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I've been out of the loop for a few days, at Mayo Clinic, yada, yada...but now I'm up to speed, let me share with you the substance of a call I received just as I left:

An old friend is the senior partner of a business-type law firm and is on the board of several local banks. According to, let's call him Wes, the beginning of the sub-prime fiasco was in the late 1970s (1977-Jimmy Carter--Community Reinvestment Act) when banks were no longer free to protect their depositors and shareholders as they deemed fit, but became a tool of government to "Level the economic playing-field" downward. This was not the "poison pill" that it is now accused of being; just the first degradation of prudent lending practices, pretty much painted over with mortgage insurance.

FDIC protected the banks' depositors to a point, and the less-desirable loans had MGIC insurance to bring them up to speed vis-a-vis Fannie Mae and the secondary market. Remember the constant reminders on the financial news programs telling sub-standard borrowers to keep checking their pay-down on their mortgage so they can ask to cancel their monthly mortgage insurance premium?

According to Wes, Fannie Mae and Freddie Mac required 20% down and the mortgage loans had to fit a certain financial and physical template (appraisal, earnings, total debt, proper zoning, available city sewer and water and other utilities). The mortgage insurance painted over some shortfalls of down-stroke, and if the secondary market rejected the loan, the bank often kept it for their own portfolio...and here is where my banker friend hits the crux...

Wes says that whenever his bank kept a loan that was declined by Fannie May or Freddie Mac, invariably a large percentage of these sub-standards became problem loans. This doesn't mean "worthless" or written off or foreclosed, but simply loans a banker wished that he had never made. IN OTHER WORDS, Fannie Mae's and Freddie Mac's criteria was valid, but during 1990s, under Bill Clinton, this changed for the worse.

Bill Clinton pressured F-Mae and F-Mac to handle increasingly riskier mortgage loans. In 1996 the Dept. of Housing and Urban Development ORDERED F-Mae & F-Mac to ensure that 42% of loans they handled went to below-median-income borrowers and another 12% had to be "special affordable" mortgages for people with less than 60% of median income. Our government required that the government-sponsored lenders (F-Mae & F-Mac) bundle loan packages that, by definition, were 54% below average! And these federally-guaranteed loan packages were sold to private investors, insurance companies, and pension funds. Now that they have gone stinko, guess who's holding the bag?

In 1995 a reform bill authored by a Nebraska republican was kept off the floor of the senate by democrats, and died. Meanwhile, the Clinton administration pressed the banks to make ever-increasingly sub-prime loans...no wonder that the mortgage brokers "...didn't give a rip about the quality of the loans..." It was government policy to loan to 54% of the population that was below the median qualification, and some (12%) were 40% below average qualifications. This defines "SUB-PRIME," and it was government policy.

Then the floodgates were opened by Bill Clinton in the last days of his administration in 2000, when he failed to veto the repeal of the Anti-Bucket Shop Law of 1907. And why should he have bothered? The repeal bill passed the house by a veto-proof majority, and was unanimous in the senate! As Pogo often said: "We have found the enemy and he is us." The "bucket shops" re-opened as Credit Default Swap security sellers who bet the sub-prime mortgages were going to default.

None of this has anything to do with originating loans for fees or servicing loans for fees; the issue is the quality of the loans, not how they originated, or where payments are made or who keeps the books. The problem is that our government took a viable mortgage industry that since 1938, with the inception of the government sponsored F-Mae, which purchased loans made to worthy individuals, and reversed the qualifications, favoring below average "sub-prime" borrowers. I don't understand your fixation with brokers earning fees or servicing organizations being compensated for handling monthly payments.

The problem was that F-Mae and F-Mac could not decline bad loans. These loans were packaged with good ones, sort of like a few over-ripe rotting apples in a bushel. The real problem is that no one knows how many rotten apples are in each bushel, and when in doubt, do nothing. Thus the loan-package securities are no longer being bought and sold; meaning "no liquidity." Why risk rotten apples after the orchard has become famous for having exercised no restraint when incorporating the bad with the good. Who has time or incentive to sort through every bushel to reinspect for what should have been selected out at harvest? And, besides, with the passage of time, all the apples are starting to go beyond their prime, or so says the drive-by media. EDM

Exceeding strange that Republican majorities in the U. S. Congress had neither time nor vision to undo all this Carter/Clinton "liberal social engineering". Ok, back to Ponzi schemes and "apres moi, le deluge".

jack

You got it right. FDR came up with Fannie Mae in 1938, and in retrospect it was a good thing at its inception. One of the problems contributing to the Great Depression was lack of liquidity. There were no 30-year mortgages; banks paired their loans to their deposits. No one was signing up to deposit $$$ for 30 years. Thus when the stock market crashed and the run on banks to cover margins depleted ready cash, banks were in no position to roll over all those one to five year mortgage loans.

You need to understand this: Pre-Fannie Mae, mortgage loans were short term and not expected to be paid in full on an amortization schedule, but were partially paid down and rolled over.

Fannie Mae changed this by packaging mortgage loans with long maturities and selling the packages as a "security" to the secondary markets. Then in 1968, as a budget trick, LBJ privatized Fannie Mae and kept governmental oversight in exchange for governmental guarantees. Fannie May and Freddie Mac were regulated and audited to minimize government exposure on the guarantee, just like banks are regulated and audited by the Fed to minimize exposure under Federal Deposit Insurance. None of this was a democratic or republican issue, just good credit managing, and the system worked till the mid-1970s, again under democratic initiative. But the worm had turned...

I don't think anyone at this late date is critical of FDR's creation of Fannie Mae or LBJ's privatizing in 1968. And here I find the need to correct a prior post: I quoted the New York Times for the proposition stated in an editorial masked as an article that "...if Fannie Mae and Freddie Mac were so important that they have to be nationalized, why weren't they regulated?" I bought this as true, but upon much looking into the subject, I find that I was wrong. The problem was not "deregulation," but these "Government Supported Entities" (GSE's) were regulated into insolvency...

First in the mid-1970s when Jimmy Carter forced through the Community Reinvestment Act of 1977, that degraded loan portfolios as a sop to inner cities where bad risk areas were red lined. This was mostly painted over with government insurance...

Until the mid-1990s under Bill Clinton's watch, when the GSE's were encouraged and then required to purchase a portfolio majority of sub-standard loans. Duh! Wasn't the result predictable?

In none of the preceding instances (1938, 1968, 1977, or 1995) were the republicans in control of the legislative branch, and in each instance a democrat was in the White House. Nevertheless, the problem did not rear its ugly head along party lines. Both sides were complicit, or asleep at the switch, as evidenced by the repeal of the Anti-Bucket-Shop law of 1907, in 2000, under Bill Clinton's watch, but with a republican majority in both houses of congress.

The real question is: Do we want these incompetent social engineers of either or both parties running our banks, brokerage firms, mortgage lenders, and automakers?

And as for the idea that republican majorities could unwind the democrats' social engineering, keep in mind that no judicial appointments have been processed of late because the democrats refuse to call any for a vote; keep in mind that thru an unprecedented trick of the rules the prospective judges have been kept in limbo by the dems not adjourning, but sending staff to keep the lights on 24/7 so there cannot be recess appointments. And the dems' filibusters hamstrung the congress repeatedly during the republican majority. But in the final analysis, I've had my fill of both political parties...and

Further EDM Sayeth Naught.

With reference to what can be laid at the feet of Democratic presidents and specifically Bubba, in January '95, Republicans took control of both houses after the '94 midterm gains of 58 seats House and 7 seats Senate. Sometimes called the Republican Revolution, or as my wife would put it: Gingrich's "Contract ON [sic] America". So whatever economic and social trial balloons were being launched, they owe their "success" not simply to bipartisan "complicity" but to the express will of the party holding a majority of legislative seats.

jack

Jack: As I said above, you got it right. The republicans were not effective to check Bill Clinton's agenda. In theory a majority can pass legislation, but in practice a minority can filibuster things to a stand-still. There was a republican effort to regulate the Government Sponsored Entities (F-Mae & F-Mac) in 1995, by republican senator Chuck Hagel of Nebraska, but a democratic party-line vote kept the bill from reaching the senate floor for a vote. Meanwhile, the relaxing of credit criteria by Bill Clinton needed no legislative approval, but was strictly administrative rule making. The only overt complicity was within the Clinton administration.

Keep in mind that it takes a super-majority to squelch a minority party-line voting block backed up by the threat of a filibuster. The republicans may or may not have supported Hagel's bill 100%, but we'll never know. However, all Clinton had to do if it passed both houses was to veto it as being contrary to his administrative policy, and the republican majority was short of the super-majority necessary to over-ride the veto. Checkmate!

It remains to be seen if a republican minority in the next congress will be equally effective to reign in BHO's agenda.