The whole meltdown in real estate is pretty interesting. In the 1970's mortgage-backed securities came into existence but it wasn't until the era of deregulation that they were widely traded. Wall street began creating more and more exotic securities backed by mortgages. Because of the way the mortgages were packaged, no one could tell just how safe the securities were. Prior to the 1980’s, the two major rating services, Standard and Poor and Moody's generated most of their revenue by offered their rating service on a subscription basis. The services then made a major change. They started collecting fees from the issuers of the securities that they were rating. If a company didn’t like their ratings, they could take their business elsewhere. Since the rating services could not really determine the credit worthiness of the securities any better than Wall Street most ended up with AAA ratings.
To make the whole mortgage backed security industry work, lots of mortgages were needed. Congress helped out by pressuring lending institution to write more mortgages and the Fed kept interest rates low. The banks responded by creating variable rate mortgages and jumbo mortgages. Suddenly everyone could afford a mortgage. The banks seeing the profit potential of writing and selling them in 30 days changed almost over night to a retail operation. They would write and sell them as fast as they could which eliminated almost all risk. Remember, in prior years banks only made money on mortgages if the homeowner made his payments, but under this new way of operating the banks had little or no incentive to say no to anybody.
So thanks to aggressive lending practices, low interest rate, real estate prices went through the roof. In 2006, investors became concerned that mortgage backed securities were overrated. Then as the default rate grew, no one wanted to own these securities. Then it was just a matter of time before the whole house of cards came down. The market for the securities dried up. Suddenly just about ever large banking house in the world was knee deep in mortgage-backed securities or their derivatives which they couldn’t sell.
Defaults did play a part in the whole debacle, but it’s Congress and Wall Street that must bear most of the responsibility. Neither Congress nor Wall Street was willing to be a party pooper by instituting regulations.
