posted on Jan, 12 2010 @ 02:04 PM
reply to post by whatukno
There are two sides of this issue and both related to government regulation. The real reason for the sub-prime mortgage problem is that the
government, starting with Jimmy Carter and then expanded by Janet Reno in the Clinton administration forced banks to loan money to people who could
not afford them. The Community Reinvestment Act mandated that a certain percentage of loans (Reno made it 50%) had to be given to low-income people
and minorities. If the bank did not meet that threshold, they were red-lined and were prohibited from lending money at all, it other words they were
stopped from doing business. In conjunction with that, the government did not relax the parameters upon which the health of a bank's portfolio was
assessed. The bad loans, with too little capital or assets to back them by definition degraded the value of the debt the bank held. That forced the
bank to take measures that enabled them to comply with the law because the loans they were being forced to make were essentially illegal in accordance
with bank regulations.
Bank deregulation had nothing to do with this problem.
Now to the point of poor/inadequate regulation being part of the problem on the other side, you are 100% correct. Banks, being unable to resell
their loans due to the poor quality of them (again this was mandated by the government), the banks created securitized loans, essentially slicing up
good loans, medium quality loans and bad loans into a tradable security. That worked fine, because even though the bank knew that the poor loans
would default, the middle tier and top tier would make up for it. When the housing market tanked the middle tier began to default and the whole
There are two areas of regulation that could have been put in place (they still have not been enacted) that would have prevented or largely prevented
this from happening. First, the government, wanting to hide the impact of the Community Reinvestment Act allowed banks to only have the top two
tiers of the debt security to be rated. You had AAA debt that in reality was not AAA because the lousy loans were purposefully excluded from the
rating. Regulated transparency would have helped, enabling folks to know what they were actually buying. Most of the folks who bought this crap
were institutional investors like teacher's retirement plans. The government could easily have limited the exposure these types of public plans
(since the plans are for public employees) had to these debt instruments.
At the end of the day the government should regulate to provide absolute transparency to financial instruments. Further they should enable banks to
have a debt portfolio that they want to have. To the extent that a bank does not want to issue loans to low income folks, they should not be forced
to do so. The government should also get rid of the private rating system. Private firms have a total conflict of interest in rating securities and
debt. The model we currently have is rife with opportunities for corruption.
There are legitimate roles for the government to play in the regulation of financial markets, but they need to be supportive of free markets and
ensure that there is transparency.