The U.S. economic recession that started in September 2008 has fundamentally changed the way commercial and consumer credit will be traded,
approved, and overseen for the next decade, and possibly beyond. Much the same way that the stock market crash of 1929 shook the nation, the 2008
crash from a market high of 15,000 on the Dow down to 7,500 on the same index changed the financial landscape worldwide.
To put it simply, the damage was driven by greed, easy money, and easy credit approvals. And
like a tumbling house of cards the credit collapse was inevitable when one of the main
underpinnings of real estate loans began to fall down.
When the recession drop did occur, however, the federal government and the Federal Reserve
were under significant pressure and demand to address the problem quickly. Since market
values and investments could not be returned, just waiting for a few bad banks to fail would not
work. The very institutions that supported the markets as a whole needed to be saved. This
required the government to step in and effectively buy out these institutions to keep their
accounts from going insolvent. In doing so, the Treasury and the Federal Reserve took charge
of what would become known as the credit bailout or the now famous TARP program, short for
“Troubled Asset Relief Program”.
Immediate Crisis Demands
The scariest and most alarming concern during the 2008 drop in the first weeks was that the
main U.S. banks would go insolvent, creating an even larger financial crisis across the country.
Much like 1929, fiscal panic raged, with concerns that if the banks failed so would everything
else. Some pundits recommended that the troubled institutions should collapse. A number of
banks and financial houses were untouched or strong enough to weather the immediate storm,
so the thinking suggested those that failed simply couldn't compete anymore under pure competition and a free market. While generally true, this
approach ignored the basic fact that without enough large institutions to sustain credit in the market, the U.S. dollar would suffer as the rest of the
world pulled back into their own borders. With so much of U.S. debt already owned by China and other countries, two wars raging in the Middle East,
and a now failing economy at home, the U.S. leadership was in no mood to let its home-grown financing institutions fail as well.
The problem for the inflicted banks was their real estate and investment portfolios. The majority of homes
bought in the U.S. by 2008 were processed through Freddie Mac and Fannie Mae, government
corporations set up to support banks and lenders in making home loans to first time home buyers.
However, due to a surge in buying, equity pricing, and quick turnover of homes, the market had heated
up to huge valuations on home properties. Additionally, both mortgage brokers, financiers, and banks saw
easy money in thousands of new loans being generated at ridiculous amounts. The more that could be
churned, the more profit could be made.
The interest alone generated after 15 years could buy a second house. Yet, as these new home loans
were financed, banks wanted to sell them off as quickly as possible to generate new loans. For the small
price of short-term financing, the banks were making profit margins on loans they then submitted to
Fannie Mae and Freddie Mac for purchase. The two government institutions then re-packaged the loans
into securities, similar to bonds or shares in a mutual fund, which could then be traded on security
markets. The loans were combined into tranches of a security which would then be rated by credit raters
on the basis of the loans' combined risk. But the rating criteria used was lax and bad loans were mixed in
plenty with good ones, the sum then being labeled good security risks.
At first, in the early 2000s the lend-buy-securitize process worked well and made money for everyone.
Homebuilders sold homes quickly. Borrowers could take their rising equity in a new home and refinance
or sell their home to a hungry market and pay off their loans for a bigger home. Banks got their money back either from quick payoffs or from the
federal corporations. Investors bought what they thought were well-paying securities. And given the rising real estate valuations, the Fannie
Mae/Freddie Mac securities sold well to other institutions looking to make more profit off of loan interest.
Credit Bailout .com