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					                       The narrative about how The Financial Crises unfolded.



The FCIC Report

In June 2005,The Economist, run an article about the imminent demise of the housing market.
Moreover, in that same month, Alan Greenspan told the Joint Economic Committee about the possible
dangers of a housing crisis that could have a negative effect in the mortgage market. However, at the
same time; Greenspan felt the economy was running on a safe track, and that if anything happened, the
financial sector was strong enough to contain any type of market disruptions. In that period of 2005,
Herb Sandler, a top executive at Golden West Financial Corporation, told Fed officials, the FDIC, the OTS,
and the OCC, that it was a mistake to rely on AAA-ratings given by these rating agencies. Much of the
work that rating agencies were doing was thanks to law passed in 2000 by congress to lift the ban on
over-the- counter derivatives. In 2006, housing prices started to take a nose dive, and along with them
the value of large portfolios derived from nontraditional mortgage products that were traded and held
by major financial institutions. Consumer advocates started issuing warnings to Fed Officials such as Ben
Bernanke about the dangers of nontraditional loans. In March of 2007, Bernanke told congress that if
there was a problem in the subprime market, it would most likely be stopped, and that there was a very
small change of such problem spreading to other parts of the economy. However, in 2007, the economy
was slowing down, a sign that the housing bubble was deflating. In 2008, tragedy struck. Major financial
Intuitions failed, such as; the epic fall of Lehman Brothers, the largest bankruptcy in US history. Others
like AIG, Bear Sterns, Freddie, and Fannie Mac were rescued by the government for fear of contagion, or
as they government likes to put it “too big to fail”. Moreover, the decisions of the government to rescue
certain firms created a great level of uncertainty that translated into a financial panic. Close to 11 trillion
dollars were lost in retirement accounts, household equity, and life savings accounts. This financial crisis
did not happened over night; it had been cooking for years, as far back as the 1990’s and developed
over the course of the Bush and Clinton administrations. In October 2008, the Trouble Asset Relief
Program (TARP) was sing into law by President George W. Bush before he left office. In 2009, when the
Obama administration took office, the $700 billion in TARP funds were distributed to firms affected by
the subprime crisis. These firms include AIG, J.P. Morgan, Wells Fargo, and Bank of America among
others. Up to this point, the financial shock was contained, however; massive layoffs kept mounting,
and soon the unemployment rate went up to around 10%. Today, the US economy is still trying to
recover from one of the greatest financial crisis since the Great Depression of 1929.



Thomas Sowell, The Housing Boom and Bust

Thomas Sowell, an economist at Stanford Universality, narrates, from his own perspective, how the
financial crisis started. In 2002, President George W. Bush said he wanted 5.5 million people to own a
house by 2010. In 2003, Barney Frank believed that Freddie and Fannie Mae were doing a great job
increasing home ownership in the US, and that those in the opposition were simply “exaggerating a
threat to safety”. Moreover, the Department of Housing and Urban Development (HUD) was pushing
Freddie and Fannie Mae to get deeper into the subprime mortgage business in order to increase home
ownership. In 2005, The Economist issued the same warning about the dangers of a collapse which is
also reported in the FCIC report. In the same year, Peter J. Wallison from the American Enterprise
Institute, pointed out the questionable practices of Freddie Mac, and Fannie Mae in regards to the
purchasing of exotic mortgage products, and warned of the potential huge losses that these two
companies pose to the economy if they continue purchasing bad loans. The head of the FDIC also
warned congress about the high levels of bad loans that were being traded in market. Another
contributor the housing bust was many building codes passed into laws which in turn made housing
prices high, and forced home buyers to take risky loans in order to afford a house. Also, these borrowers
had to commit more of their income in order to keep up with rising cost of owning a home. The idea for
these laws was coming from individuals, groups, and communities with the excuse of protecting the
environment. Thus, politicians saw a political gain advantage and help this groups pas laws on building
restrictions. In 2006 housing prices started falling considerably in places where prices had the highest
jumps such as California, Nevada, Arizona, and Florida. These were place were many building codes
were made into laws. By 2007, foreclosures shot up to 87% around the country. The state of California
was one of the epicenters for foreclosures. In San Francisco prices were down 31%, in Los Angeles prices
fell 28%, and 27% in San Diego. In 2008 most houses for sale in around the San Francisco area were
foreclosures.By the end of 2008, the S&P reported that in October of 2007 to October of 2008, the
house-price index had the deepest decline not seen in twenty years, large financial institutions collapse,
TARP was enacted to help companies avoid bankruptcy, and those troubled firms lined up to get funds
from the government. In an interview with 60 Minutes, Alan Greenspan, when he was no longer
chairman of the Fed, admitted that he had no idea about the magnitude of the financial crisis until very
late in 2006.



An unregulated Free Market

 The FCIC report gives a sense that the market was unregulated. As the commission report rating
agencies were being left lose when it came come to rating highly risky mortgages. As these agencies,
where giving this risky investments AAA ratings. It seems as if the SEC was completely out of the picture.
Perhaps there were conflicts of interests within the rating agencies. They were advising firms on how to
structure debt, and at the same time they were rating their own work, and the agencies were giving
firms positive rating in order to secure their business. Furthermore, the report points out high rank
official within the Fed such as Greenspan, and Bernanke failed to exercise their power to regulate the
market.



Excessive Regulation

 Mr. Sowell points out, the intricate involvement of Government Sponsor Agencies or GSA’s along with
government officials pushed for excessive regulation from the government. TheGSA’s Freddie Mac and
Fannie Mae were loading heavily on exotic mortgage due to the pressure put on them by HUD.
Moreover, they had Barney Frank and President George W. Bush standing up to defend their business
practices and to encourage more home ownership.



Government Bureaucrats

Contrasting both perspectives, the FCIC’s and Mr. Sowell’s, the most obvious fact that comes out to light
in both opinions about the financial crisis is that high ranking officials within the government had no clue
about the real damage that a bursting of the housing bubble posed to the economy. Perhaps one can
argue that every crisis is different, but as both narratives show, there were warning sings everywhere.
The lack of commitment and hard work from government bureaucrats shines thru their un wiliness to
dig deeper into the financial matters that pose a threat to the economy. In both accounts of the
financial crisis, Mr. Sowell’s and the FCIC’s former Federal Reserve Alan Greenspan comes out as the
main culprit. Not only does he admit about not being aware of the real dangers that these exotics
mortgages, but he failed to push for a more aggressive investigation into the subprime market given the
fact that others industry leaders, and some officials in the government were questioning such business
models within the housing market.



Politicians enact flawed laws

The FCIC report points to the passage of the law that banned restrictions on the trading of over-the –
counter derivatives, as one of the laws that help feed “the madness” in Wall Street. As rating agencies
were rating these securities, they also experience conflict of interest. This problem was due to the fact
that rating agencies were advising client on how to structure debt and at the same time they were rating
their own work. Therefore, an assumption can be drawn that high level executives were giving kickbacks
to rating agencies for their work. On the other hand, Mr. Sowell many laws on buildings codes that
restricted the construction of houses in some localities was the work of irresponsible politicians guided
by the greed of political gain.In the 1970’s, there were numerous laws that put restrictions on land. The
motive for these restrictions was the need to preserve green areas, farmland, and saving the
environment. As housing prices kept rising in this localities, home buyers loaded up on debt by taking
out nontraditional loans that allowed them to buy expensive properties. According to Mr. Sowell by
2006 more than half of all subprime loans were “stated income” loans or “liar loans”. Borrowers that
carried these loans were committing more than 40 percent of their incomes for the mortgage.
Therefore; all of this laws that allowed people to charge higher prices for homes and at the same time
foster conditions for abusing borrowers by making them sing into loans that they would never be able to
pay. Thus, both narratives give u a slightly different taste. The FCIC report points toward greedy
executives corrupting politicians where as Mr. Sowell perspective goes to toward politicians enacting
laws that benefit their purpose at the expense of the public
                                   The cause of The Financial Crisis



The FCIC Report

Unregulated Free Markets

When it comes to identifying the main cause of the financial crisis, the FCIC report and Mr. Sowell’s have
two very different culprits. The FCIC report blames Wall Street firms for playing a big role in the crisis,
and Mr. Sowell points to government policies for the financial collapse. According to the FCIC report,
one of the key factors in the collapse of the housing market started with lax regulation practices. The
report points out to more than three decades of deregulation promoted by former Fed chairman Alan
Greenspan whom had the idea that financial institution could check on themselves to make sure they
complying with the rules. The lack of regulation facilitated the work of private entities in the shadow
banking industry as well as the over the counter derivatives markets. Furthermore the FCIC reports that
financial institutions were allowed to choose their own regulators. These people entrusted with
regulating the markets opted to avoid executing their fiduciary duties. For example, the Security
Exchange Commission along with the FDI failed to supervise the capital reversed of bank engaged in the
trading of derivatives tied to the housing market.

These banks were so highly leveraged that if the market turned down a couple of percentage points,
they would not have sufficient capital to cover losses. For example some investment banks had leverage
ratios of 40 to 1 which mean that for $40 in assets, there is $1 of capital. Clearly, these banks had poor
liquidity management. They did not have sufficient capital to cover their deposit demands. As Bank
Management dictates banks need to protect from large deposit outflows. Management at the banks did
not care to look into the issue. Perhaps, they were relying on their deposit insurance to make wild bets
without proper capital in case of a failure. They were also affected by the principal agent problem, in
which they had huge monetary incentives to overlook their liquidity problems.

 As time went by changes were implanted but given the magnitude and power of financial institutions
regulations got diminished. According to the FCIC report, Wall Street firm spent a total of $2.7 billion
lobbying regulators and political groups. Also individuals and political action groups gave more than $1
billion in campaign contributions. Thus, as the report shows there was a much unregulated market that
prevented regulators to establish a market free of obstacles to its sound operation.



Government Bureaucrats

The FCIC report points out to incompetent Government bureaucrats as the cause of the financial
turmoil. During the 1990’s, there was a larger influx of capital from China and other oil-rich countries as
they were trying invest in the US and Europe as way to load their big cash surplus. This led to low
interest rate and easy credit which allowed for investment in risky mortgages. By the end of the 1990’s
and early 2000’s a housing bubble formed. All of these factors were let unchecked by the Federal
Reserve as they were had the power to warn about the possible effects of interest rate, and also;
establish reasonable mortgage-lending practices. Due to the lack of oversight by the Fed, financial
institutions invested heavily on mortgage related securities. Furthermore these firms were relaying on
billions of dollars on overnight borrowing that were back by mortgage securities. On top of that, rating
agencies were giving these exotic mortgages AAA ratings. Therefore, the FCIC reports concludes that
the failure of the Fed to address monetary policy along with the flow of capital from overseas created a
housing bubble that led to poor lending standards. Some of these nontraditional loans were done based
on the idea that housing prices will keep on rising. Institutions that were doing these loans could not be
held accountable since they relied in the originate-to-distribute model that allowed for the securitization
of these loans, and then, these bad loans could be sold to other financial institutions. The Federal
Reserve wasn’t diligent enough to recognize the adverse consequences that the housing bubble could
have on the financial system, and acted too late contained its negative effects.



Politicians and Flawed Laws

The FCIC commission reports that Politicians were also responsible for creating laws that created
conditions for private organizations to abuse market conditions. In 2000 both houses of congress
enacted a legislation to remove regulation by Federal and state governments of over-the-counter or OTC
derivatives. The commission points out that the enactment of such legislation was a key to the cause of
the financial crisis. All types of business entities use derivatives to hedge against or speculate about
changes in commodities, stocks, etc. However, as useful as this method might be, if left unchecked it can
get out of hand. The derivatives market grew out of control to the tune of $673 trillion that firms
involved in this market had no adequate collateral, their leverage was out of hand, capital was
insufficient to cover their positions, had inaccurate estimates of risk, lacked transparency in their
transactions, and reports on how these firms were interconnected thru derivatives. The way OTC
derivatives worked was as follows: credit default swaps (CDS) were sold to insure against default from
top-rated tranches of CDOS. CDOS or Collateralized Debt Obligations were created by taking lower rated
tranches out of Mortgage Back Securities (MBS) that contain hundreds of subprime mortgages all
bundled together. Lower tranches in MBS had low ratings but had the potential to earn more. The CDOS
created out of the lower tranches of MBS had AAA ratings, even though; they were created out of the
riskiest tranches in MBS. Add to CDOs, CDO-square which follow the same idea for creation as CDOs.
Therefore; CDS allowed the sale of AAA CDOs by telling investor of their low risk, but at the same time
increased the risk of seller of the CDS to a potential collapse in the housing sector. Furthermore, CDS
allowed for the creation of Synthetic CDOs that contained credit default swaps, and thus; allowed
investors to bet on the performance of the housing sector. Years later, when the housing sector
collapsed, derivatives did a lot of damage especially to AIG who had sold $79 billion of theses
sophisticated investment instruments, and who had not put capital aside as protection for the
protection it was selling. When hell broke loose, the government ended up spending $180 billion to
recuse AIG because of fears of a trigger effect due to contagion to other business entities. Thus as one
can see the work of a couple of Government bureaucrats can do quite some damage.
Thomas Sowell, The Housing Boom and Bust

Excessive Market Regulation

Mr. Sowell’s account for the cause of the financial crisis differs in that Wall Street was not the cause of
the financial crisis but the excessive meddling of the government. Mr. Sowell tells that the market was
far from being unregulated, but heavily regulated by the Government. Such regulation fostered the
perfect environment for reckless behavior on the part of firms involved in the financial mess. As far back
as 1989, the administration of President H.W. Bush thru The Department of Justice demanded access to
loan records from several Atlanta banks. The administration was alleging possible racial discrimination
from banks against customer with a certain racial background when these customers applied for loans.
In 1992 a bill was signed into law asking banks to make housing loans to people in “underserved areas”.
Furthermore, during the Clinton administration former Attorney General Janet Reno threatened banking
institutions with legal actions, if they denied loans to their customers based on race. The majority of the
people applying for loans had sketchy credit histories and an unstable financial situation. Thus, the
reason why banks were hesitant to make housing loans under traditional standards, but not because of
race. Nonetheless, the government forced banks to make loans to the “underserved population”. In
order for banks to have people qualify for housing loans, they created exotic types of mortgages such as
low-down payment, no-down-payment, and interest only mortgages among others types which are
considered risky mortgage loans. Furthermore, pressure was put on Freddie Mac and Fannie Mae, also
known as “government-sponsored enterprises”, to buy these nontraditional house loans. As soon as
Banks knew that there was a way to pass on the risk on the GSEs, they were willing to create more risky
loans, even lower there criteria to make borrowers qualify to get these nontraditional loans. At the first,
it was only required for Freddie and Fannie to buy a small portion of these bad loans. However in 1996,
the Department of Housing and Urban Development, an agency commanded by any administration
currently in power in Washington, that exercises control over Fannie Mae and Freddie Mac started
demanding these two GSEs loan quotas of 40 percent, and later 53 percent. For Fannie and Freddie, it
wasn’t so difficult to meet such quotas because there were market and political incentives for them to
do so. Since these GSEs offered high risky investments they could also make higher profits, and if there
were any losses they could use taxpayers money to make up for them. Furthermore, Fannie and Freddie
could borrow at low interest rates because they were sponsored by the government, and thus; they
could use sponsorship of the government as collateral to borrow money. As Mr. Sowell shows it all this
excessive regulation turned into a vicious cycle of reckless behavior from the people enchased of
running these GSEs and from people at the head of major financial institutions.



Government Bureaucrats

Following with the analysis from Mr. Sowell’s book, when it comes to Government bureaucrats who lack
intelligence, and not corruption, Barney Frank and Christopher Dodd take the tile. In 2003 Barney Frank
came out to defend Freddie Mac and Fannie Mae practices by saying that those who were criticsing
these GSEs were exaggerating such allegations. Mr., Frank believed that the Federal Government still
needed more in terms of pushing for more affordable housing. He wanted Freddie and Fannie to get
deeply involved in low-income housing and provide subsidies if needed. Also, he expressed concern for
the criticism about lower lending standards, and told that such criticism could jeopardize affordable
housing. Furthermore, he dismissed fears about these two GSEs engaging in risky operations that could
pose a problem to the federal government because of a possible bailout. Barney Frank became
chairman of the House Committee on Financial Services in 2006. However, in January 2009, Mr. Frank’s
assertions were proven wrong when Fannie and Freddie had to receive bailed out money for about $238
billion. During the bailout period, One United Bank of Massachusetts wasn’t eligible for bail out money,
however; Mr. Frank somehow arranged for One United Bank to receive up $12 million. Congressman
Barney Frank wasn’t alone in his arcane assertions, Senate Chairman Christopher Dodd of the Senate
Banking Committee, back in 2004; told that Fannie and Freddie were a success story and warned that
restricting their business practices could do a lot of harm to these “great engines of economic success”.
Later and article published in the Wall Street Journal found that Fannie and Freddie had been donating
to about $5 million since 1989 to members of congress. One of those members was Senator Christopher
Dodd with $16500.



Politician and Flawed Laws

Continuing with the review of Mr.Sowell account on the financial crisis, he points out the community
Reinvestment Act was a flawed law enacted by politicians that cause damaged to banks and benefited
government bureaucrats and private groups such as Acorn and HUD. The main purpose to the CRA was
to direct Federal financial agencies to encourage banks to help less credit worthy borrowers get loans in
the communities where such banks were established. If banks decided not comply with the CRA
requirement, regulator could deny banks request to open new branches or conduct business
transactions such as mergers. Government officials used the CRA to put pressure on banks to lend to
who they wanted to. During the Clinton and George W. Bush administration pressure grew not just to
lend to the people in the communities they were established, but to lax lending qualifications in general.
Private organizations such as Acorn saw the opportunity in the CRA to extract millions of dollar from
banking institutions. ACORN’s tactic was to charge bank about not living up to their responsibilities
within the community. Therefore, because regulators could look at bank’s CRA record, banks had to pay
large sums of money to ACORN in order to have such allegation removed. Also the HUD started taking
action against mortgage lenders that turned down a large percentage of people applying for a mortgage
loan. Thus, lenders had no choice but change their lending standards in order to qualify more borrowers.



                               The Blame Game in The Financial Crisis



The FCIC Report
The FCIC blames the free unregulated market for the financial crisis. The commission points out that the
Federal Reserve led by Alan Greenspan, successive administrations, Congress, pushed by powerful Wall
Street leaders allowed for more than three decades of deregulation with the idea that the market could
self-regulate. Moreover, the Federal Reserve failed to contain the flow of risky mortgages by not setting
reasonable mortgage lending principles. Financial institutions trade securities that were not examined
carefully about their potential risk to the economy. Firms also were heavily leveraged and depended on
overnight borrowing to finance their operations. At the same time, they were using their subprime
mortgage securities as collateral to attract funding. Top executives at these firms were motivated to
take such extreme risk due to the high compensation packages that rewarded their reckless actions.
Furthermore rating agencies were facilitating the sale of risky mortgages securities by assigning AAA
ratings. As this all shows, federal agencies such as the Federal Reserve, the Federal Reserve Bank of New
York, and the Treasury Department were not at their posts. Also the FCIC report concludes that even
though, Freddie Mac, and Fannie Mae had deep flaws in their business practices, and contribute to the
crises, they were not primary cause. The GSEs “followed rather than led Wall Street and other leaders in
the rush for fool’s gold”. The mortgage related securities purchased by the GSEs were of high quality and
these purchases were not representative of the overall mortgage securities market. Furthermore, the
commission adds, the value of the securities purchased by the GSE’s held their value and did not
contribute to the crisis. Also the commission points out that the indolent of the HUD in respect to the
goals placed on Freddie Mac and Fannie Mae to reach affordable housing to low income people, only
contribute marginally to the involvement of the GSEs in risky mortgages. The Community Reinvestment
Act was not a major factor in the crisis either. According to the commission many lenders were not
subject to the CRA, and those that were only represented 6% of all the high cost loans made. Those CRA
regulated lenders’ loans that were required to lend in the communities they were established were only
half as likely to default as similar loans made by other lenders not subject to the CRA. The commission
adds, rather than blaming these acts, and policies; government entities such as the Federal Reserve and
other regulators failed to exercise their authority to oversee the markets.



Thomas Sowell, The Housing Boom and Bust

On the other hand, Mr. Sowell blames politicians and their flawed policies saturated the market with too
much regulation. Administration from both parties such the Clinton and the Bush administration pushed
for higher rates of home ownership. The HUD put tremendous pressure on Fannie and Freddie by
setting loan quotas to accept risky loans. Also, the HUD had indirect regulatory power over banks thru
the Community Reinvestment Act. The HUD required banks to report regulator their approval and denial
rates on loans. If the regulator saw unsatisfactory approval rates, they could charge bank with not
meeting their CRA requirements. Therefore; in reality government agencies were requiring lower
lending standards in order to meet political goals. As for Wall Street firm, they did what any business
would do which is to serve the needs of their customer by creating investment vehicles that would
allowed to bring in profits for their customers and their firms, but in many cases neither the creators nor
purchasers of the securities, along with rating agencies were aware of the financial records of the home
buyers. These institutions were dealing with problems of their own such as liquidity problems and
principal agent problems that in the end contributed in part to the financial crisis.

				
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