I've hammered the borrowers for creating the mess we are in without much enthusiastic support from you all. I don't blame you for wanting the bad guy to be the banks. They are an easy target. Greed trumps all.
Since the mid-1990s there has been a concerted effort on the part of politicians and policy makers to force banks to relax their lending standards. The crowbar that was used to open the bank vault was the charge of racial discrimination in lending. A Boston Fed study seemed to show that racial discrimination was the single factor that resulted in banks lending less to blacks than to other races. The authors of the study below debunks that study, but from the date that it was blessed by the Fed, banks that wished to keep their standards for lending were in deep trouble.
The Fed proclaimed that banks must evaluate a borrower's credit worthiness based on cultural factors. Banks that did not do so were open to fines of up to $500,000 for "discriminatory practices". So the banks complied and made the loans to borrowers who, previously, would not have qualified as credit-worthy. The banks did so grudgingly at first, and then aggressively as WaMu and CountryWide used Fannie Mae as a source of funds for subprime loans (with Fannie's encouragement) and exploded their revenues.
A Bear Stearns sales presentation documents that Bear accepted and promoted the Fed logic that people with bad credit were no longer people with bad credit and, therefore, that all the loans Bear was buying and tranching were AAA. Basically the whole world of judgment about credit-worthiness went nuts together in what appears to be a good-hearted attempt to get poor people into their own homes combined with political correctness that demanded no one challenge the underlying racial issue.
Amazingly, although the defaults of sub-prime borrowers are about 10 times greater than those of prime borrowers, both groups experienced a rise in defaults that contributed to the meltdown. It wasn't just sub-primes. The authors of the study below believe that the real culprit in this mess was the decision by banks to promote adjustable mortgages.
As the market heated up with the entry of millions of previously excluded buyers, loose money and low rates, prices went up and the speculators jumped in. TV shows like "Flip That House" were popular enough to indicate a broad interest in real estate speculation, particularly in California, where a buyer is not personally liable for a real estate mortgage and can, therefore, walk away if things go badly. Adjustable mortgage loans became very popular with speculators who didn't expect to own the home for 2 years, much less own it when the loan came due 5 years down the road.
Then things went badly. Real estate prices peaked and started to drop. Speculators who saw no hope of profiting from holding on simply walked away from their obligations. Foreclosures skyrocketed and suddenly all those loans on the books of WaMu and Fannie Mae and all the derivatives based on those loans that Bear Stearns owned and sold -- all that went flop.
And here we are.
Now go play.