Community Reinvestment Act - Part Four

Everybody's happy in 1997. During Jimmy Carter's Democratic administration in 1977, a vague law called the Community Reinvestment Act was passed. It was reworked many times over the years and became very powerful. The CRA became powerful enough to pressure banks of all shapes and sizes into making loans to uncreditworthy people. The CRA was especially adept at pressuring financial institutions into putting "hookers and crack addicts in homes that they couldn't afford," as my friend Mike would say. So the Democratic Government is very happy in 1997.

In October 1997, a couple of investment banks launched the first publicly available securitization of Community Reinvestment Act loans. The securities were guaranteed by Freddie Mac and had an implied "AAA" rating. So now the banks that were pressured into making these risky loans have a way to get rid of them - and they are more relieved than happy.

Moreover, the fly-by-night mortgage-lending companies (who were never subject to the CRA) made millions by "...[saddling] entire neighborhoods with risky, high-priced loans that borrowers could never hope to pay back, sold those loans to Wall Street and then went out of business." Source.

Thanks so much to Mike762, who as always, is so patient in answering my questions. The following is his take on the thread I started at Hunter's Campfire:

"Everybody along the way made money, except the end user. The bank or mortgage broker made their commissions, and since they weren't holding the underlying mortgage to maturity, but were instead passing the risk along, their due diligence on creditworthiness went out the window. Adding fuel to the fire was the Government pushing to put hookers and crack addicts in homes that they couldn't afford, and using various exotic mortgage products, the banks complied. Then the investment banks bought these mortgages from the originators of the loans, packaged them into a "bond", and sold it as a AAA rated risk that paid a few basis points more than Treasuries. Pension funds and other institutional investors bought them because they met the fiduciary requirements of ERISA. So did foreign governments, and foreign investors.

Guess what? All of this bailout money has been going to these foreign banks and investors (primarily China and the oil patch) to make them whole, so they will continue to buy US Treasury debt to finance Government operations. Most pension plans and insurance annuities that have these "investments" are insolvent, because they cannot be sold, except at a huge loss. That is why the requirement of FAS 157 to mark assets to market has been suspended. That's also why AIG was bailed out, and continues to be, because they sold Credit Default Swaps, or insurance against non performance on these "bonds". The sad part is that most of these CDS's are held by parties unrelated to the original CDO. In essence, people were betting that other peoples investments would fail. In some cases, they actively worked to make this happen so they could collect on the CDS.

Bottom line, the financial system in the entire world is broken, and cannot possibly be repaired, There are over $1.4 Quadrillion of these derivatives out there, and $600 Trillion are based on mortgages. There are CDS's covering all of these derivatives from default. In other words, there isn't enough money in the entire universe to cover the paper involved. The Fed and the Treasury are throwing everything that they can think up to cover, but none of it is working, and the market reflects that. Expect it to get worse toward the end of the year. How much worse remains to be seen.