We might live in the postindustrial era, but economic booms and busts have not disappeared. Unfortunately, these days the taxpayers seem to get stuck with the losses.
The current crisis results from expanded mortgage lending, much of it financed by subprime loans secured through “collateralized debt obligations” (CDOs) by private investors and the government-sponsored enterprises Fannie Mae and Freddie Mac. The federal government spurred lending at every turn: Banks had been targeted for “red-lining”—not lending in poor neighborhoods. Fannie Mae/Freddie Mac subsidized ever more mortgage lending. The Federal Reserve’s expansive monetary policy artificially inflated property and commodity values.
Rising housing prices caused borrowers, lenders, and investors to treat subprime loans as a no-lose proposition. Even if a borrower got into trouble, the home could be sold for a profit, making everyone whole.
Eventually, the housing market slowed, causing the entire “don’t worry, be happy” mortgage-based system to collapse. Prices fell, foreclosures rose, mortgage repayments dropped, and the value of mortgage-backed securities collapsed. This set off an ever-worsening financial cycle, taking down homeowners, brokers, mortgage firms, commercial banks, and investment banks.
To date, total subprime losses and write-downs...