A Fighting Chance

By selling the mortgages to investors, the banks had more money to lend. That turned out to have good and bad elements: more people now had access to mortgages and could buy homes, but with more mortgage money available, the housing bubble also began to inflate and prices began to rise. See “The Financial Crisis Inquiry Report.” The 2008 crisis had many contributing factors and no one solution can address all of them, but I partnered with Senators John McCain, Maria Cantwell, and Angus King several months after arriving to the Senate in proposing a twenty-first-century Glass-Steagall Act to dial back the risk and shrink the largest institutions. The big banks remain adamantly opposed, but we’ve had some strong support from Americans for Financial Reform, the Progressive Change Campaign Committee, and many other groups who are fighting for a safer banking system.

out to make a quick buck: Banks became heavily involved in developing and peddling mortgage-backed securities in the 1990s and 2000s. As Fannie Mae and Freddie Mac focused on securitizing prime mortgage loans, banks, thrifts, and investment banks focused on securitizing riskier mortgage loans, such as subprime loans, “Alt-A” loans, and non-conforming loans. Since interest rates were low, many investors were looking for safe investments that would pay higher premiums. Home mortgages seemed like the perfect answer, with low default rates and higher returns. Over time, originators began to peddle more and more high-risk mortgages to satisfy the greater and greater demand for the securities. And the mortgage bundlers developed more and more refined techniques for disguising the risk, even fueling further demand for the securities. Thus originators peddled more and more high-risk mortgages to satisfy greater and greater investor demand for the securities. This was all done with the imprimatur of the credit rating agencies that repeatedly signed off on the safety of the underlying packages of mortgages. Between 2003 and 2007, financial institutions created more than $4 trillion in mortgage-backed securities. See “The Financial Crisis Inquiry Report.” As the Financial Crisis Inquiry Commission noted, this “originate-to-distribute model undermined responsibility and accountability for the long-term viability of mortgages and mortgage-related securities and contributed to the poor quality of mortgage loans” (125).

got more and more complicated: “In the first decade of the 21st century, a previously obscure financial product called the collateralized debt obligation, or CDO, transformed the mortgage market by creating a new source of demand for the lower-rated tranches of mortgage-backed securities. Despite their relatively high returns, tranches rated other than triple-A could be hard to sell.… Wall Street came up with a solution: in the words of one banker, they ‘created the investor.’ That is, they built new securities that would buy the tranches that had become harder to sell. Bankers would take those low investment-grade tranches, largely rated BBB or A, from many mortgage-backed securities and repackage them into the new securities—CDOs. Approximately 80% of these CDO tranches would be rated triple-A despite the fact that they generally comprised the lower-rated tranches of mortgage-backed securities.” “Between 2003 and 2007, as house prices rose 27% nationally and $4 trillion in mortgage-backed securities were created, Wall Street issued nearly $700 billion in CDOs that included mortgage-backed securities as collateral.” See “The Financial Crisis Inquiry Commission Report,” 127–50.

mortgage bundles AAA ratings: See “The Financial Crisis Inquiry Commission Report” on AAA ratings of bundled mortgages.

For one example, see: “In May 2007, Standard & Poor’s confirmed its initial AAA ratings on $772 million of a collateralized debt obligation known as Octonion I. Within 10 months, the Citigroup Inc. (C) deal defaulted, costing investors and the bank almost all their money.… Octonion I underscores how inflated grades during the credit boom contributed to more than $2.1 trillion in losses at the world’s financial institutions after home-loan defaults soared and residential prices plummeted.” Jody Shenn, “Default in 10 Months After AAA Spurred Justice on Credit Ratings,” Bloomberg, February 5, 2013. For more examples, see Kevin G. Hall, “How Moody’s Sold Its Ratings—and Sold Out Investors,” McClatchy, October 18, 2009. See also David Evans, “Banks Sell ‘Toxic Waste’ CDOs to Calpers, Texas Teachers Fund,” Bloomberg News, June 1, 2007.