EXCERPT: 'Hot, Flat, and Crowded,' by Thomas L. Friedman

"Fannie and Freddie were the enablers," said Wallison. They first stimulated the development of a subprime and Alt-A market on Wall Street by buying huge amounts of AAA tranches of subprime mortgages from different investment banks, and holding the bonds. Then, in late 2004, they began to buy these primary junk loans in large amounts and bundled them into bonds themselves, competing for product with Wall Street. "The fight between Wall Street and Fannie and Freddie," said Wallison, "drove down the price of junk mortgages, drove up the housing bubble, and filled it with unprecedentedly low quality mortgages . . . This is a story about how a well-intended government policy caused a substantial decline in the quality of U.S. mortgages and ultimately the financial crisis we are living with today."

By the way, what are AAA tranches? This is important. Imagine that you had a pile of dishes in your sink and each of those dishes represented a group of mortgages of different qualities that were all being packaged into one bond offering. The worst BBB and CCC dishes were at the bottom of the sink and paid the highest interest because they were the riskiest. The best, with the most secure borrowers—AAA—were at the top. Then you started to fill the sink with water—the Great Recession of 2008/9. The riskiest tranches of mortgage-backed securities quickly went under water. The best, the AAA tranche, would normally remain above water. Usually, those tranches of mortgage-backed securities never got wet. But this Great Recession was not usual and today many of those AAA tranches are also under water and worth either nothing or only a fraction of their original value.

This subprime frenzy, though, was abetted by more than just a U.S. government desire to promote homeownership and construction. It was also abetted by a broader easing of credit and low interest rates—too low for too long—under the Federal Reserve leadership of Alan Greenspan in the early 2000s. This easing of credit by the Fed, in turn, was enabled by the massive amount of dollars sloshing around the global economy from all the high-saving countries, particularly the Asian Tigers, Middle East oil exporters, and China. Many economists now believe that it was this huge pool of Asian savings and Middle Eastern petrodollars—managed by sovereign wealth funds in all these different countries and reinvested back in America—that depressed interest rates on U.S. Treasury securities and spurred investment bankers and financial wizards to come up with "innovations" that would produce higher yields. This led them to offer more and more subprime mortgages and more and abstruse and exotic derivatives and insurance products surrounding them.

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