In a recent editorial you relate to the excellent description given by Michael Lewis in his book "The Big Short" of what was behind the crash of the real estate market. Unfortunately a very important causal factor was omitted in the book, as well as, in your description.
To allow banks to obtain additional funding Fannie Mae and Freddie Mac were created many years ago by our government. By being able to sell loans through Fannie Mae, Freddie Mac and others, retaining fees for servicing and a small profit margin, banks could again use these derived funds to make more loans. Once loans are sold, the lender no longer bears the risk of foreclosure when borrowers default. The result has been to progressively relax loan standards to allow marginal buyers to qualify.
We see this specifically when the Fed placed an excessive amount of money into the economy to address the recession that started just prior to the George W. Bush presidency and extended to ease the economic blow of 9/11.
This inordinate amount of money deposited into our banking system had to be loaned out since that is how banks make money. The ability to easily sell the loans removed the liability of foreclosure and the result was the accelerated development of creative loans to meet the demand.
The increased demand caused home prices to increase markedly attracting speculators. The increased need for buyers of these loans was met by Wall Street's investment bankers.
They created bonds that were backed by a bundled package of a variety of mortgage types and initially priced by a complicated mathematical formula. Called Mortgage Backed Securities they became considered as highly desirable investment vehicles and were sold worldwide.
Meanwhile, attempting to counteract what was occurring, the Fed started to reduce the money supply. This increased the Federal Funds Rate multiple times, but was unable to curb the excesses that had been created and the housing-price bubble finally burst.
The collapse of housing prices also resulted in the collapse of the market for MBS. Their value could no longer be adequately determined by the market or by the original pricing mechanism due to the complexity of this security."
Without the Fed's artificial inordinate increase in the money supply flooding the banking system the funding would not have been available to create the housing bubble.
Ben Cerruti is a resident of Brentwood.