Checks and balances down the securitization chain

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hold securitized assets on their balance-sheets with little capital backing them. Checks and balances down the securitization chain thus weakened. This allowed subprime mortgage lenders to pursue aggressive lending practices. A subtle effect of the subprime lending boom was that the share of higher quality – “conforming” – mortgages fell. As described in Chapter 3, the GSEs gradually lost market share in the MBS market. To keep up profits for their shareholders, they started buying ever more risky mortgages in the years 2003 to 2007. The quality of their portfolio was not helped by Congress’ mandate for Fannie and Freddie to buy an ever higher proportion of mortgages from low-income households and underserved areas. Not long after house prices peaked in the summer of 2006, the first subprime mortgage lenders started to go belly-up. Bear Stearns’ hedge funds collapsed in June 2007, primarily due
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63 to problems in their mortgage portfolio. In 2007, Freddie and Fannie’s gigantic portfolio of loans incurred $8 billion in credit losses, and the GSEs turned their first annual loss after fifteen years of record profits. These credit losses spiraled out of control in the second half of 2008. Because the GSEs were so highly levered, any credit losses had a dramatic impact on their solvency. On September 7, 2008, the GSEs were placed in the government’s conservatorship. As of the late summer of 2010, the GSEs have used up $145 billion from their initial $200 billion government lifeline, with analysts projecting at least another couple of hundred billions to fill the hole of their credit losses from their misguided mortgage investments of 2007 and earlier. This bailout will have the largest net costs (outlays minus recoveries) of all of the government’s bailout efforts, far exceeding the cost of the AIG bailout or the TARP program. The GSE bailout represents the creation of a “bad” bank for mortgage-related losses in the United States. Through the conservatorship, the government has kept the mortgage market afloat in 2009 and 2010, and it has used the GSEs as a tool for mortgage modifications. This chapter relives the collapse in slow motion. 5.1 Falling Off a Cliff On March 1, 1984, NASA sent the fifth Landsat satellite into space. At an altitude of 450 miles, its purpose was to transmit pictures of Earth, taking about 16 days to cover its entirety. At the U.S. Geological Survey’s center for Earth Resources Observation and Science, one can download these pictures over the last 25 years. Focusing on images of Las Vegas in five-year intervals from 1984 to 2009, one can observe the remarkable growth of this city -- its push towards the desert just west of Vegas in the 1980s, southward in the 1990s, and finally southwest by 2004. From a population of 741,000 in 1990 to 1,846,000 by the end of 2005, with a corresponding increase in housing units of 317,000 to 737,000, Las Vegas was the fastest growing metropolitan area in the United States.
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