Was the growth in private label mbs the culmination

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Was the growth in private label MBS the culmination of the dream of the deregulation advocates of the 1980s coming to fruition, albeit two decades later? Or was it the emergence of new government-sponsored enterprises in the form of too-big-to-fail financial institutions? We argue the latter, and, with this emergence, came a battle between the GSEs and the too-big-to- fail large complex financial institutions (LCFIs), and a race to the bottom in mortgage finance. We argued in chapter 1 that no private firm could compete with Fannie and Freddie because of Fannie and Freddie’s access to government guaranteed capital. So how did the competitive race to the bottom play out till it all ended? One way that the private sector started competing was through moving down the credit curve of increasingly shaky mortgage loans -- loans that were difficult for Fannie and Freddie to compete with, given their “conforming loan” underwriting standards. But this is not the whole story, as it still does not explain why anyone would purchase high-risk MBS in the first place. The standard argument in the media is that securitization markets failed because originators and private firm securitizers of mortgages did not have skin in the game, and naïve investors – such as the proverbial Norwegian village -- were left holding the bag. But the evidence does not bear this out. A Lehman Brothers study from 2008 showed that over 50% of AAA-rated non-GSE MBS were held within the financial sector, which was highly concentrated in just a few LCFIs. For example, in June 2007, just prior to the start of the financial crisis, a dozen firms held almost two-thirds of all of the assets of the top 100 firms ($21 trillion) and
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39 constitute a “who’s who” of the crisis that subsequently emerged: in order, Citigroup, Bank of America, JP Morgan Chase, Morgan Stanley, Merrill Lynch, AIG, Goldman Sachs, Fannie Mae, Freddie Mac, Wachovia, Lehman Brothers, and Wells Fargo. (Bear Stearns and Washington Mutual come in at No. 15 and 17, respectively.) All of these LCFIs were actively engaged in the mortgage market, and, of these 15 firms, one could convincingly argue that at least 9 of them either failed or were about to fail in the absence of government intervention. Of course, the GSE firms and these LCFIs were not identical in form. The LCFIs had a more diversified product line, were afforded greater flexibility, and increasingly were perceived to have a too-big-to-fail government guarantee -- while the GSEs had a public mission, received a more explicit government guarantee, and were subject to lighter capital requirements. But when one digs beneath the surface, the failure of the LCFIs and the GSEs is quite similar – a highly leveraged bet on the mortgage market by firms that were implicitly backed by the government with artificially low funding rates only to differing degrees.
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