A Straightforward Description of How Government Caused the Financial Crisis

Simple to follow and easy to understand: AIG is Left Holding the Government’s Bag:

On March 16, Obama said this about AIG:

I do want to comment on the news about executive bonuses at AIG. … This is a corporation that finds itself in financial distress due to recklessness and greed. Under these circumstances, it’s hard to understand how derivative traders at AIG warranted any bonuses, much less $165 million in extra pay. I mean, how do they justify this outrage to the taxpayers who are keeping the company afloat?

In the last six months, AIG has received substantial sums from the U.S. Treasury. And I’ve asked Secretary Geithner to use that leverage and pursue every single legal avenue to block these bonuses and make the American taxpayers whole.

Yes, AIG and other financial institutions indeed were reckless. The essence of their recklessness was that they trusted and unwittingly bailed out the US Government. Now the US Government has returned the “favor,” with strings—tied into a noose—attached.

Let us review the sequence of events, which began with the Government’s creation of Fannie Mae (in 1968) and Freddie Mac (in 1970):

1. The U.S. Government, armed with the Community Reinvestment Act of 1977, forces banks to make home loans to people who cannot afford to repay the loans. At the same time …

2. Fannie Mae and Freddie Mac—Government-sponsored enterprises (GSEs)—create a credit-scoring formula with a very low qualifying score. They tell banks and other lending institutions, “If you make a home loan to anyone who meets our low qualifying score, we will buy the loan from you at a profit to you.” The lenders play along and make more bad loans. The GSEs play along too and buy the bad loans from the lenders. The GSE’s create a portfolio of about $6 trillion (half the mortgage market) in this manner.

3. At this point, the mortgage crisis is unavoidable, because this mortgage portfolio that is nominally worth $6 trillion is really worth much less, because the people who took out the mortgages will not be able to pay them back. Many of these people would not have gotten a mortgage in a free market. Others would have gotten a smaller mortgage, to buy a home for a much lower price than the price they had to pay; the artificial demand created by the GSEs has caused home prices to skyrocket.

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