Mortgage-Backed In-Securities
With 2008 having been an election year, it has been convenient to levy all blame for our country's current economic condition on our nation's presidential administration for the last eight years. However, a significant portion of the fiscal woes now plaguing both Wall Street and Main Street originated well before the current administration ever set foot in the White House. In fact, it was in 1999 that the previous administration openly urged the Federal National Mortgage Association (aka "Fannie Mae") to reduce down payment and credit requirements for sub-prime or "at risk" borrowers in what appeared to be a valiant attempt to increase home ownership rates among minorities and low-income consumers.
In an amazingly prophetic article written by Steven A. Holmes of The New York Times when Fannie Mae began purchasing sub-prime mortgages in 1999, Mr. Holmes explained that "Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But . . . may run into trouble in an economic downturn prompting a government rescue." Holmes further explained "If they fail, the government will have to step up and bail them out."
Once the housing bubble began to burst in 2005 and 2006, home prices started declining and by late 2007 the United States' economy as a whole began to decline. With so much attention directed at slumping housing and stock values, it is easy to forget that this fiscal contraction began with the sub-prime mortgage crisis that has since turned Wall Street into a house of cards that seems to shed portions of its structure each week. By 2008, both of the government sponsored enterprises ("GSE") known as Fannie Mae and Freddie Mac ultimately failed and were eventually rescued by the Federal Government as predicted.
Even enormous public investment houses and banks like Bear Stearns, Lehman Brothers, A.I.G., Washington Mutual and Wachovia have all required government intervention that has cost tax payers hundreds of billions of dollars to date. Despite continuous public outcries condemning the "Wall Street Fat Cats", it is difficult to blame these failed public corporations that either originated these sub-prime mortgages that conformed to GSE requirements or purchased or insured supposedly sound mortgage-backed securities from the GSEs.
Specifically, banks like Washington Mutual and Wachovia originated loans to sub-prime borrowers according to GSE conforming loan requirements before selling these mortgages on the secondary loan market to Fannie Mae and Freddie Mac. Investment banks such as Bear Stearns and Lehman Brothers then assisted the GSEs by pooling these mortgages together to attempt to diversify risk, thereby creating collateralized debt obligations called mortgage-backed securities that were sold to institutional investors. Companies like A.I.G. provided credit-default swaps ("CDS") that acted like insurance for institutional investors that purchased the mortgage-backed securities to protect them from defaults by the original borrowers.
It is critical to remember that before the sub-prime loan defaults escalated far beyond generally anticipated levels that caused the house of cards to start falling, the companies originating, purchasing and insuring these loans and securities were operating under the assumption that they were working with relatively safe loans that conformed to the requirements of government sponsored entities. It is unfortunate that it was these very requirements that had been relaxed in 1999, which in turn formed the unstable foundation upon which all of the cards ultimately fell.
About the Author:
Brian S. Icenhower, Esq., BS, JD, CRB, CRS, ABR is a broker, attorney, real estate expert witness, prosecution consultant for district attorney real estate fraud units, a real estate law instructor, and a Director for the California Association of Realtors.
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