Reader Mike heard on 60 minutes that the lack of government regulations were part of the cause of the mess that we are in with the stock market. He suggested that I look into this and more specifically write a post that spells out what happen, why it happened and what is being put in place to make sure it doesn’t happen again for the average guy to understand.
Over the last few days, I did some research and instead of finding information on lack of regulations being the cause, I found that many people were arguing the contrary. It was enlightening to read through posts after posts explaining what the government did to create this whole mess. While I’m still undecided on what I believe is the real cause (I need to read more arguments on the other side before that happens), I want to lists out some of the points many articles seem to make for you to decide.
Community Reinvestment Act (CRA)
Politicians wanted more Americans to own homes, so the CRA was signed in 1977 to encourage commercial banks to make loans to much riskier borrowers. In 1995, the Clinton administration revised the act to put even more pressure for banks to create riskier loans. New regulations were passed that made it possible to turn home mortgages into securities. This meant that banks can sell these home mortgages to investment banks, so the banks no longer need to care about whether borrowers could pay the loans back or not because they don’t even own the loans.
Fannie Mae and Freddie Mac
The government has always encouraged these two government sponsored enterprises (GSEs) to lend more money to low income home owners. In 2004 and 2005, both GSEs agreed to expand their direct lending to low-income, higher-risk customers. Some say it’s a settlement for Fannie and Freddie’s accounting scandal but whatever the reason may be, this meant that both these institution increased risks because they had the backing of the government and taxpayers’ money.
Federal Reserve
The federal reserve lowered the key interest rate to extraordinary low levels beginning in 2001. This created the illusion that houses were much more affordable than they actually were, and in effect increase demand and therefore exaggerated the effect of the already inflated housing prices that started in the 1990s.
More or Less Regulation?
Was it the right thing for congress to keep urging everyone to be able to own a home? Did the government do the right thing and will it do the right thing in the future? That’s for all of us to decide and also find out.
Further Reading:
- Government Regulation, not Free Market Greed, Caused This Crisis - Yahoo News
- Did the Lack of Regulation Caused the Subprime Mortgage Mess? - Seeking Alpha
- Community Reinvestment Act - Wikipedia
- Over-regulation Caused the Housing Crisis - Buffalo News
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{ 3 comments… read them below or add one }
I don’t think there’s a way to figure out exactly who’s at fault because everyone played a role in this whole economic mess. All parties’ action is interrelated to each other I’m sure everybody is at fault!!
Good post. It’s always great to learn more information!
Hi,
When there is problem, people will start pointing their fingers at one another. But do remember, every time we point one finger at another person, 4 fingers will be pointing back at us.
Finding out who created the problem from the beginning does not solve the problem. And even if we find out who did it, how will it benefits us anyway?
At this time of turmoil, we should be looking hard at ourselves. Spend more time planning and thinking of ways to survive this crisis.
Did the government do the right thing and will it do the right thing in the future?
I will be delighted if they can competently do something right. But generally, I feel that we shouldn’t depend on the government to do the right things or things right… in anyway, they will be paid handsomely no matter what the world becomes and we will be carrying the bad debts they have bought. I am thinking of ways to save up for the tax, what are you doing?
If you still do not know what to do, just visit my crisis cartoon blog to unwind first …
Great Post!
Ren
You left out a key component, which was the passage of the Gramm-Leach-Bliley Act, which overturned Glass-Steagall. Glass-Steagall was enacted after the Depression to separate the activities of banks and brokerage firms because the feeling was that banks should be secure and not be tempted into activities that would jeopardize depositor assets. Gramm-Leach-Blilely, written by Republicans but signed into law by Clinton in 1999, allowed the big mergers we’ve seen over the last several years. Without that, I doubt that we would have had the collateralized mortgage obligation market expand to the extent that it did, which is a big part of the problem. On the other hand, we also wouldn’t have had the fake economic boom we’ve had over the last few years either. It was in the political best interest of incumbents to allow the bubble to keep growing for as long as they could.