Much of the prosperity that occurred during the mid 1990’s into early 2000 came as the result of speculation over emerging technologies and the financial potential of the internet. The belief that business without national boundries and global consumers could be brought together with the click of a button produced a feeding frenzy of investment and speculation. How best to tap into this brave new financial world moved hungry investors into uncharted territory. What resulted was closer to the pioneers who flocked westward seeking their fortune with little law and great risk, as the result many became wealthy beyond imagination, others found financial ruin.

      By the middle of 2001 speculation was coming to an end which was hastened by the attack on the world trade center, pushing a economy that was beginning to show signs of struggle into recession. The Federal Reserve moved quickly to spur economic activity by cutting interest rates. Investors seeking a safer haven for investment shifted from stocks, into Real Estate and coupled with the lowest interest rates in decades helped to fuel a real estate boom. Zero interest on credit cards and low and no down payment auto loans and mortgages made it attractive for consumers and business alike to borrow. The new dollars that flooded the market primed a struggling economy which saved jobs and created new ones. Without banks the auto and real estate industry the recession of 2001 would have almost certainly been longer and harsher. However, it also set the stage for rising debt, fueled by the hope that the economy would eventually begin a new growth cycle based upon something more substantial than borrowed money.

     A similar phenomenon occurred around the country, driven by low interest rates and easy credit, fueling inflation in the housing market. Normally banks tend to be conservative in their lending practices. Lenders make little money when they write new mortgages, most of their profit comes by selling the new mortgage to a secondary market on wall street. Bundling together prime and sub prime loans in large numbers enabled banks to make loans to people with poor credit and limited income minimizing the risk to investors. Without someone willing to buy those loans banks would be less likely to take such risk, but with so many jobs and so much profit at stake no one waned to be responsible for shaking the foundation of the nations prosperity. With property values soaring people could use the equity in their homes to buy their way out of trouble.

     The number of people that had refinanced their homes 3 or more times in only a few years exploded, seeking just another twenty five thousand dollars to keep the ship a float. Rather than lenders engaging in predatory lending practices, borrows ran up heavy debts with little sense of responsibility, after all their was more money just another loan away. Home ownership has been a primary source of wealth creation in the U.S. Owning a home can put your children thru school, help with retirement and be a source for investment . It can also be used like a bank account giving people the opportunity to buy things they normally couldn’t afford. With rapidly increasing values people could run up their credit cards, buy expensive cars and even second homes looking to capitalize on rising values, all paid for by home equity and creative financing.

     No nation on earth makes it easier to borrow money than the United States. Limited government regulation means that lenders will adjust their lending practices based on their own assessment of risk. Using credit reports as a means of looking at how consumers pay back debt allows a lender to see a decade of credit history. More than sufficient time to understand the problem of high risk loans. Only a few years before the housing boom a person with a questionable credit history and an inability to document their income would be required to have a sizable down payment. Normally 20% which diminished the risk of default since the potential borrower would have a substantial investment of their own money in the new home. After 1999 things would change a combination of wide spread banking deregulation and pressure to increase home ownership among minorities would create a whole new class of borrowers and a new market for international investors.

      The question of why banks and wall street investors would take such risk is really at the core of the problem. Profits and ever increasing competition motivated lenders to find new and creative ways to capture a larger share of the market. None of this would have been possible without subsidy motivating normally cautious institutions to abandon conservative lending practices. Fannie Mae and Freddie Mac are privately owned companies that are securitized by the federal government. Both expanded their lending criteria to take increased risk with sub prime borrowers and they weren’t alone. Dozens of new lenders emerged eager to take advantage the fastest growing part of the explosive real estate market funded by a flood of international money. Motivated by the promise of substantial profits and the good intentions of the federal government.

     Pressure to increase home ownership among minorities and people with limited income and poor credit came in 1977 from the Carter administration in the form of the Community Reinvestment Act. In 1997 new teeth were put into the original law by the Clinton administration limiting new investment opportunity for banks if they didn’t comply. This gave increased leverage to minority business’s and communities to block new mergers with threats of lawsuits. In an effort to conform banks were forced to find increasingly exotic ways to lend to sub prime borrowers and with the government willing to subsidize the risk banks and investors were all to happy to comply. The nature of any subsidy is to produce more of what is being subsidized Pay farmers to grow corn and you get more corn. Pay them to grow less corn you get more farmers producing less corn. Subsidizing sub prime mortgages increased their numbers and they grew at double the rate of conventional home loans, substantially increasing the risk of serious financial failure.

     Programs to help minorities and people with modest credit and limited down payments were already in place more than 40 years before the Community Reinvestment Act. In 1934 the Federal Housing Administration was created as a way to increase home ownership. FHA as it became known is one of the few federal programs that is not paid for by tax payer dollars. Instead it is largely self sustaining with premiums paid by the borrower insuring a portion of the mortgage against default. Making it possible for private institutions such as banks, savings and loans or credit unions to lend to people with less than perfect credit by helping to insure the lender against loss.  However under FHA guidelines the client must be able to document sufficient income to pay their monthly debts. With pressure from the Federal Government to increase home ownership, programs like FHA weren’t enough. The criteria for determining credit worthiness would have to change. Enabling home buyers with poor credit no down payment and no closing costs to walk into a home without any financial stake of their own, and do little more than sign their name.