View Single Post
Old 06-03-2008, 08:08 AM   #13 (permalink)
aceventura3
Junkie
 
aceventura3's Avatar
 
Location: Ventura County
Banking deregulation is probably not the most proximate cause of banks assuming more risks in their loans. The Community Reinvestment Act of 1977, amended in 1995 probably had a bigger impact, and on the sub-prime mess in particular. In the interest of addressing "redlining" problems the legislation requires banks to make loans they would not ordinarily make.

Here is a quick reference.

Quote:
The CRA mandates that each banking institution be evaluated to determine if it has met the credit needs of its entire community. That record is taken into account when the federal government considers an institution's application for deposit facilities, including mergers and acquisitions. The CRA is enforced by the financial regulators (FDIC, OCC, OTS, and FRB). In 1995, as a result of interest from President Clinton's administration, the implementing regulations for the CRA were strengthened by focusing the financial regulators' attention on institutions' performance in helping to meet community credit needs. These changes were very controversial and as a result, the regulators agreed to revisit the rule after it had been fully implemented for five years. Thus in 2002, the regulators opened up the regulation for review and potential revision.

The 1995 revisions were credited with helping to substantially increase the amount of loans to small businesses and to low- and moderate-income borrowers for home loans. Part of the increase in the latter type of lending was no doubt due to increased efficiency in the secondary market for mortgage loans. The revisions allowed the securitization of CRA loans containing subprime mortgages. The first public securitization of CRA loans started in 1997.

Criticism

Critics claim that government policy actually encouraged the development of the subprime debacle through legislation like the CRA, which they say forces banks to lend to otherwise uncreditworthy consumers.[2] [3] Defenders of CRA disagree, pointing out that half of all subprime loans were made by institutions that are not subject to CRA and another substantial share of subprime loans were made by subsidiaries of banks that do not fully come under CRA. Additionally, subprime lending intensified as enforcement of CRA was abating.
http://en.wikipedia.org/wiki/Community_Reinvestment_Act

So we have the "securititazation" and we have Fannie Mae and Freddie Mac two government sponsored entities. It was the secondary loan market that allowed banks to package and resell loans. In many cases because of this ability to package and sell loans banks were able to assume more risk than they would have ordinarily.

Quote:
THE FEDERAL NATIONAL MORTGAGE ASSOCIATION (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) dominate the U.S. secondary market for conforming single-family residential mortgages as both investors in and securitizers of these loans. (1) As of year-end 2003, these government-sponsored enterprises (GSEs) together held about $1.8 trillion in mostly mortgage-related assets and had another $2.1 trillion in net off-balance mortgage guarantees outstanding. (2) Indeed, these two portfolios accounted for almost 50% of the credit risk and over 20% of the market risk associated with all U.S. residential mortgages outstanding at that time (Frame and White 2005). Further, both Fannie Mae and Freddie Mac are highly leveraged, with ratios of total book equity capital to total assets consistently below 4%. Taken together, the large absolute sizes, portfolio concentrations, and comparatively thin capital ratios of Fannie Mae and Freddie Mac have led the Federal Reserve to conclude that the companies pose a systemic risk to the U.S. economy (Greenspan 2005). (3)

In the wake of recent revelations of significant interest-rate risk exposure (at Fannie Mae) and accounting misstatements (at both Fannie Mae and Freddie Mac), Congress is considering material changes to the companies' federal safety-and-soundness oversight. Among the new legal authorities being considered is the ability of the safety-and-soundness regulator to set minimum capital requirements; the current standards are embedded in statute and can be modified only by an Act of Congress. Such capital requirements are central to any safety-and-soundness structure and should be set commensurate with the risks being undertaken by the regulated firms. In addition to minimum capital requirements (and any direct limits on risk-taking), a positive differential between the market value of a regulated firm's equity and its book value can also serve as a disincentive to risk-taking. This differential is related to the expected future profitability of the firm, which reflects expectations about future competition. During the 1990s and the early part of the current decade, Fannie Mae and Freddie Mac did enjoy a substantial positive differential between the market values and book values of their common equity. Arguably, this partly reflected their special GSE charters, which limited their competition in the secondary conforming mortgage market.
http://goliath.ecnext.com/coms2/gi_0...ncentives.html

It is the use of government authority to control and manipulate the market that created arbitrage opportunities that would not have ordinarily existed. The market exploited these opportunities to the greatest degree until it all collapsed. Less government involvement not more is the key to avoiding these types of events in the future.
__________________
"Democracy is two wolves and a sheep voting on lunch."
"It is useless for the sheep to pass resolutions on vegetarianism while the wolf is of a different opinion."
"If you live among wolves you have to act like one."
"A lady screams at the mouse but smiles at the wolf. A gentleman is a wolf who sends flowers."

aceventura3 is offline  
 

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 118 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133 134 135 136 137 138 139 140 141 142 143 144 145 146 147 148 149 150 151 152 153 154 155 156 157 158 159 160 161 162 163 164 165 166 167 168 169 170 171 172 173 174 175 176 177 178 179 180 181 182 183 184 185 186 187 188 189 190 191 192 193 194 195 196 197 198 199 200 201 202 203 204 205 206 207 208 209 210 211 212 213 214 215 216 217 218 219 220 221 222 223 224 225 226 227 228 229 230 231 232 233 234 235 236 237 238 239 240 241 242 243 244 245 246 247 248 249 250 251 252 253 254 255 256 257 258 259 260 261 262 263 264 265 266 267 268 269 270 271 272 273 274 275 276 277 278 279 280 281 282 283 284 285 286 287 288 289 290 291 292 293 294 295 296 297 298 299 300 301 302 303 304 305 306 307 308 309 310 311 312 313 314 315 316 317 318 319 320 321 322 323 324 325 326 327 328 329 330 331 332 333 334 335 336 337 338 339 340 341 342 343 344 345 346 347 348 349 350 351 352 353 354 355 356 357 358 359 360