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Sep 22

Written by: Diana West
Monday, September 22, 2008 12:14 PM 

From a nod to the US government's financial guarantees and social engineering that together seem to have triggered sub-prime meltdown:

....But lack of oversight is hardly the problem, Richman said, because “the financial industry is regulated all over the place.” In Richman’s analysis, it is precisely the government guarantee of Fannie and Freddie that is “short-circuiting” the market.”
That guarantee “removes market discipline,” emboldens banks to make bad loans, and encourages Fannie and Freddie to back them. This, Richman asserted, is a “moral hazard.”
“It’s like if I invite you to Vegas and say the winnings are all yours and I’ll cover your losses,” Richman said. “You’re going to have a great old time. On the other [hand], if you go by yourself and you know you’ve got to cover your losses, you’re going to behave differently, and that’s been the problem.”
Providing context, Richman said government policy laid the foundation of this crisis more than 30 years ago when Congress passed the Community Reinvestment Act of 1977. This law forced banks to loan money to low-income borrowers as a way to ensure that financial institutions would “meet the credit needs of the local community.”


Under the Clinton administration, federal regulators began using the act to combat “red-lining,” a practice by which banks loaned money to some communities but not to others, based on economic status. “No loan is exempt, no bank is immune,” warned then-Attorney General Janet Reno. “For those who thumb their nose at us, I promise vigorous enforcement.”   
The Clinton-Reno threat of “vigorous enforcement” pushed banks to make the now infamous loans that many blame for the current meltdown, Richman said. “Banks, in order to not get in trouble with the regulators, had to make loans to people who shouldn’t have been getting mortgage loans.” 
This threat combined with the government backing of Fannie and Freddie set the stage for the current uncertainty, because the “banks could just sell the loans off to Fannie or Freddie,” who could buy them with little regard for negative financial outcomes, Richman said.

Until now.


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