I'd recommend Andrew Leonard's "How The World Works" column on Salon.com. He's done a great job of explaining the whole mess, starting with the housing bubble, in layman's terms.

This is for after you talk to mullacc, of course.

Thanks BoPo, I'll check it out.

This explained the entire thing in 59:03 more effectively than weeks of reading about it was able to do. There's a follow-up here.

Fannie Mae was a New Deal program meant to provide liquidity to the mortgage markets. It went "private" in 1968 (which I believe had to do with financing the war effort in Vietnam). Freddie Mac was created to give Fannie some competition. Both were privately-owned companies, but the market always assumed an implicit guarantee from the US government and the two companies had a federal regulator. That implicit guarantee gave Freddie and Fannie a funding subsidy and thereby they came to dominate the US mortgage market. By relying on this implicit guarantee, investors created a self-fulfilling prophecy that forced the government to make good on that guarantee (and now Fannie & Freddie are explicitly guaranteed). BTW, Fannie and Freddie, along with the government-owned Ginnie Mae, are collectively referred to as GSEs (government-sponsored entities).

Your dad is right that Fannie/Freddie made it possible for more low-income borrowers to afford homes. The Democrats were big backers of the GSEs because it was a vehicle for affordable housing. Some Republicans have always hated the GSEs because they're a big New Deal throwback.

But the GSEs are NOT the primary culprit in this debacle. They were a factor, but not the driving engine. Wall Street loved the GSEs because they provided a way to supercharge the mortgage-backed securities (MBS) market. For a long time, it was VERY profitable for banks to originate loans that conformed to Fannie/Freddie standards and then sell those loans to Fannie/Freddie, or even simply sell pools directly to the MBS market with Fannie/Freddie guarantees.

And since banks could lay-off most of their vanilla mortgages to Fannie/Freddie, they could use their capital for more creative/risky/innovative investing. Sub-prime lending, which are by definition "non-conforming" loans, grew out of this.

Two phrases you hear a lot in these discussions are "originate and distribute model" and "regulatory arbitrage". Both refer to this basic model I describe above. The old school bank model in which a bank generates a mortgage and then holds it on its books does not generate a sexy return on capital--bank regulations force banks to hold a certain amount of capital against those loans. But if you originate a bunch of mortgages, sell off the high-quality mortgages to the GSEs and then package the rest into securitizations (MBS), you can collect a shitload of fees and residual income while dedicating relatively little capital to the operation. This is basically a loophole in the regulatory scheme. It allows banks and other players to pile on a ton of leverage and generate very sexy returns on capital.

The supercharged mortgage industry drove up home prices, so Fannie and Freddie were forced to reduce standards in order to continue providing affordable mortgages.

This lasted until sub-prime mortgages started defaulting and investors were no longer willing to buy the crappy MBS that banks were selling. And since home prices are inextricably linked to the mortgage markets, falling home prices and locked up mortgage markets create a reflexive death spiral.

to sum up: It appears to be a highly complex and intertwined issue that no one can (or should be able to) tidily polarise or sum up by pointing the blame at [specific political entity].

thanks mullacc, that made more sense than anything else I've read lately.

mullacc is SO very right that it's not the GSEs which were the primary problem. You have to take into account the crazy rise of the residential-mortgage-backed securities trading in the collateralized debt obligation markets, which followed the millions of dollars in defaults in the savings and loan crisis of the late 1980s. (I rather like this paper from Feb 2007, as an explanation of what the problems of subprime lending were and were going to be. It does not get into the history of residential-mortgage-backed securities, though, but it's really fascinating and hideously dense and most of it goes out of my head as soon as I learn it).

It's complicated, too, because not all of the "foreclosure crisis" is from "bad" subprime lending (e.g. loans to people with no proof of any income at all, loans for 4 times what a subprime borrower could ever hope to pay back, "investors" who took out no-proof-of-income-loans and planned to sell before the first mortgage payment came due). Restructuring ("bailing out") the non-bad subprime loans that are in default and/or in foreclosure works for the greater good. If the mortgage companies take too many losses (and in foreclosure they almost always do), home prices and credit market will stay locked in that death spiral.

Great synopsis, mullacc.

On the political side, while Carter and Clinton did both sign milestone bills, those bills built onto programs (with somewhat shaky foundations to begin with) that the Republicans also had their hands in. No one gets a free pass on this one. Throwing blame at one side or the other is a pointless exercise. Rather, the issue now is deciding who has the less risky solution.

i love you mullacc!

Slate has a decent article on the subject.

Basically, someone sold and bought the Brooklyn Bridge about 60 trillion times.

I'm listening to the follow-up TAL episode about the bailout package and I have to say that listening to both of those shows really explained it all in a way that was objective and clear.

What I got out of part 1 is that because the global economy needed to invest their money somewhere and U.S. bankers wanted to get some of it, they tried to come up with new ways to make it, and that's when someone came up with the subprime, no income verification loans, etc. Which lead to the rampant buying/selling of mortgages, etc.

Because such a thing had never been done before, the traditional indicators of whether or not such a thing was safe were wrong, and no one thought to come up with a new one just yet, so even firms that were traditionally good bets were buying them like crazy.

And then when someone who can't verify their income all of a sudden doesn't have an income and defaults on their loan, and that keeps happening, you get a collapse of the system.

Basically, homeowners who didn't do enough homework into the mortgages, mortgage brokers who sold them, broker-traders who bundled them and sold them up, the investment firms that took those and traded them, everyone else, and the person who created these kinds of loans... those are the people to blame.

Signed,
Smug Renter Whose Rent Money is Essentially Paying for Her Roommate's Mortgage

Thanks all! I'm catching up on all this now.