Good explanations of the causes of the credit crisis

I’ve been in a recession for well over a year now, so I welcome everybody else to the ‘party’. I work, or at least used to work in commercial mortgage backed securities, the big brother to residential mortgage backed securities that more or less caused this whole mess. So I have a pretty good feel of how we got here and love (ie hate) when people try explaining it to me and really just blame one political party or the other in the course of such “explanation”. The following resources I found are very good primers if you’re not savvy about the financial world.

Marketplace editor Paddy Hirsch does a good job explaining Credit Default Swaps: Credit Default Swaps

and CDOs simply in video format: CDOs

Most importantly, the Reason blog has a good post about a broader history of this crisis, including how the Community Reinvestment Act was not great but wasn’t the direct cause of this crisis. It’s wordy, but worth it  Anatomy of a Breakdown

Here are some quotes if you really can’t take the time to educate yourself:

In 1993 the Federal Reserve Bank of Boston published “Closing the Gap: A Guide to Equal Opportunity Lending.” The report recommended a series of measures to better serve low-income and minority households. Most of the recommendations were routine and mundane: better staff training, improved outreach and communication, and the like. But the report also urged banks to loosen their income thresholds for receiving a mortgage. [...]

You can’t lend money if you don’t have it. And beginning in 2001, the Federal Reserve made sure lots of people had it. In January 2001, when President Bush took office, the federal funds rate, the key benchmark for all interest rates in this country, was 6.5 percent. Then, in response to the meltdown in the technology sector, the Fed began cutting the rate. By August 2001, it was at 3.75 percent. And after the terrorist attacks of September 11, the Fed opened the spigot. By the summer of 2002, the federal funds rate was 1 percent.

The central bank’s efforts went so far that, at one point in 2003, we had interest rates below the rate of inflation, or effectively negative. Institutional investors, looking at low yields on Treasury securities, needed a place to park money and earn some kind of return. Mortgage-backed securities became a favorite investment vehicle. Under traditional models, they were very safe and, because of Fed policy, even the most conservative fund could earn better returns than they could on Treasury notes.

Investment houses would bundle individual mortgages from several banks together into bond-like products that they would sell to individual investors. Mortgages historically have been seen as among the safest investments, and the era of rising house values transformed “safe” into “guaranteed returns.” [...]

It’s hard to overstate the role Fannie Mae and Freddie Mac played in creating this crisis. Chartered by Congress, Fannie in 1938 and Freddie in 1970, the two government-sponsored enterprises provided much of the liquidity for the nation’s housing market. Because investors believed—correctly, it turns out—that Fannie Mae and Freddie Mac were backed by an implicit guarantee from the federal government, the companies were able to raise money more cheaply than their competitors. They were also exempt from federal, state, and local taxes. The chief mission of Fannie Mae and Freddie Mac was to buy up mortgages issued by banks, freeing up bank money for additional mortgages.

Really it’s an excellent backgrounder - go read!