The Recipe for Economic Crisis

The other day I was reading an article which mentioned an organization called FM Watch.1 Out of curiosity, I did a key-words-search on: FM Watch. I discovered FM Watch was founded by private mortgage industry interests in the late 1990’s. Apparently, FM Watch was created with defined purpose of focusing attention on anti-competitive and risky mortgage lending practices employed by the Government Sponsored Enterprises, Fannie Mae and Freddie Mac.2 And, it seems FM Watch even anticipated that, if unchecked, the behavior of these Government Sponsored Enterprises would evolve even further into more risky and stronger anti-competitive behavior.3

While I was reading about FM Watch I saw a reference and a hyperlink to a video presentation called “A Crisis of Credit Visualized” it was claimed to be a very good video presentation describing the circumstances involved in the real estate bubble and the mortgage crises. Out of curiosity I went to the link and watched the video presentation. I thought you might also find the presentation interesting.4  

I thought “A Crisis of Credit Visualized” was a good presentation of the basic processes in mortgage lending, mortgage securitization and mortgage financing. However, with the exception of the comment about the role of Greenspan era U.S. Federal Reserve interest rate policy, it lacks any discussion about the role of federal housing policy and the Government Sponsored Enterprises (Fannie Mae and Freddie Mac) in the creation and the extension of the housing bubble.

Furthermore, the presentation fails to specifically explain how government subsidized cheap money financing and government subsidized mortgage insurance increased demand and pushed home prices to levels that exceeded borrowers’ ability to repay what they borrowed (to finance their home purchases).

And, the presentation fails to emphasize that, after the bubble peaked, as riskier borrowers defaulted on their mortgages and those homes went on the market, the excess supply of houses and downward cascading home prices caused home values to drop to the point that well qualified borrowers, who could afford their mortgages, began to question the economic wisdom of continuing to pay down their mortgage. These qualified buyers’ decisions not to continue to pay their mortgage contributed further to the excess supply of homes which contributed to the further deterioration of home prices.5

In the viewer comments on “A Crisis of Credit Visualized” I found a comment mentioning the lack of information about how federal housing policy and the behavior of the Government Sponsored Enterprises contributed to the crises of credit. The commenter provided a link to another video titled, Burning Down the House: What Caused Our Economic Crisis?6 I believe that, by watching both “A Crisis of Credit Visualized” and “Burning Down The House: What Caused Our Economic Crisis” one can gain a very clear understanding of the major forces which caused the U.S. economic crisis.

1. Freddie’s Friend Newt By Holman w. Jenkins Jr. Wall Street Journal Opinion/Editorial page November 19, 2011.

2. Is FM Watch a Crusader With an Agenda? By Louis Sichelman – RealtyTimes, pub. 7/5/1999

3. New Alliance Confronts FM Watch, Champions Existing Housing Finance System By Broderick Perkins RealtyTimes, pub.10/5/2000

4. The Crisis of Credit Visualized A video presentation by Jonathon Jarvis published on Vimeo - 3 years ago

5. Many mortgage borrowers think of the home as an investment they will use in later years to fund children’s education, or their own retirement. If these home borrowers begin to believe the investment will end-up being a loss, or can’t be refinanced, their attitude toward continuing to make their mortgage payment changes - significantly. See, Underwater Home: What You Should Do if You Owe More Than Your Home Is Worth? By Professor Brent T. White - pub. 10/15/2010 and/or key-words-search “Strategic Default”.

6. Burning Down The House: What Caused Our Economic Crisis YouTube by TheMouthPeace pub. Sept. 30, 2008

The Rating Agency Scandal

The Scandal Too Few Are Discussing

You might be aware that in the United States we have what are called Nationally Recognized Statistical Rating Organizations (NRSRO’s). Under this system a small number of credit rating agencies (Moody’s, Standard & Poors and Fitch) were approved as raters of the credit risk of debt instruments. Institutional purchasers of debt, like insurance companies, banks, and general fiduciaries, are required by law to use these organizations’ ratings as a guide to their purchases. In general, such investors are required by law to only purchase debt instruments which are rated by the NRSRO’s as “investment grade”. Other’s investing in debt also rely on the NSRO’s ratings as a indication of the risk profile of their investments. [See, Nationally Recognized Statistical Rating Organizations Wikipedia entry at:    http://en.wikipedia.org/wiki/Nationally_Recognized_Statistical_Rating_Organization ].

Recently, I became curious about Financial Crisis Inquiry Commission (FCIC) hearing testimony and Congressional hearing testimony on the subject of the NRSRO’s role in the housing bubble and the ensuing financial crisis. Fortunately, C-SPAN maintains a video library of such hearings, and in the video library I was able to find and watch some interesting questions and answers on the role of the NRSRO’s in the housing bubble and financial crisis.

The full hearings are a bit long, but I was able to copy a couple exchanges which I thought were interesting and characteristic of each of the two hearings from which they came. I’ve posted my brief video-clip copies on youtube. I thought you might find the video-clips interesting. The URL’s below are hyperlinked to the hearings

Too Little, Too Late (compare the dates Mr. Raymond McDaniel mentions to your bubble timeline):

The Role of The Rating Agencies (pursuing market share?):