HOW IT STARTED 1. U.S. government embarks on an aggressive home ownership policy empowering Fannie Mae and Freddie Mac to offer loans to potential buyers without regular credit analysis, at “teaser” rates for excessively high principal amounts. 2. Mortgage brokers and property developers jump on the bandwagon, encouraging new home owners to purchase houses they can’t afford and existing home owners to take out risky additional mortgages. 3. Result: a river of bad loans with a high probability of default on both interest payments and repayment of principal. THE DANGER GOES UNDETECTED 4. The initial loans held by mortgage banks, regional banks and money center banks are quickly sold to investment banks that repackage them into securities traded on the stock market, called Collateralized Debt Obligations (CDOs). 5. The mortgage, regional and money center banks retain no residual risk for the loans they make while collecting substantial fees from the investment banks for issuing the loans. This leads to a degradation of underwriting standards. 16 | Incentive | February 2009 | incentivemag.com
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Table of Contents for the Digital Edition of Incentive - February 2009