Simultaneously, The Community Reinvestment Act (Cra) Of

The mortgage crisis of 2007 marked catastrophe for millions of homeowners who suffered from foreclosure and short sales. Most of the problems involving the foreclosing of families’ homes could boil down to risky borrowing and lending. Lenders were pushed to ensure families would be eligible for a loan, when in previous years the same families would have been deemed too high-risk to obtain any kind of loan. With the increase in high-risk families obtaining loans, there was a huge increase in home buyers and subsequently a rapid increase in home prices. As a result, prices peaked and then began falling just as fast as they rose. Soon after families began to default on their mortgages forcing them either into foreclosure or short sales. Who was to blame for the risky lending and borrowing that caused the mortgage meltdown? Many might blame the company Fannie Mae and Freddie Mac, but in reality the entire system of buying and selling and free market failed home owners and the housing economy.

The world’s financial system was almost brought down in 2008 by the collapse of Lehman Brothers that was a major international investment bank at that time. The government sponsored these banks’ bailouts that were funded by tax money in order to restore the industry. Before the crisis, banks were lending irresponsible mortgages to subprime borrowers who had poor credit histories. These mortgages were purchased by banks and packaged into low-risk securities known as collateralized debt obligations (CDOs). CDOs were divided into tranches by its default risk. The ratings of those risks were determined by rating agencies such as Moody’s and Standard & Poor’s. However, those agencies were paid by banks and created an environment in which agencies were being generous to ratings since banks were their major clients.

With the obvious incentives of complying with the CRA, local bankers began to tap into markets that would have been considered prior to CRA enforcement in the late 70’s. These lower-income areas proved fiscally viable, and began to draw the attention of financial institutions other than depository banks. These investment banks were involved in speculative investment and resale of mortgages and were not regulated under the terms of the CRA. Non-CRA covered lending institutions have played an increasingly large role in lending to low-income neighborhoods since the law was enacted.

Many factors that led to the crash of the financial markets in 2008. Liberals and conservatives have differing views on the reasons for this crisis. From 1980 to 2007, deregulation, HUD, the Community Reinvestment Act (CRA), and bank management pushing banks to make high risk loans caused the market to shatter. Hedge funds contributed a humongous portion of the market crash. A commission of conservatives and liberals was established to try get to the bottom of how the stock market crashed. The name of the commission to conduct this study is Financial Inquiry Commission.

As competition increased between savings and loans, banks, and credit unions, banks were eager to attract loan applicants in order to increase revenue and compete with other financial institutions. Jack S. Light, the author of Increasing Competition between Financial Institutions, said in his book that “commercial banks are diversifying their assets toward higher percentages of mortgages and consumer loans, and thrift institutions are seeking authority to diversify their loan structures. Moreover, mounting pressures are working toward, and have partially succeeded in, changing the authority of thrifts to include third-party payment accounts similar to commercial bank demand deposits.” (Light) Because of this eagerness to bring in new clients, they were willing to give out loans without checking into the financial stability of the borrower or the business that was requesting the loan. Unfortunately since the banks didn 't look into their clients’ financials adequately, many clients defaulted on their loans because they could not afford the payments, especially when balloon payments started.

“Growing income inequality in the United States stemming from unequal access to quality education led to political pressure for more housing credit. This pressure created a serious fault line that led to distorted lending in the financial sector.” (Rajan,2010, P.54)

During this time period, homeownership typically required a 20 percent down payment (Melicher & Norton, 2014, 168). Lending institutions were very careful about whom they lent money to, and credit standards were high (Melicher & Norton, 2014, 168). Melicher & Norton (2014) called this the “save now, spend later” philosophy, and it would change in the coming years (p. 168).

The CRA originated in 1977 to combat mortgage discrimination in the U.S. In 1995, the CRA required all mortgage-lending banks to be rated by their demonstrated efforts to lend to LMI residents. This CRA requirement involved members of two political parties and it was made to expand homeownership rates among minorities and the poor. Part of this bipartisan consensus was the Clinton, and both the Bush Administrations.

In the early-2000s, Moody’s, one of the leading credit rating agencies in the world, evaluated thousands of bonds backed by so-called “subprime” residential mortgages—home loans made to those with both low incomes and poor credit scores. When housing prices began to fall in 2006, the value of these bonds disintegrated, and Moody’s was compelled to downgrade them significantly. In late 2008, several commercial banks, investment banks, and mortgage lenders that had been

According to the author, the 2007 financial crisis began when banks and mortgage companies used several questionable strategies in order to lure customers into buying mortgages they could not afford. Not only were over ¾th of the mortgage loans made to individuals with bad credit disregarding the risks this would entail but they also

One of the first indications of the late 2000 financial crisis that led to downward spiral known as the “Recession” was the subprime mortgages; known as the “mortgage mess”. A few years earlier the substantial boom of the housing market led to the uprising of mortgage loans. Because interest rates were low, investors took advantage of the low rates to buy homes that they could in return ‘flip’ (reselling) and homeowners bought homes that they typically wouldn’t have been able to afford. High interest rates usually keep people from borrowing money because it limits the amount available to use for an investment. But the creation of the subprime mortgage

It should be noted, prior to the crisis, there was already an increasing concern of economists and critics about the credit quality that was provided by the financial sector at the time when there was low interest rates that were applied by the government. There were also issues about the inappropriateness or ineffectiveness of the standards that were used in extending credit by the financial sector (Calvo, 171).

The act encouraged banks to lend to low- and moderate-income neighborhoods. While this was an admirable goal, some believe that to meet quotas established by this act, banks were forced to engage in imprudent lending. In the 1980s, coming off a recession, Congress enacted several laws designed to promote free enterprise by reducing regulations. One of these laws was the Alternative Mortgage Transaction Parity Act of 1982, an act that permitted the creation of adjustable rate mortgages, balloon mortgages, and negative amortization mortgages. These would be the types of mortgages that would create what became the subprime crisis, as buyers who did not qualify for standard mortgages, at prime interest rates, would be attracted to these higher-interest-rate mortgages and eventually default on them.

The structure had always carried the risk of the crisis going global. Investor confidence stumbled globally, the negative sentiment spread throughout the market and no one wanted to buy these securities, leading to a crash in their prices. Banks, having to use Mark-to-Market accounting practices, were forced to write-down losses on these securities into their balance sheets. This resulted in large losses across the banking industry in the third and fourth quarters of 2007 (Tiller, 2010). Bear Stearns finally collapsed on March 16, 2008 and was later sold to JP Morgan Chase.

A rating agency was required find out the creditworthiness of an investment. This can apply to any company, bank, government or an investment. There were namely 3 famous rating agencies involved in the crisis namely, Standard & Poor's (S&P), Moody's, and Fitch Group. To give an example of a rating would be like the big internet search company “Google” would be given a rating like AA+ i.e. a high grade. Many of these CDOs however were given good ratings such as AAA+ the highest rating possible given by any rating agency. These CDOs did not deserve the rating as the CDOs were made of mortgages of lenders who were unable to pay their mortgage. The reason for such a high rating was simple. In the past, rating agencies were paid by the buyer to rate the assets they were going to invest in. In 1970s however, the systems changed and now it was the seller that was paying the agency for the ratings, on a per-rating basis. This gave incentives for rating agencies to rate more and be more generous in their rating. A conflict of interest rose and rating agencies were now earning large amount of profit for these CDOs. They were more then happy to rate them. Moody’s earned nearly US$1 billion a year from rating in 2005 and 2006. With an average of $300k per rating why wouldn’t they want to rate more? Aside from that, they had to give a good rating due to