I am in the real estate industry so I have a pretty good understanding of the financial markets and while getting my MBA economics was a hammered into our poor heads
It is a pretty complex system that not only involves our national economy but I will try to explain it as simplified as possible.
When a US bank fails the money up to certain cap is refunded to the bank customer through the FDIC, so most of the money that we have in our checking and savings accounts are FDIC insured. If a US bank goes belly up there obiviously is an impact as lost jobs, angry shareholders, etc. but it usually only has a negative impact on the geographical area.
The government has not bailed out any local banks and I don't think they will.
The downfall of Fannie Mae and Freddie Mac would have had much greater implications, you could compare it somewhat to a wildfire shaking loose and not a localized explosion, effecting our national and the global economy.
If you buy a house your local bank or lender would take the money that they have from deposits from their customers and you would pay your principal and interest over 15 or 30 years back to them. However, they would be limited in how much they can lend (limited deposits) and whereas your interest rate would stay the same, the interest rate they are paying on those deposits fluctuate and they could be taking a loss.
That's why secondary lenders were establisehd. Freddie and Fannie are secondary mortgage institutions, meaning they are providing liquidity to the primary lender, the Wells Fargos, Washington Mutuals, credit unions etc. Freddie repackages the loans and sells them as securities, Fannie repackages the loans that they are "buying" into bonds and sell them off to investors for an agreed upon interest. Usually several hundred mortgages are lumped together into those bonds, under the assumption that only a few will default. That is a great model as long as the housing market was doing well. They were pretty low risk for investors because Fannie Mae would make up for any missed payments or losses on the loans that were lumped into those bonds.
Now, whereas we had local investors a great deal was also purchased by foreign investors. Chinese central banks and Persian Gulf governments took the dollars we spent for oil and manufactured goods and would spend them on US Treasure Bonds, therefore financing our consumption and keeping interest rates low. Those treasury bonds always were a safe bet, but as the Feds slashed interest rates a few years ago, these foreign investors moved from treasurey bonds to the bonds from Fannie Mae and Freddie Mac. With their implicit guarantee, they were deemed to be just as safe as U.S. government bonds but paid a slightly higher interest rate. As problems with Fannie and Freddie became more apparent foreign investors started backing out, not wanting to buy those bonds anymore, because of fear that Fannie or Freddie would go bankrupt but Fannie and Freddie needed to sell billions of dollars of debt (loans) on a weekly basis, money that they had already given to local lenders.
The US government had to step in to keep the capital flowing and avoid an implosion of our financial markets and our economy.
I, however, completely disagree with the spending of tax payer money for bail outs without the restructuring of those companies and I do think the bail out "without strings attached" is completely irresponsible. As the mortgage industry was booming the CEOs of Fannie and Freddie took home millions of $$ in salaries and bonuses, and now we are bailing them out and won't get the money back. This money should have been a temporary loan and to be repaid to the American tax payers once they start getting out of red.
But the main question for me is, how did we get there? And what are we gonna do to make sure this does not repeat?
The main culprit in the housing crisis started with the deregulation of the mortgage industry, a bill that was written by John McCain's economy advisor, Phil Gramm and passed through the Republican Congress.
The deregulation of the mortgage industry resulted in what I call the "anyone who could fog a mirror will get approved for a mortgage law". As a real estate agent I was often speechless by the madness that mortgage lenders called a loan and suggested to borrowers.
I am all for free markets and capitalism but there are some sectors that need to be regulated. Without wanting to make this a political thread government regulation has it's place and I bet anything that in retrospect some people would have loved to have a bureaucrat stand between them and an insane loan that ruined their and their family's life.
If it wasn't so serious I'd be somewhat amused about the people yelling at the top of their lungs "no tax-and-spend". What else are we supposed to do "borrow-and-spend"? We are in a huge hole and if we don't stop this insanity we all better start learning Chinese or Arabic
