To, continue the conversation….
Joe, like you I have an imperfect understanding of the situation. I don’t have an overall theory as to why things occurred as they did. Here’s a few factors that I think at least contributed…
I think there was a general recognition of the possibility of a problem, both with Fannie Mae and mortgage lending generally. Fannie Mae has always been that weird entity that wasn’t really public and wasn’t really private. Over the previous period, it became too focused on profits. I’m pretty sure that Warren Buffet had a significant Fannie Mae/Freddie Mac position in years past because it was generally a cash machine.
The problem, a problem that I think government saw but didn’t do anything about, is that the housing market was running out of the “good” borrowers. Fannie Mae required growth in order to keep expanding profits. Expanding beyond “good” borrowers was acceptable public policy because it allowed for the expansion of home ownership.
Just as that was happening, Greenspan was attempting to fight deflation. The entire world was flush with cash. For example, for much of the last decade the Japanese central bank pursued a negative real-interest rate policy. Yes, that means that in Japan, after inflation, you were basically being paid to borrow money. In what was known as the carry-trade, people would borrow huge sums in Japan and invest in mortgages here. They were getting paid in both places.
When that much cash is around there needs to be a place to put it. That place ended up being property markets around the world. When you run out of good borrowers, you find slightly less good borrowers. Then even worse borrowers. As long as property prices are going up and as long you can off-load the mortgage you just made onto a cash-flush world, you keep profiting.
But, as WaMu found, if property prices don’t go up and you can’t offload that mortgage, well…
While tighter regulation of Fannie Mae may have helped somewhat, I think that the majority of the problem came outside of the types of loans that Fannie Mae would be involved in. Fannie Mae had regulated guidelines regarding what loans it could purchase. I betcha that Fannie and Freddie end up being the least expensive aspect of the bailout. I think there is more governmental culpability with Fannie however because of the underlying implication that it was a governmental entity.
It was in the unregulated areas of mortgage brokers and investment banks which the most egregious problems occurred. Over a period of years, we have gone from bank-funding of mortgages to investor funding of mortgages. Investors got careless.
Investors will get careless again. I know this sounds kinda weird, but I think that the world is too rich. People don’t know where to put money in order to achieve the kinds of returns they want to achieve. In the last decade, we’ve had bubbles in the telecom industry, the internet industry, commodities and housing.
Alternative energy, imho, is next. I’d suggest getting in early, getting out early and then sitting back complaining as the government bails out windmill owners.