drewjoseph.com

I'm trying to figure out the whole story behind the mortgage crisis. Here is the (very imperfect) story I've got so far:

Before the Great Depression, investment services and commercial banking services were often dealt with by the same companies.

This led to frequent conflicts of interest and to fraud and abuse.

In the prosperous 1920s, the volume of investment and banking increased - and fraud and abuse increased as well.

In the late 1920s, there was a speculative boom. More and more people were investing in the stock market, causing prices to go higher, causing more confidence in a bullish market, causing people to buy even more stock, etc.

This led to a bubble, where stocks were highly overvalued.

Eventually, people were investing so much that they were actually taking out loans and then putting the money in the stock market.

Like all financial bubbles, this one eventually crashed in 1929, marking the beginning of the Great Depression. The stock market did not recover to pre-1929 values until 1954.

In response, FDR and the Democratic Congress passed a law in the 1930s to separate investment from banking.

Later in 1938, FDR & the Democratic Congress created a new organization, "Fannie Mae", to guarantee government-issued mortgages and provide liquidity to the mortgage market.

In 1968, LBJ & the Democratic Congress converted Fannie Mae into a private corporation, and transfered responsibility for guaranteeing gov't mortgages to a new company, Ginnie Mae.

In 1992, President George H.W. Bush and the Democratic Congress passed the Federal Housing Enterprises Financial Safety and Soundness Act, which mandates specific goals for Fannie Mae in regard to lending to low income individuals.

http://assembler.law.cornell.edu/usc-cgi/get_external.cgi?type=pubL&target=102-550

In 1999, President Clinton and the Republican Congress passed the Gramm-Leach-Bliley Act, which repealed the 1930s law separating investment service companies from banks.

http://www.govtrack.us/congress/bill.xpd?bill=s106-900

Soon after, banks started merging with investment companies again, forming "financial service companies."

The merging of investment and banking again increased the incentives for banks to loan out more money than they otherwise would. The ability to auction off mortgages to others insulated these companies from risks on the microeconomic scale, making them even more eager to issue loans.

These companies also had increased incentives to loan to low-income, low-credit borrowers because of the 1992 law.

In the 2000s, there was another speculative boom. Many people began speculating and investing in real estate property, causing housing prices to rise.

As time went on, more and more people saw the bullish housing market and began to invest, further driving up prices.

Financial service companies lent more and more money to more and more people with less and less credit and income, which the people then reinvested in the housing market.

Some companies even began granting people loans without requiring any down payment at all.

This artificial increase in demand for housing led to a bubble, where homes were highly overvalued.

The invasion of Iraq and the subsequent insurgency raised tensions in the middle east, driving up oil prices. Economic progress in China and in developing nations worldwide increased demand for oil, driving up prices further.

Oil prices were driven up again when hurricanes damaged offshore oil drilling stations.

Since Americans use more oil than we can extract domestically and hence import a majority of the oil we use, higher costs meant more and more money was going out of the US economy into the economies of countries with larger oil reserves.

Transporting general goods became more expensive, causing prices on many things to go up.

People had less money to invest in houses.

The bubble popped. Housing prices started coming back down to market value.

Many people had overinvested, lost their money, and were unable to repay the loans/mortgages.

Banks/Financial service companies were unable to deal with more and more people defaulting on their loans.

In 2008, these companies started going bankrupt.

Other banks have started to become much more reluctant to loan out money, both for housing investments and general purposes.

More reluctance to loan money will mean less money to start new businesses, expand existing businesses, help students get through college, etc.

As these trends continue, the economy slows down more and more.



So, Congress decides to send $700 billion to the financial service companies who made all of the loans that they should never have made, so they stay in business and hopefully keep loaning out money, postponing the end of the market correction.

Congress' bill doesn't do anything to separate banks from investment companies again, or to discourage banks from making more high-risk loans to low-income, low-credit borrowers.

It seems kind of like writing a check out for more money than is in the checking account, getting billed for overdrafts when it gets processed, and then going to a pay-day money loan place to borrow money to put back into the checking account. Yeah, there is more money in the checking account for paying the bills, but the underlying problem hasn't been eliminated - it has been postponed and made even worse.