than loans originated by institutions that held loans in their portfolios.[26] On the whole, the GSEs appear to have had a conservative influence on mortgage underwriting.
Wallison has been widely criticized for attempting to politicize the investigation of the Financial Crisis Inquiry Commission, and his critics include fellow Republican Commissioners.[34]
On September 30, 1999, The New York Times reported that the Clinton Administration pushed for more lending to low and moderate income borrowers, while the mortgage industry sought guarantees for sub-prime loans:
Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits. In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers... In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s.[35]
In the early and mid-2000s, the Bush administration called numerous times[36] for investigation into the safety and soundness of the GSEs and their swelling portfolio of subprime mortgages. On September 10, 2003 the House Financial Services Committee held a hearing at the urging of the administration to assess safety and soundness issues and to review a recent report by the Office of Federal Housing Enterprise Oversight (OFHEO) that had uncovered accounting discrepancies within the two entities.[37] The hearings never resulted in new legislation or formal investigation of Fannie Mae and Freddie Mac, as many of the committee members refused to accept the report and instead rebuked OFHEO for their attempt at regulation.[38] Some believe this was an early warning to the systemic risk that the growing market in subprime mortgages posed to the U.S. financial system that went unheeded.[39]
A 2000 United States Department of the Treasury study of lending trends for 305 cities from 1993 to 1998 showed that $467 billion of mortgage lending was made by Community Reinvestment Act (CRA)-covered lenders into low and mid level income (LMI) borrowers and neighborhoods, representing 10% of all US mortgage lending during the period. The majority of these were prime loans. Sub-prime loans made by CRA-covered institutions constituted a 3% market share of LMI loans in 1998.[40] Nevertheless, only 25% of all sub-prime lending occurred at CRA-covered institutions, and a full 50% of sub-prime loans originated at institutions exempt from CRA.[41]
An analysis by the Federal Reserve Bank of Dallas in 2009 concluded unequivocally that the CRA was not responsible for the mortgage loan crisis, pointing out that CRA rules have been in place since 1995 whereas the poor lending emerged only a decade later.[42] Furthermore, most sub-prime loans were not made to the LMI borrowers targeted by the CRA, especially in the years 2005-2006 leading up to the crisis. Nor did it find any evidence that lending under the CRA rules increased delinquency rates or that the CRA indirectly influenced independent mortgage lenders to ramp up sub-prime lending.
Others have pointed out that there were not enough of these loans made to cause a crisis of this magnitude. In an article in Portfolio Magazine, Michael Lewis spoke with one trader who noted that "There werent enough Americans with [bad] credit taking out [bad loans] to satisfy investors appetite for the end product." Essentially, investment banks and hedge funds used financial innovation to enable large wagers to be made, far beyond the actual value of the underlying mortgage loans, using derivatives called credit default swaps, CDO and synthetic CDO. As long as derivative buyers could be matched with sellers, the theoretical amount that could be wagered was infinite. "They were creating [synthetic loans] out of whole cloth. One hundred times over! Thats why the losses are so much greater than the loans."[43]
Economist Paul Krugman argued in January 2010 that the simultaneous growth of the residential and commercial real estate pricing bubbles undermines the case made by those who argue that Fannie Mae, Freddie Mac, CRA or predatory lending were primary causes of the crisis. In other words, bubbles in both markets developed even though only the residential market was affected by these potential causes.[44]
As of March 2011 the FDIC has had to pay out $9 billion to cover losses on bad loans at 165 failed financial institutions.[45]
[edit] Growth of the housing bubble
Main article: United States housing bubble
A graph showing the median and average sales prices of new homes sold in the United States between 1963 and 2008 (not adjusted for inflation)[46]Between 1997 and 2006, the price of the typical American house increased by 124%.[47] During the two decades ending in 2001, the national median home price ranged from 2.9 to 3.1 times median household income. This ratio rose to 4.0 in 2004, and 4.6 in 2006.[48] This housing bubble resulted in quite a few homeowners refinancing their homes at lower interest rates, or financing consumer spending by taking out second mortgages secured by the price appreciation.
In a Peabody Award winning program, NPR correspondents argued that a "Giant Pool of Money" (represented by $70 trillion in worldwide fixed income investments) sought higher yields than those offered by U.S. Treasury bonds early in the decade. This pool of money had roughly doubled in size from 2000 to 2007, yet the supply of relatively safe, income generating investments had not grown as fast. Investment banks on Wall Street answered this demand with the MBS and CDO, which were assigned safe ratings by the credit rating agencies.[49]
In effect, Wall Street connected this pool of money to the mortgage market in the U.S., with enormous fees accruing to those throughout the mortgage supply chain, from the mortgage broker selling the loans, to small banks that funded the brokers, to the giant investment banks behind them. By approximately 2003, the supply of mortgages originated at traditional lending standards had been exhausted. However, continued strong demand for MBS and CDO began to drive down lending standards, as long as mortgages could still be sold along the supply chain. Eventually, this speculative bubble proved unsustainable.[50]etc etc etc
