Heads in the Sand
As I explained yesterday greed led to the devastation of lending standards that had been around for decades. Today I want to cover four more reasons that led to this HUGE Mortgage Mess.
First, after awhile no one on Wall Street truly knew what they were buying or providing the money for and the credit rating agencies like S & P, Moody's, Fitch's did not really know what they were insuring. Everyone thought that the mortgage lending standards of the past were not needed anymore and so old fashioned.
Plus, Fannie Mae and Freddie Mac were still backing a majority of these loans and it was assumed (wrongly now) that they knew what they were doing. But, Wall Street and the credit rating agencies thought if Fannie Mae and Freddie Mac are still willing to back these loans with their blessing everything must be ok.
However, greed had set in at Fannie Mae and Freddie Mac too. Plus, Fannie and Freddie were receiving huge amounts of pressure from another party to this mess that I will introduce you to later.
Earlier this decade throughout much of the country home prices soared as millions of more home buyers were now able to buy homes because lending standards had been thrown out every window and door in the building. At this time if could fog a mirror you could buy a home.
What happens when demand for a product soars? Prices soar and with time supply will increase to try to meet that demand. This is the first lesson in economics.
As demand increased and prices soared underwriting standards became even more lax. Why? Who cares if you have to foreclose later when home prices are rising 20% a year, you are protected. So they thought.
Third, the investment banks leveraged themselves to the hilt to make even more money because they thought it was impossible to lose money with this game. We have lots of protection they believed. Whereas commercial banks can only borrow $10 for every $1 in assets an investment bank could borrow $30 for every $1 dollar in assets. Thus, they loaded up on debt to make even more money.
Fourth, this led to Fannie Mae, Freddie Mac, some banks and insurance companies, and investment banks to become too big for us to allow them to fail. For example, AIG is a trillion dollar plus company with "tentacles" in nearly every other financial firm in the world.
Wall Street was the second major player in this debacle for a total of six different reasons that I have covered in my previous blog and this blog. Tomorrow, I will cover the third party to this Mortgage Mess.