Sunday, June 27, 2010

What Caused our Global Financial Crisis?

The U.S. Housing market became a "bubble" for the following reason -- people who could not afford the down payment nor the mortgage payment of the home were allowed to borrow anyway. Banking institutions then packaged these mortgages and sold them to Fannie Mae and Freddie Mac.

So how did this happen? The United States Government -- Executive Branch since Clinton, and the Legislature -- has promoted home ownership by lowering the financial requirements. In the 1980's, over 80% of homes had a 20% cash downpayment required with a 30 year fixed rate mortgage. By 1992, with the Community Reinvestment Act, Banks were not just ALLOWED to accept 15%, then 10% then 5% then no downpayment, then were told they could generate the loan and then sell it to Fannie Mae and Freddie Mac. Let me go further...Banks were now only allowed to offer variable rate mortgages, but they were encouraged to market products which ASSUMED home price appreciation and a growing economy (because it had been so for 30 years), because they could SELL THE MORTGAGES to the Government.

All the Investment Banks which set up Collateralized Debt Obligations did so because not everyone is so stupid as to think that people can put zero down, and not make a payment for 12 months and then only pay 3% for 24 more months and then the rate goes to 5 percentage points over 90 day T-bills. That's just retarded.

So what is the answer, you ask? Higher Capital Requirements (ala Basel III) for all banks, globally. Only Capital on hand can mitigate risk taking. The higher the risk activity, the higher the capital required to hold in reserve.

Unfortunately, the "fines and fees" to punish banks, and the restrictions on their profitablity work directly against increasing capital requirements (say 10% overall on a risk-adjusted basis).

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