The Causes of the Subprime Mortgage Crisis

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BY 

KIMBERLY AMADEO

 

Updated December 30, 2019

Hedge funds, banks, and insurance companies caused the subprime mortgage crisis. Hedge funds and banks created mortgage-backed securities. The insurance companies covered them with credit default swaps. Demand for mortgages led to an asset bubble in housing.  

When the Federal Reserve raised the federal funds rate, it sent adjustable mortgage interest rates skyrocketing. As a result, home prices plummeted, and borrowers defaulted. Derivatives spread the risk into every corner of the globe. That caused the 2007 banking crisis, the 2008 financial crisis, and the Great Recession. It created the worst recession since the Great Depression. 

Hedge Funds Played a Key Role in the Crisis

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Hedge funds are always under tremendous pressure to outperform the market. They created demand for mortgage-backed securities by pairing them with guarantees called credit default swaps. What could go wrong? Nothing, until the Fed started raising interest rates. Those with adjustable-rate mortgages couldn't make these higher payments. Demand fell, and so did housing prices. When they couldn't sell their homes, either, they defaulted. No one could price, or sell, the now-worthless securities. And American International Group (AIG) almost went bankrupt trying to cover the insurance.

The subprime mortgage crisis was also caused by deregulation. In 1999, the banks were allowed to act like hedge funds. They also invested depositors' funds in outside hedge funds. That's what caused the Savings and Loan Crisis in 1989. Many lenders spent millions of dollars to lobby state legislatures to relax laws. Those laws would have protected borrowers from taking on mortgages they really couldn't afford.

Derivatives Drove the Subprime Crisis

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Banks and hedge funds made so much money selling mortgage-backed securities, they soon created a huge demand for the underlying mortgages. That's what caused mortgage lenders to continually lower rates and standards for new borrowers.

Mortgage-backed securities allow lenders to bundle loans into a package and resell them. In the days of conventional loans, this allowed banks to have more funds to lend. With the advent of interest-only loans, this also transferred the risk of the lender defaulting when interest rates reset. As long as the housing market continued to rise, the risk was small.

The advent of interest-only loans combined with mortgage-backed securities created another problem. They added so much liquidity in the market that it created a housing boom.

Subprime and Interest-Only Mortgages Don't Mix

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Subprime borrowers are those who have poor credit histories and are therefore more likely to default. Lenders charge higher interest rates to provide more return for the greater risk. So, that makes it too expensive for many subprime borrowers to make monthly payments.

The advent of interest-only loans helped to lower monthly payments so subprime borrowers could afford them. But, it increased the risk to lenders because the initial rates usually reset after one, three, or five years. But the rising housing market comforted lenders, who assumed the borrower could resell the house at the higher price rather than default.

Two Myths About What Caused the Crisis

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Fannie Mae and Freddie Mac were government-sponsored enterprises that participated in the mortgage crisis. They may have even made it worse. But they didn't cause it. Like many other banks, they got caught up in the practices that created it.

Another myth is that the Community Reinvestment Act created the crisis. That's because it pushed banks to lend more to poor neighborhoods. That was its mandate when it was created in 1977.

In 1989, Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) strengthened the CRA by publicizing banks' lending records. It prohibited them from expanding if they didn't comply with CRA standards. In 1995, President Clinton called on regulators to strengthen the CRA even more.

But, the law did not require banks to make subprime loans. It didn't ask them to lower their lending standards. They did that to create additional profitable derivatives. 

Collateralized Debt Obligations

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The risk was not just confined to mortgages. All kinds of debt were repackaged and resold as collateralized debt obligations. As housing prices declined, many homeowners who had been using their homes as ATMs found they could no longer support their lifestyle. Defaults on all kinds of debt started to creep up slowly. Holders of CDOs included not only lenders and hedge funds. They also included corporations, pension funds, and mutual funds. That extended the risk to individual investors.

The real problem with CDOs was that buyers did not know how to price them. One reason was they were so complicated and so new. Another was that the stock market was booming. Everyone was under so much pressure to make money that they often bought these products based on nothing more than word of mouth.

Downturn in Real Estate Prices Triggered Disaster

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Every boom has its bust. In 2006, housing prices started to decline. Subprime borrowers couldn't sell their houses at a higher price than they paid for them.  Banks weren'​t willing to refinance when the home's value was less than the mortgage. Instead, banks foreclosed.  

The Subprime Mess Spread to the Banking Industry

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Many of the purchasers of CDOs were banks. As defaults started to mount, banks were unable to sell these CDOs, and so had less money to lend. Those who had funds did not want to lend to banks that might default. By the end of 2007, the Fed had to step in as a lender of last resort. The crisis had come full circle. Instead of lending too freely, banks lent too little, causing the housing market to decline further.

How a Little Accounting Rule Made Things Much Worse

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Some experts also blame mark to market accounting for the banks' problems. The rule forces banks to value their assets at current market conditions. First, banks raised the value of their mortgage-backed securities as housing costs skyrocketed. They then scrambled to increase the number of loans they made to maintain the balance between assets and liabilities.  In their desperation to sell more mortgages, they eased up on credit requirements. They loaded up on subprime mortgages. 

When asset prices fell, the banks had to write down the value of their subprime securities. Now banks needed to lend less to make sure their liabilities weren't greater than their assets. Mark to market inflated the housing bubble and deflated home values during the decline. 

In 2009, the U.S. Financial Accounting Standards Board eased the mark to market accounting rule. This suspension allowed banks to keep the value of the MBS on their books. In reality, the values had plummeted.

If the banks were forced to mark their value down, it would have triggered the default clauses of their derivatives contracts. The contracts required coverage from credit default swaps insurance when the MBS value reached a certain level. It would have wiped out all the largest banking institutions in the world. 

The Bottom Line

The ultimate cause of the subprime mortgage crisis boils down to human greed and failed wisdom. The prime players were banks, hedge funds, investment houses, ratings agencies, homeowners, investors, and insurance companies.

Banks lent, even to those who couldn’t afford loans. People borrowed to buy houses even if they couldn’t really afford them. Investors created a demand for low premium MBS, which in turn increased demand for subprime mortgages. These were bundled in derivatives and sold as insured investments among financial traders and institutions.

So when the housing market became saturated and interest rates started to rise, people defaulted on their loans which were bundled in derivatives. This was how the housing market crisis brought down the financial sector and caused the 2008 Great Recession.  

How robots help to combat COVID-19

These machines are joining humans to help fight the coronavirus pandemic

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Published:  April 04, 2020 15:43Christian Borbon, Digital Content Editor

  

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A robot modified to screen and observe COVID-19 coronavirus patients is photographed at the Regional Center of Robotics Technology at Chulalongkorn University in Bangkok.Image Credit: AFP

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Members of medical staff and the director of infectious diseases department, Paolo Grossi (C), pose with a robot called Ivo used to help patients infected by the novel coronavirus at the Circolo di Varese hospital, amid the the spread of the epidemic COVID-19.Image Credit: AFP

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A robot advises clients at a supermarket about appropriate behaviour in times of the coronavirus outbreak in Lindlar, Germany.Image Credit: AP

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A Postmate delivery robot is seen on its route to deliver food to customers in Los AngelesImage Credit: AFP

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Humanoid robot 'Prepper' stands at the cash desk of a supermarket of the Edeka retail chain in Lindlar, western Germany, to explain protective measures and to promote solidarity with each other, amid the novel coronavirus / COVID-19 pandemic.Image Credit: AFP

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A robot helping medical teams treat patients suffering from the coronavirus disease (COVID-19) is pictured at a patient's room in the Circolo hospital in Varese, Italy.Image Credit: Reuters

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A robot helping medical teams treat patients suffering from the coronavirus disease in the Circolo hospital in Varese, Italy.Image Credit: Reuters

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Robots have been deployed at Chennai's Government Stanley Medical College and Hospital to serve food and medicines to COVID19 positive or possibly infected persons, in Chennai.Image Credit: ANI

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Humanoid robot Prepper is standing at the checkout counter of the Edeka grocery store to explain protective measures and to promote solidarity with each other, as the spread of the coronavirus disease (COVID-19) continues, in Lindlar, Germany.Image Credit: Reuters

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A Tunisian police robot patrols along Avenue Habib Bourguiba in the centre of the capital Tunis as a means of enforcing a nationwide lockdown to combat the COVID-19 coronavirus pandemic. The locally-built robots are remotely operated and equipped with infrared and thermal imaging cameras, in addition to a sound and light alarm system.Image Credit: AFP
SEE https://plawiuk.blogspot.com/search?q=ROBOTS

‘Why I didn’t report it’: Saudi women use social media to recount harassment

Women who report incidents have faced smear campaigns on social media, say activists

Published: April 06, 2020 Reuters

Photo for illustrative purposes only.Image Credit: Gulf News archives

Amman: Hundreds of women in Saudi Arabia are taking to social media to share their experiences of sexual harassment in a rare exploration of a taboo topic in the kingdom.

Using the hashtag “ #Why_I_didn’t_report_it    ”, women and some men are recounting abuse endured at home or in public which they did not report to authorities fearing shame - or blame.

Saudi Arabia has outlawed domestic violence and sexual harassment in sweeping reforms recently that ended decades of gender segregation in restaurants and a ban on women driving.

But women who report incidents have faced smear campaigns on social media and been blamed for being harassed, rights groups say.

“My friends were punished when they reported (their abuse) and experienced more harm,” wrote one Saudi Twitter user who called herself Bella.

“I chose silence,” she said.

Saudi Crown Prince Mohammad Bin Salman last year allowed adult women to travel and get a passport without permission.

Under the regulations women can still face arrest if they disobey their guardian, often a husband or father.

One woman on Twitter who uses the online name Udor said she was arrested after her father beat her, kicked her out of the house and reported her to the police for disobedience.

A Saudi government body tasked with tackling domestic violence used the hashtag to urge those who had suffered abuse to get in touch privately.

Some women said they were afraid to speak up, especially in cases when their abuser was a family member.

“I reported it and the police came to convince me to drop the charges while my abuser sat with them,” wrote a Twitter user by the name of Catolina.

High profile cases such as that of 18-year-old Rahaf Mohammed al-Qanun who fled to Canada in 2019 to escape what she said was an abusive family have rallied opposition to the kingdom’s male guardianship system.

COVID-19: World faces spectre of next great depression

If lockdowns persist, so does the probability of another globalwide depression: analysts

Published: April 04, 2020 Justin George Varghese, Staff Reporter GULF NEWS

People attend a job fair in Miami. With the world’s biggest economy – United States – having shed 6.5 million jobs last week, up from 3.5 million the week before, economists are now being led to believe that the economy was in far worse shape than initially thought.Image Credit: AP

Dubai: Does the threat of more lockdowns to contain an untamable virus spread raise the chances of another Great Depression? – analysts say it does.

The coronavirus pandemic and lockdowns imposed by governments worldwide have already pushed the global economy into the sharpest downturn since the Great Depression. And it doesn’t seem to end.

“It’s clear that the economy is contracting more quickly than ever before during peacetime,” said Jack Allen-Reynolds, an economist at Capital Economics.

Economies crumble

With the world’s biggest economy – United States – having shed 6.5 million jobs last week, up from 3.5 million the week before, economists are now being led to believe that the economy was in far worse shape than initially thought.

More people have been laid off in the US over the last two weeks than were laid off in the first two months of the financial crisis of 2008-09.

Analysts currently see a prolonged period of 15 per cent unemployment in the US, but because of the rapid increase in unemployment the past couple of weeks and no peak in sight for the rate of infections, the debate is around whether it will exceed over 25 per cent like it was during the Great Depression.

“Crisis like no other”

“This is a crisis like no other,” said Kristalina Georgieva, head of the IMF, on Friday. “Never in the history of the IMF have we witnessed the world economy coming to a standstill – it is way worse than the global financial crisis.”

The shock US employment numbers followed business surveys across Europe showed the services sector to be in deep trouble with the largest drop in activity and prospects for more than 20 years.

Indices of activity by purchasing managers in the eurozone, UK and Swedish purchasing managers’ indices all fell around 20 points, from levels below those seen at the worst point of the financial crisis.

Italy, which went into lockdown first, had the weakest PMI index on record with a figure of 17.4, compared with a figure of 50 which represents the point at which an equal number of companies reported rising and falling activity.

Rethinking recession

The dire state of curfew-struck countries is forcing some analysts to move past the conclusion of the economy being in recession to what’s possibly coming next – from a state of extended recession to a repeat of the Great Depression seen during the 1930s.

“Recession is baked in the cake – the global economy has stopped, and money has ceased flowing, and not only that, confidence has evaporated and, when that happens so quickly, it takes a long time to come back,” said Murray Gunn, head of global research at Elliott Wave International.

“The economy will be suffering post-traumatic stress disorder for a long time – therefore, a deep and elongated recession, a depression, is probable.”

“The crash from a high point in the US market means that it is the start of something rather than the end,” said Gunn. “Much like in 1929 to 1932, the stock market will probably bounce after this initial crash only for another devastating wave down to complete the deflationary process.”

Cash is king

The rapid-fire selloff in stock markets and dire economic forecasts due to the coronavirus have spurred a dash for cash, a Bank of America fund manager survey had showed.

Cash holdings in March surged to an average 5.1 per cent, just shy of the 5.5 per cent seen during the 2008 financial crisis, as equity allocations were in a record collapse, mainly led by Eurozone and emerging markets, the survey further indicated.

“Stocks, bonds and commodities all decline in deflation, but the one asset class that has benefitted through this is cash and, as the deflationary environment intensifies, cash will remain king,” said Gunn, the lead contributor to deflation.com. “The key to riding out deflation is to have cash, an income and as little debt as possible.”

“If you want to see how the value of your cash increases in a bear market, just turn the chart of the stock market upside down,” Gunn added. “When the bear market ends, it will be the cash holders that can pick up some amazing bargains.”

BOOK REVIEW
Bullshit Jobs: A Critical Pedagogy Provocation
Joyce Canaan
Professor of Sociology, Birmingham City University
For what and for whom do I study? And against what and against whom?...
To the extent that the future is not inexorably sealed and already decided,
there is another task that awaits us. Namely the task of the inherent
openness of the future . . . It is not by resignation but by the capacity for
indignation in the face of injustice that we are affirmed (Freire, 2001:73-
74).

I precede the ‘provocation’ —a word I first heard used by my colleagues Gordon
Asher and Leigh French—below with the following caveats. First, I produced this
provocation as part of a workshop on Critical Pedagogy that Gordon Asher, Leigh
French and I co-organised preceding a day conference on Critical Pedagogies.

Second, the provocation that follows, like those of Asher and French, sought to spark
off debate; it used David Graeber’s rhetorical argument about paid work today, with
its explicit use of the ‘b’ word, to encourage academics at the event to re-
contextualise regimes of accountability in the university that they are experiencing
and to consider how critical pedagogy could help them do so. Finally, I have been
lucky enough to leave full time employment when voluntary redundancy was on offer
(being already off work on stress-related sick leave, for the first and last time in my
full-time, paid working life). This allowed me to stop being a wage slave and become,
instead, as one of my colleagues put it, like Tony Benn who left Parliament to take up
politics; I was leaving the university to take up education.

David Graeber’s recent (2013) piece ‘On the phenomenon of bullshit jobs’ observes
that during the 20th century, the percentage of people in the US and UK performing
‘professional, managerial, clerical, sales and service’ sector jobs rose from 25% to
75% of the workforce, in part accounted for by ‘an unprecedented expansion of
sectors like corporate law, academic and health administration, human resources and
public relations’.

 Why has there been such a growth in these jobs? Graeber says first like many others, that de-industrialisation, coupled with technological, communicational and transportation advances, led to whole swathes of work being dramatically reduced and/or moved South (as was the case with industry). 

Second, again, not an uncommon observation, there has been a significant increase in service, and, especially, administrative sector jobs. The latter rests on ‘the creation of new
industries like financial services or telemarketing, or on the unprecedented expansion
of jobs in areas such as ‘corporate law, academic and health administration, human
resources, and public relations’ (Graeber, 2013) and in sectors of work supporting the
needs of the above sets of workers. Graeber deems these service and administrative
sector jobs ‘bullshit jobs’—a concise term that emphasises their seeming
meaninglessness.

'

 He notes that the expansion of jobs in these two sectors occurred
alongside the elimination of productive jobs, in which workers interacted with the
world and made tangible (even if sometimes virtual) things. Most remaining workers
only spend a fraction of their time doing the work they believe they were originally
hired to do; more time is spent performing morally and politically dispiriting ‘bullshit’
tasks. Only a small fraction of this remainder still have the kinds of employment that
many of the latter group thought they were initially entering.

READ THE REST OF THE REVIEW HERE