It Was Fannie and Freddie! (Part-2)

There was a lack of responsibility in the financial sector that spread like a severe form of cancer leading up to the financial crisis of 2008. Ordinary people who wanted a slice of the "American Dream" were instead given toxic subprime mortgages. Before securities took hold of the housing sector, a family wanting to purchase a house would go down to their local bank and apply for a mortgage. They would pay their monthly mortgage directly to that bank until the house was paid off. Since this process took so long to complete, banks were fairly strict on who they lent to. Securities changed that.

Instead of paying your local bank directly, the bank would sell your mortgage to investment banks such as the ones discussed in Part-1 like, Goldman Sachs, Merrill Lynch, Lehman brothers etc. Once the mortgages were in the hands of the investment banks they would put them in a bundle called CDO's or, Collateralized Debt Obligations. These CDO's contained student loan debt, car loans, credit card debt, among other forms of debt along with your mortgage. The investment banks would then turn around and sell the CDO's to investors. Once sold to investors your little mortgage that you thought was being paid to your local bank was now in the hands of millions of people world wide.

At this point in what has been dubbed the "securtization food chain" there is no one that cares if you pay your mortgage. This is why mortgage banks, or lenders in general, were giving out so many subprime mortgages to so many unqualified people. There was no risk. What all these institutions allowed themselves to believe was that housing prices could never decrease. The Fed chair at the time, and still, Ben Bernanke famously said in July of 2005, "We’ve never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s gonna drive the economy too far from its full employment path, though." 

As we all know now, the housing market did decline, people did default, and banks/investors were caught holding the bag all around the world as most of the industrialized world went into recession. 

In Part-3 I will discuss how and why this was allowed to happen.