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The Subprime Story As past and present bankers from Goldman Sachs, JP Morgan, Bears Sterns and Washington Mutual sit on the hot seat in front of Congress, Americans have to be collectively scratching their heads. What exactly are these guys guilty of? And, why won't any of them own up to any wrong doing? As the Congressional Financial Crisis Inquiry Commission continues to grill bank executives about the role each institution played in the recent economic crisis, a theme seems to be emerging: The banks did nothing illegal. Moral obligations aside, the path to the financial meltdown was paved in greed, but probably not criminal acts. The story starts with the rise in popularity of subprime lending, which is loans to borrowers of questionable credit worthiness. Once restricted by usury laws, subprime lending began to build after government deregulation in the 1980s. According to "A Short History of Subprime" published on Allbusiness.com, subprime lending was originally the purview of mortgage lenders like The Money Store and Countrywide Home Loans. It wasn't until the late 1990's that more traditional lenders began to take an interest in these types of loans. Starting in 1998, the smaller mortgage banks began to be acquired by larger banks, with Washington Mutual buying Long Beach Financial Corporation. By 2001, both Citigroup and Chase Manhattan Mortgage Corporation had acquired smaller lending components. While this was happening in the banking industry, the housing market was taking off with historically low interest rates and unprecedented increases in home prices. The building of the economic perfect storm was rounded out by what the article referred to as "subprime securitizations by Wall Street firms and the willingness of investors to buy those securities" starting as far back as the mid-1990s. According to the Federal Reserve Bank of Dallas, banks needed to be able to back these risky non-traditional loans in non-traditional ways. Most traditional, prime rate mortgage loans are funded by bank customer deposits. This is where it gets tricky, but not illegal. The proliferation of subprime loans began to be funded by what is called government sponsored enterprises, better known as Fannie Mae and Freddie Mac. The loans were pooled together, government guaranteed and then sold to investors. This worked well, until the loans got riskier and beyond the government sponsored enterprises. The rise of residential mortgage backed securities grew through the mid part of the decade as banks began to be more creative in pooling and packaging these loans to investors. Credit ratings for these investment packages were irrationally rosy, giving investors a sense of security in these investments based on very risky loans, all teetering precariously at the top of an inflated housing market. The story is all too well known now: The housing bubble burst, borrowers began to default on the risky loans, and investors opened their prettily packaged securities to find nothing inside. Americans were left holding the bag, while bankers seem to still be laughing all the way to...well, their own banks. For the moment, the Congressional grilling seems to be doing nothing more than causing some uncomfortable moments for the Wall Street elite. As the Federal Reserve and Congress grapple with new banking regulations, Americans seem to want the bankers to share in the responsibility for the economic crisis. They may or may not have done anything illegal, but it does feel like they did something wrong.
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