What Happened?: Outlining the Evolution of Our Mortgage Industry and How Bad

What Happened?: Outlining the Evolution of Our Mortgage Industry and How Bad

Politics Led to the Financial Meltdown of 2008

Kenneth E. Ortiz

MGT 581

Holy Family University

Abstract

The United States economic system is built on intricacies often affected by even the most insignificant political policies and the simplest of industry trends. The lesson learned from this recent debacle is a reminder of the old adage every action has a reaction.

The hope is that every society learns from its mistakes, in hopes to avoid future unwanted adverse affects and to keep from making repeat miscalculations. This however depends on individuals, within any particular society, fully understanding their collective errors. The tragedy of modern America is that the average American citizen does not truly understand what causes negative economic trends, therefore has no chance of knowing how to stop them. The even greater tragedy is that Americans, when facing a recession, often choose to embrace the very political policies that actually caused the problems.

As the United States entered into a new millennium there were several economic trends and political policies that led to the greatest housing boom in American history. Unfortunately, the economic climate which immediately followed would later devastate the lending industry. This devastation led to the economic meltdown of 2008.

This essay will explain why this meltdown took place by adumbrating the evolution of our modern mortgage industry, by highlighting the political policies that helped to shape the framework for modern mortgage lending, and by exposing the poltroons and the irresponsible politicians involved in passing bad policies. Furthermore, this essay will demonstrate how Americans commonly embrace the very political policies that caused this horrific meltdown, and are likely to embrace similar policies in the future.

What Happened?: Outlining the Evolution of Our Mortgage Industry and How Bad

Politics Led to the Financial Meltdown of 2008

In September 2008, the Dow Jones Industrial Average plummeted, and so did every other major trading market, as banks and financial institutions began to report record losses. At the center of it all was the sub-prime mortgage industry. However, these economic troubles did not begin in September, or with the recent housing boom for that matter. The falling Dow Jones was simply a reaction to those things put into motion long before the markets ever collapsed. More than six years before the 2008 meltdown, Daniel Arnold wrote about a looming financial collapse; a collapse that could destroy American free-market capitalism as we know it (2002). He writes that "the wait for such a collapse had long been in the making" and can be directly attributed to the bad policies passed over the past 70 years (et al. Arnold).

The Nutshell Version

Rational observers might ask themselves: "So what exactly caused this mess?" This essay will start by first giving a simple concise version of events. This essay will then outline, in much detail, each aspect of the recent financial calamity. Here is the bulleted nutshell version:

* In the early 1930's the federal government began offering insurance to lenders, through the FHA, to insure mortgages made by the lenders to government-approved borrowers.

* In the late 1930's the federal government, through Fannie Mae, began directly buying whole mortgages that had been made to government-approved borrowers.

* In the 1970's the federal government began imposing quotas on lenders, forcing the lenders to make mortgage loans to low-income, high-risk borrowers.

* In 1991, 1993, and 1994 the federal government imposed more quotas on the lenders. Millions of borrowers, who ordinarily would not have qualified, received mortgages.

* In 1997 these mandated high-risk mortgages, originally made to low-income borrowers, began to be traded, swapped, and sold in bulk by privately held entities other than Fannie Mae and Freddie Mac. These privately held banks were not mandated by the federal government to buy these riskier loans giving them a significant competitive advantage over Fannie Mae and Freddie Mac.

* In 1999, the federal government passed a deregulation act which:

1) made it far easier for many different types of investors and financial institutions to invest in the mortgage market;

2) allowed insurance companies and alternative financial institutions to invest in emerging markets that they previously could not invest in;

3) allowed commercial banks to offer both savings and investment products;

4) made it far easier for mortgage lenders to relax qualifications for all borrowers.

* After the attacks on 9/11, the downward economy and the weak dollar led to an enormous influx of capital from foreign investors, Asian and European. Many of these foreign investors began investing in the mortgage markets.

* In 2002 and 2003, foreign mortgage investors flooded the mortgage markets with capital. They severely undercut American investors and bought the best mortgage pools. This gave them a significant competitive advantage over Fannie Mae and Freddie Mac.

* In 2003 and 2004, the foreign investors demanded more mortgages be made to quench their investing appetites. This led to banks lowering standards, to make more mortgages, in order to meet the demand. With the newly enacted limited regulation, many banks now were able to do this with little interference from the federal government.

* In 2003, Congressional Republicans try to bring massive changes to Fannie Mae and Freddie Mac but Congressional Democrats blocked the changes.

* From 2003 - 2006 the United States saw the greatest housing boom in history.

* By 2005, the worse of the government-mandated mortgage loans began defaulting at an alarming rate. Fannie Mae owned many of the worse of these loans.

* In 2005 and 2006 China and India began to import oil at rates faster than ever, driving the costs of oil and gas significantly higher than what most Americans could afford.

* In 2005 and 2006 many adjustable rate mortgages began adjusting upwards.

* The combination of rising fuel costs and adjusting