Financial markets no longer reflect human activity. This is the result of short term trading driven by AI
systems and algorithms to generate enormous sums of wealth. This has led to the financialization of
the economy as finance is growing as a percentage of the economy. This means that many of the
financial institutions focus on providing services rather than on investing in physical production or
innovation that would improve standards of living. The real economy is being ignored.
In 1994 then president Bill Clinton pressured Robert Reich into pushing for government pension funds
to invest in affordable housing. That year Reich testified before congress and urged pension funds to
support the president’s “Economically Targeted Investment”. Housing and Development secretary
Henry Cisneros convinced pension funds that investing in affordable housing is just as safe as
investing in stocks and bonds.
Six pension funds decided to invest in public housing and it was supported by $100 million in grants
from the federal government. Eventually, pension funds turned away from this effort to direct any of
their money to someone else’s benefit.
Clinton succeeded in getting Freddie Mac and Fannie Mae and the lending industry into the affordable
housing movement. This was accomplished by utilizing a portion of the Community Reinvestment Act,
a 1977 housing bill, that mandated that banks meet local credit needs.
I’m going to quote the next three paragraphs of the article.
“Effective in January 1993, the 1992 housing bill required Fannie and Freddie to make 30% of their
mortgage purchases affordable-housing loans. The quota was raised to 40% in 1996, 42% in 1997,
and in 2000 the Department of Housing and Urban Development ordered the quota raised to 50%.
The Bush administration continued to raise the affordable-housing goals. Freddie and Fannie
dutifully met those goals each and every year until the subprime crisis erupted. By 2008, when both
government-sponsored enterprises collapsed, the quota had reached 56%. An internal Fannie
document made public after the financial crisis (“HUD Housing Goals,” March 2003) clearly shows
that by 2002 Fannie officials knew perfectly well that these quotas were promoting irresponsible
policy: “The challenge freaked out the business side of the house [Fannie] . . . the tenseness around
meeting the goals meant that we . . . did deals at risks and prices we would not have otherwise
done.”
The mortgage market shows the dramatic results of this shift in policy. According to the nonprofit
National Community Reinvestment Coalition, total CRA lending rose to $4.5 trillion in 2007 from
$8 billion in 1991. The American Enterprise Institute’s Ed Pinto found that in 1990 80% of the
residential mortgage loans acquired by Fannie and Freddie were solid prime loans with healthy down
payments and a well-documented capacity by borrowers to make mortgage payments. By 1999 only
45% of their acquisitions met this standard. That number fell to 15% by 2007. By 2008, roughly half
of all outstanding mortgages in America were high-risk loans. In 1990, very few subprime loans were
securitized. By 2007 almost all of them were.
Everything appeared to work fine as long as accommodative monetary policy and ca
pital inflows from developing countries continued to fuel the upward float of housing prices. Home
ownership grew to 69% in 2006 from 64% in 1993, but when monetary policy tightened the housing
bubble broke and the mortgage-default rate soared.”
Its surprising that 28 million high risk mortgages were made during the housing bubble that did not
meet follow regulations that ensure safety. No one has gone to jail for this. A review of the banking
regulations added since 1980 reveals that not one regulation was repealed. Conflicted laws led to
conflicted regulations and conflicted regulators.
During the Clinton administration the Glass Steagall Act which separated commercial from
investment banking was repealed. Investment banks tends to take risk on securities such as
derivatives. During the housing bubble commercial banks took their mortgages and sold mortgage
back bonds to investors. This created a great deal of risk. Also, banks sold credit default swaps to
ensure the bonds.
In recent years the derivative market has grown tremendously. Currently, the value of all
outstanding derivative contracts is $542.4 trillion while the gross value is $12.7 trillion. Derivatives
are securities that derive its value from another security. There are three types of derivatives,
futures, options, and default swaps. A future is a contract for future delivery of a commodity if the
commodity is sold before the delivery date the commodity is not delivered. There two types of
options. A put is an option for the right to sell a stock at a certain price by a predetermined date.
A call is an option for the right to buy a stock at a certain price by a predetermined date. A default
swap mitigates risk for the failure of a bond. A credit default swap ensures against the failure of a
bond.
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