Current Financial Crisis Explained

It is not, as the bigots on the right love to say, because of increased lending to "minorities." It stems from (1) Too much unregulated securitization of mortgage loans, and (2) Too many of such loans made in bad faith by unregulated mortgage brokers. Barry Ritholtz of The Big Picture blog explains:

Nothing in any of these Bush speeches [quoted by Ritholz at the link] that pushed for more lending to minorities and increased lower income home ownership caused the problem. Neither did any similar Clinton speeches. Nor did related the legislation related to the Bush speeches, nor did the CRA, nor Fannie Mae or Freddie Mac. Indeed, none of these actions required the sort of reckless lending that we saw from 2002-2007.

Understand this simple fact: In an ultra-low rate environment, where prices are appreciating rapidly, and mortgages are being securitized, ALL THAT MATTERS IS THAT THE BORROWER NOT DEFAULT IN 90 days (or 6 Months). The goal was to make a loan that did not default in that period of time, it cannot be put back to the originator.

As a mortgage salesman, you only lose your a fee if a borrower defaults within 3 or 6 months. What do you do to maximize your returns? The best way to do that -- to put people in houses that would not default in 90 days -- was the 2/28 ARM mortgages. Cheap teaser rates for 24 months, then the big reset. By then, it was no longer your problem.

Can you grasp what a monumental change this was? Instead of making sure that borrowers could pay back ALL OF THE 30 YEAR FIXED MORTGAGE, you only had to find people who could afford the teaser rate for a a few months. THIS WAS AN ENORMOUS AND UNPRECEDENTED SHIFT IN LENDING.

This is the key to the housing boom and bust, and ultimately underlies the entire credit freeze. And, it would not have been possible without the Greenspan ultra-low rates, which made the teaser portion (the "2" of the 2/28) of these mortgages so attractive.