When the Greenspan Fed drove short-term funding costs in the wholesale money markets down to 1 percent by the spring of 2003, it enabled Wall Street to finance massive "warehouse credit lines" to local mortgage brokers and bankers. Stocked up with Wall Street money, the latter did not need retail deposits or capital and, instead, operated as fee-based agents and were therefore free to issue risky loans. They worked out of makeshift offices and did not need vaults, tellers, or drive-through windows. With no skin in the game, they were driven entirely by mortgage production volume (see chapters 18 and 19). When the great Wall Street investment houses—including Bear Stearns, Lehman, Goldman, and Morgan Stanley along with the wholesale banking departments of JPMorgan, Citigroup, and Deutsche Bank—became aggressively involved in financing the local mortgage bankers, brokers, and boiler rooms, the planking for the subprime mortgage fiasco was laid. The Wall Street houses were able to access nearly unlimited amounts of low-cost wholesale funding by means of the commercial paper and repo markets and recycle it through their "warehouse lines" to local mortgage bankers and brokers. Unfortunately, the sudden availability of these multibillion-dollar warehouse lines proved to be a financial poison in the world of home finance, not the socially beneficent "innovation" claimed by investment bankers.
Needless to say, the new army of mortgage brokers put into business by these Wall Street credit lines had not spent decades building up a franchise in local home mortgage markets, thereby acquiring the skills in prudent underwriting and borrower selection on which long-term survival in the home mortgage business inherently depends. But they did know how to organize turbo-charged boiler-rooms which cranked out prodigious numbers of new mortgages.
These new mortgage brokers also had the capacity to grow by leaps and bounds. They had quickly discovered that salesmen currently pitching Amway products, aluminum siding, and used cars could become fully functioning mortgage bankers in a matter of days and weeks. This was especially the case after the government-sponsored enterprises Fannie Mae and Freddie Mac and the big Wall Street banks introduced online computerized underwriting.
Like the operators of McDonald's drive-through windows, brokers simply tapped the screen and another serving of home mortgage loans would instantly appear. Brokers then obtained the money for loan disbursements to homeowners simply by drawing down their warehouse lines until enough volume was achieved to facilitate a block sale of freshly minted mortgages to their Wall Street partners. The latter then completed the securitization and distribution process, harvesting generous fees and markups at each step along the way.
At the peak of the housing boom, outstanding warehouse lines offered by the top Wall Street houses soared to several hundred billion dollars. These huge credit lines constituted an efficient financial superhighway to transport truckloads of sketchy mortgages from Main Street America directly to Wall Street.
Needless to say, the operators of these fly-by-night mortgage-stamping machines were not "bankers" in any traditional sense of the word—they had no skin in the game. Wall Street actually even went further, hiring traditional banks to write subprime and other riskier mortgages. It then periodically bought all the resulting loans on a wholesale basis, meaning that what remained of George Bailey's Savings and Loan was enlisted in the rinse-and-repeat style of mortgage lending as well.
Accordingly, the residential loan books of the commercial banking system were surprisingly clean, even as the securitized mortgage meltdown gathered force in the fourth quarter of 2008. At that point, total commercial bank assets were $11.6 trillion. Yet only $200 billion, a tiny 1.7 percent of total assets, consisted of "toxic assets"; that is, private-label mortgage-backed securities of the type originated by the Wall Street securitization machine and which were now plummeting in value.
Furthermore, these minor holdings of toxic private-label mortgage assets were dwarfed by commercial banking system investments of nearly $1 trillion in Fannie Mae and Freddie Mac mortgage-backed securities. These "agency" backed mortgage securities had always been considered blue chip credits and a close imitation of Treasury bonds, and had officially become "risk free" upon the US government's nationalization of Freddie and Fannie.
From a big-picture perspective, then, the nation's hinterland banks had played a pretty good hand of mortgage finance poker. First, they had sold off most of their subprime originations to the Wall Street securitization machine. Next, they largely avoided reinvesting in the garbage securities Wall Street crafted from these subprime loan pools. And finally, they backfilled their investment accounts by buying mortgage securities wrapped with Uncle Sam's money-good insurance via the Freddie and Fannie guarantees, not the bogus kind sold to Wall Street and the European banks by AIG.