Fannie Mae and Freddie Mac simply packaged debt, and hardly the worst of the stuff. The real culprit was the widespread growth of variable rate mortgages.
Most traditional mortgages are fixed-rate. Homeowners agree to pay the bank __% over the course of the mortgage in return for the bank providing payment up front. The house is collateral so the bank doesn't lose money if the homeowner fails to make payment. Variable rate mortgages are simply promises to pay the bank a certain percentage over its own cost of securing funding. This is usually tied to inter-bank lending rates.
Variable rate loans were popular with banks because they pushed risk onto homeowners. Banks no longer risked losing money if their cost of borrowing spiked (and interest rates were at historic lows....). The same loans were popular with speculators who could get cheap capital to purchase housing in a rising market.
This causes: (1) an explosion of variable rate mortgage products, and lots of people getting them to cover real estate purchases, (2) increased (speculative) demand which drives up housing prices and encourages speculation, (3) people going further into debt using the increased value of their existing property as collateral. In many cases homeowners took out second mortgages just to give themselves more free income. This is a lot like borrowing cash from the bank using your Pets.com stock as collateral back in 1999.
The game becomes untenable in two situations (1) when money stops flowing into the housing market and prices stop rising, or (2) when interest rates rise.
The Republicans have really screwed up here. The Fed is trying to lower the cost of borrowing between banks to help push down the interest rate and keep people from being forced out of their homes by rising payments - a situation that would only exacerbate the financial crisis from the perspective of lenders who have paid $$$$ and are now stuck with the collateral worth $$ and falling. Banks are failing and so banks don't want to lend money to other banks. This causes the inter-bank borrowing rate to shoot up, further exacerbating the problem.
Now that spreads are soaring again we can expect a lot more foreclosures which will push more glut onto housing markets and tank the price of property. Perhaps even the collapse of the banking system. That might have happened anyway though, since no-one has any clue about what sort of money is being lost in derivatives.
Most traditional mortgages are fixed-rate. Homeowners agree to pay the bank __% over the course of the mortgage in return for the bank providing payment up front. The house is collateral so the bank doesn't lose money if the homeowner fails to make payment. Variable rate mortgages are simply promises to pay the bank a certain percentage over its own cost of securing funding. This is usually tied to inter-bank lending rates.
Variable rate loans were popular with banks because they pushed risk onto homeowners. Banks no longer risked losing money if their cost of borrowing spiked (and interest rates were at historic lows....). The same loans were popular with speculators who could get cheap capital to purchase housing in a rising market.
This causes: (1) an explosion of variable rate mortgage products, and lots of people getting them to cover real estate purchases, (2) increased (speculative) demand which drives up housing prices and encourages speculation, (3) people going further into debt using the increased value of their existing property as collateral. In many cases homeowners took out second mortgages just to give themselves more free income. This is a lot like borrowing cash from the bank using your Pets.com stock as collateral back in 1999.
The game becomes untenable in two situations (1) when money stops flowing into the housing market and prices stop rising, or (2) when interest rates rise.
The Republicans have really screwed up here. The Fed is trying to lower the cost of borrowing between banks to help push down the interest rate and keep people from being forced out of their homes by rising payments - a situation that would only exacerbate the financial crisis from the perspective of lenders who have paid $$$$ and are now stuck with the collateral worth $$ and falling. Banks are failing and so banks don't want to lend money to other banks. This causes the inter-bank borrowing rate to shoot up, further exacerbating the problem.
Now that spreads are soaring again we can expect a lot more foreclosures which will push more glut onto housing markets and tank the price of property. Perhaps even the collapse of the banking system. That might have happened anyway though, since no-one has any clue about what sort of money is being lost in derivatives.