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The Subprime Debacle
by Dr. Kuni Michael Beasley
30 Years in Gestation

The Democrats are doing a lot to try to pin the subprime debacle on the Republicans and the Bush administration. However, there is a long tail to this problem that just happened to pop at this time.

Now, for the rest of the story. Definitions first.

Fannie Mae is the Federal National Mortgage Association (FNMA), founded in 1938 as a publically traded government sponsored enterprise (GSE) that is stockholder owned that makes loans and issue loan guarantees.
Its cousin is Freddie Mac, the Federal Home Loan Mortgage Corporation (FHLMC), founded in 1970 as another GSE created to expand the secondary market for mortgages. Freddie Mac buys individual mortgages on the secondary market, pooled them into packages, and sold them to investors on the open market.

The secondary market packaged mortgages as collateral and issues securities called collateralized mortgage obligations (CMO) and collateralized debt obligations (CDO), to reduce the risk of individual loans. CMOs are a separate entity that is the actual legal owner of the mortgages it has in a “pool.” CMOs sell bonds to investors based on the value of the mortgages. Investors receive payments based on the increased value of the loans in the pool. The collateral for the bonds are the actual mortgages.

CDOs are a separate entity like CMOs, but are more focused on fixed income assets such as, but not limited to mortgages (and can include commercial mortgages and corporate loans). The focus is cash flow and slices (tranches) of these cash flows are sold to investors.

The subprime mortgage crisis surfaced first in 2007, but it had been incubating for years, indeed, decades. Though roots can be traced back to the New Deal legislation in the 1930’s, the current crisis actually draws its source from the Community Reinvestment Act (CRA) [1977] during the Carter administration that forced banks to lend money to less credit worthy clients. Lending institutions were evaluated to determine if it met the “credit needs of the community” and this was factored into regulatory decisions of the federal government such as applications for facilities, mergers, and acquisitions.

Interest in the CRA resurfaced in the Clinton administration when regulations in the CRA (which could be manipulated without any participation of congress) essentially forced institutions to offer loans to higher risk individuals and businesses. The term “Ninja” loans emerged describing high risk loans made to people with No Income, No Job, and no Assets, but completed a particular bank’s portfolio sufficient to keep federal regulators off their backs.

As access to easy money for high risk borrowers increased, certain institutions began to take advantage of these new opportunities to score fed points and make easy money. Name dropping here: Countrywide began to process, package, and offer investment instruments (CMOs) based on these loans. Revisions to the CRA by the Clinton administration allowed mortgage companies to offer loans without the relative reserve of deposits normally required of banks and other financial institutions.
In addition, this allowed for securitization of sub prime mortgages based on the pooling and packaging of cash-flow producing assets into securities that could be sold to investors – with the asset value not tagged to actual value of the property, but to the value of the cash flow produced by the asset held (sounds weird). The first public securitization of CRA loans was started in 1997 by (familiar name) Bear Stearns!

Now, let’s understand sub-prime loans for a moment. A sub-prime loan is a mortgage offered at a deep discount on interest the first year or two so the borrower could qualify for a larger loan and more expensive house, betting that their economic profile would get better and they could afford large payments later. Adjustable Rate Mortgages (ARMs) are a form of this where the entry rate is low and rises based on certain criteria such as the rates for government securities.

Simply put, lenders (not necessarily banks, but more often mortgage
companies) offered low cost, low entry rate mortgages to people who would not normally qualify for that amount of debt.

These loans were “warehoused” by financial institutions, where a financial institution like Merrill Lynch would set up a separate, but wholly owned mortgage company (First Franklin) to attract loans.
Merrill Lynch would retain control of the loans as a “trustee” or “servicer,” and derive benefits from fees for “managing” the loans and increase assets by keeping escrow deposits. In turn, these loans would be sold to Fannie Mae or Freddie Mac (who were assumed to guarantee the loans), who, in turn, repackaged them for the secondary market.

In 2003 the Bush administration tried to head-off what they saw as a potential crisis by moving the supervision of Fannie Mae and Freddie Mac under a new agency

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M M asked:


We got married in 2006. In 2007, my mom-inlaw refinanced the house & put my husband’s name on it (in short, they joint home loan mortgage). I was not in the loan & they let me signed an Inter-Spousal Deed Agreement. Bcoz of mom-inlaw conflict, my husband & I were planning to buy a house, but for 2-mortgage brokers that we went through, they told us that we can’t be approved with any loan bcoz: My husband have a joint mortgage with his mom (but he’s not on the title). The loan balance as of now is $242,685 (originally $250,000). He also has a joint installment with a monthly payment of $131. Since we can’t get a loan, we were thinking of renting a house for now just to be separated from his mom. But, since we will rent & pay for it, we won’t be able to give money to his mom to pay the house… meaning there is a high chance that it will go into foreclosure bcoz mom-inlaw can’t pay for it — she is retired & only have less than $1000 of income (house payment is $1700/month). This will definitely affect my husband’s credit rights? Am I going to be affected too? (I don’t have a credit yet bcoz I just came in the US 3yrs ago, & I’m a full time student & I don’t work yet).

My husband have a good credit history on his credit cards, & since I don’t have a credit yet, we were thinking that he will include me in his 2-credit cards for me start. But, if they will go into foreclosure & his credit score will go down, am I going to be affected as well even though I was excluded in the mortgage? We were planning to build my credit bcoz if in case they will go into foreclosure, we both want to make sure that in a few yrs. we can buy our house under my name.

Any good advice from knowledgeable person regarding these matter? Thanks in advance.
*** I’m trying not to say anything to be safe. *** (corrected from above)
Buying the house out from mom-inlaw is a good advice, but the things is mom-inlaw don’t want that to happen bcoz she dosn’t want to give-up the house, even to us, bcoz she wanted control. She even lied to my husband before they refinanced the house. My husband thought that he was in the title deed, & later on we found out that the house was only in her name. he just used my husband to co-sign her for the mortgage bcoz she can’t qualify herself. That’s one of the reason my husband got mad bcoz she lied. For both us, it’s not about who’s on the title, it’s about honesty & respect. And now, mom-inlaw is telling everybody that if not to her we were nothing, & that’s not right! She even lied to everybody that am doing or talking to her badly, when the truth is I don’t speak to her bcoz I’m trying to say anything to be safe. Still, it gets worst.

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OrangeCountyCA asked:


There are significant limits to what regulation can accomplish. As a dramatic illustration, take two of the biggest accounting disasters in the past ten years: Freddie Mac and Fannie Mae. We’re talking billions and billions of dollars of misstatements at both places.
Now, these are two incredibly important institutions. I mean, they accounted for over 40% of the mortgage flow a few years back. Right now I think they’re up to 70%. They’re quasi-governmental in nature. So the government set up an organization called OFHEO. They stand for Office of Federal Housing Enterprise Oversight.] But if you go to OFHEO’s website, you’ll find that its purpose was to just watch over these two companies. OFHEO had 200 employees. Their job was simply to look at two companies and say, “Are these guys behaving like they’re supposed to?” And of course what happened were two of the greatest accounting misstatements in history while these 200 people had their jobs. It’s incredible.
The Office of Federal Housing Enterprise Oversight (OFHEO) was an agency within the Department of Housing and Urban Development. It was charged with ensuring the capital adequacy and financial safety and soundness of two government sponsored enterprises — the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). It was established by the Federal Housing Enterprises Financial Safety and Soundness Act of 1992.

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