The bubble was bound to burst

To the editor: 

In the fall of 2008, a lot of us asked “howcould it go so bad so fast?” The short answer was the housing bubble burst in large part because of new investment instruments created byWall Street, “derivatives.” An investment vehicle that was so new and complex the federal regulators, big banks and evenWall Street claim they didn’t foresee the damage they would do.

Actually, the groundwork for the Great Recession was laid 40 years before. Fannie Mae, the Federal NationalMortgage Association, was created in 1938. It was established byWashington to provide local banks with federal funds to finance home mortgages. It worked pretty well for 30 years.

Then 44 years ago, in 1968, because of fiscal pressure created by theVietnam War, President Lyndon Johnson privatized Fannie Mae in order to remove it fromthe national budget. Fannie Mae began operating as a GSE (government sponsored enterprise) generating profits for investors while enjoying the benefit of implied government backing. The taxpayer lost control of Fannie Mae while retaining the liability.

Wall Street saw these billions of dollars in home mortgages, but they couldn’t be turned into profits as long as they were individual instruments. That changed with the creation of the firstCMOin 1983, almost 30 years ago. ACMO, a collateralized mortgage obligation, gathered hundreds of millions of dollars of mortgages then the different cash flows created were sold as separate investments.

These were the first “derivatives.”

So derivatives are nothing new. Wall Street has been tracking our nation’s mortgages, packaging them, and selling the “derivatives” for 30 years. Sophisticated models were used to project the actions of homeowners. Wall Street’s success was based on correctly predicting these trends.

So what did happen? Fannie Mae purchased sub-prime mortgage in part to increase profits and because of pressure fromWashington. In order to keep the money machine working,Wall Street started to include these subprime mortgages into the derivative mix.

Wall Street had spent 30 years developing these derivatives. They knew what would happen if enough subprime mortgages were included. They knew that the market would collapse; it was just a matter of when. 

JERRY GRUBB 

Danville