The Key Players
Consumer
The consumers were taking out loans to purchase homes they could generally not afford. They were — or should have been — aware of their poor credit history, low level of income and employment status. Subprime borrowers were able to receive loans despite not being qualified, because brokers weren’t performing thorough background checks. Borrowers were enticed by the prospect of owning a home with a negligible down payment and low initial payments. Most of the loans, however, were scheduled to adjust to a higher level after a couple of years. As it happened, the borrowers would have trouble making these new payments. When housing prices began to fall, owners found themselves paying more for a house that was worth less than when it had initially been purchased. Many homeowners simply defaulted on their payments until the banks foreclosed on their home and they were left with nothing.
Lender
Lenders found themselves with more capital to loan in the early 2000s, when property values rose consistently and central banks provided capital liquidity by reducing interest rates. Mortgage brokers began offering subprime mortgage loans to consumers without doing much of a background check. The consumers receiving the loans, sometimes called subprime borrowers, often had poor credit ratings and little disposable income. Although this type of lending is risky, higher risks typically yield higher investment returns.
The drop in interest rates and increasing prices for housing created a strong demand for mortgages. Brokers found one way to provide them to as many consumers as possible. Brokers were able to continually create more capital to loan through selling off the mortgages to investment banks.
Wall Street
Wall Street had a hand in turning the American mortgage crisis into a global economic meltdown. Banks on Wall Street bought tonnes of subprime loans from mortgage brokers, lumped several thousand of them together and repackaged them into bonds. Then they sold these bonds, many of which were never delivered, to other banks, many of which were overseas. It is unclear whether or not Wall Street firms were aware of how bad and how risky the underlying loans actually were. But higher risks offer a possibility for higher returns than safe investments do. Regardless, they, just like the brokers and borrowers, assumed American mortgage-backed assets were safe as long as housing prices continued going up. Regardless, Wall Street bankers are typically considered smart and money savvy.
Politician
When new mortgage-granting institutions started popping up, Washington never set any laws or regulations. Mortgages had previously been controlled by banks which were, and still are, supervised by the government. There was a complete lack of regulation in this relatively new method of lending to homebuyers. In order to prevent the country’s entire financial system from failing, Congress has pumped hundreds and hundreds of billions of taxpayers’ dollars – a lot of which was used even before the $700 billion rescue fund was proposed – into financial institutions. The government’s bailout actions have been criticized by some analysts. The government nationalized Freddie Mac and Fannie Mae, committing to give $100 billion to each mortgage company. But a few days later it let Lehman Brothers go, forcing the company to file for bankruptcy protection, sending shockwaves through the market.
Timeline
mid-90s – early 2000s: Brokers lend money to subprime borrowers – people who don’t have the credit score, income or assets typically necessary to receive loans. Unemployed citizens, people carrying massive debt and illegal immigrants receive mortgages. Subprime lending and adjustable rate mortgages encourage homebuying, especially in an environment where home values are increasing. Subprime mortgages are bundled and repackaged, then sold to investors. This is a process called securitization, in which the lender has sold the right to receive payments on a loan. Investors who buy the risky securities are confident borrowers will make payments and house values will continue to increase.
2002-2006: Fannie Mae and Freddie Mac are government-sponsored enterprises that bought mortgages from the lenders, then either held on to them or sold them as securities to other banks. Combined, the value of subprime securities they purchased from banks and brokers rose from $172 billion to over $500 billion, then dropped to $450 billion per year.
2004: Homeownership rates in the United States peak at 69.2 per cent.
2005-2006: Housing market bubble begins to burst. Prices for homes start falling, while owners’ payments increase. Unable to find extra money, homeowners start to default on their payments. The mortgage-backed securities held by financial firms begin to lose almost all value. Without these securities, banks find themselves with less capital. The result is the beginning of the credit crunch; with less capital, the banks have less money to loan.
February 2007: HSBC announces it will experience losses higher than anticipated. American borrowers defaulting on their subprime mortgage payments are considered a major cause.
Sept. 16: Feds announce government will pay $85 billion into American International Group, effectively taking over 80 per cent of the insurance giant. AIG put itself in a bad position by insuring banks against mortgage defaults.
Sept. 18: United States Treasury Secretary Henry Paulson and Congressional leaders meet to figure out a bailout plan to stabilize the financial system. The aim is to buy weak assets from the banks, thus clearing up some capital and allow the banks to loan money.
Sept. 29: The House of Representatives rejects the first version of the rescue plan
Sept. 30: Senate Majority Leader Harry Reid and Minority Leader Mitch McConnell restructure the proposal, amending an existing bill and using that as the vehicle for the legislation. The new plan includes some provisions intended to help the taxpayers.
Oct. 3: The House of Representatives approves the bill passed by Senate. President George W. Bush signs into law Public Law 110-343, creating a $700 billion Troubled Assests Relief Program, with immediate access to $350 billion. The intention is to use the funds to purchase the mortgage-backed securities, which are essentially unrecoverable debt at this point, from Wall Street institutions. The government hopes that once the banks are stabilized, investors will regain confidence in the system. Moreover, without heavy debt, banks will have more capital available to lend. One of the conditions of receiving money from the bailout fund is that the company has to set limits on executive pay.
September 2008: Government pledges to inject up to $200 billion to Fannie Mae and Freddie Mac
Sept. 22: Goldman Sachs and Morgan Stanley, the last two independent investment banks on Wall Street are converted into traditional banks. This gives them access to Federal Reserve funds and guarantees an increase in governmental regulation. A few days later, American citizens become upset at the prospect of their money being used to bailout the big wigs on Wall Street, while taxpayers are left with no homes and plummeting savings. Federal Reserve chairman Ben Bernanke assures skeptics taxpayers’ money will be recovered when the weak assets are sold.
Oct. 1: Senate approves the amendment.
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Where the Money has Gone
Banks: The banks that were holding weak assets backed by subprime loans were the first institutions to receive any of the bailout fund.
– Of the $250 billion pledged to banks, $162 billion has been used to purchase shares and warrants. An additional $10 billion is expected to go to Merrill Lynch, but is dependent on its potential merger with the Bank of America.
– $40 billion has been paid to AIG insurance
– $20 billion has been pledged to Citigroup bank
– $5 billion will go to General Motors Acceptance Corporation, the financing arm of General Motors, plus an additional $1 billion to be received from GM.
Auto industry: Initially, Congress said it wouldn’t use any money from the rescue plan to bailout the auto industry. Eventually though, it caved, agreeing to inject $13.4 billion. There is a potential for an additional $4 billion in February if the industry can prove it is still viable.
– GM has already received $4 billion. It will also receive an additional $1 billion it will invest in GMAC; Chrysler is still negotiating the terms of its $4 billion.
– Part of the agreement calls for executives to accept limits on pay and perks, such as the corporate jets CEOs of the Big Three used to fly into Washington when they first asked for financial aid.
– Loans will be called back if the auto industry can’t prove itself viable.
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Criticism and the Future of the Bailout Plan
– According to United States Treasury Secretary Henry Paulson, the bailout plan was initially intended to stop the United States financial industry from crumbling. The government would use taxpayer money to purchase weak assets from banks. The funds were to be used as a loan and be returned to the taxpayers in due time. With the bailout of the auto industry, the focus of the plan has shifted somewhat. The decision to bailout GM and Chrysler has set a precedent; the door to asking for bailout money has been opened for other industries experiencing financial difficulties.
– Those in charge of the bailout program have not taken any action to stop or slowdown the rate of foreclosures.
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