The Market is Innocent, Part II

"The free market failed."

"Greedy businessmen have ruined us all."

"The age of capitalism is over."

Such are the explanations that surround the collapse of the financial and real estate markets from 2007 to 2008, shortly followed by a nationwide recession. Big banks and speculators had made too many risky investments, we are told, and lost their fortunes, putting at risk the entire economy. At the surface this is indeed what took place to set up the crisis. The whole truth, however, requires far more than a surface-level understanding of the boom and bust of the 2000's. To gain an understanding of what happened during the economic bust, one must first understand what took place beforehand--the economic boom

This is the second of a three-part series detailing the complete failure of government intervention and the innocence of the free market in the buildup to the current economic crisis. Part I can be found here.

The Next Big Thing

Beginning in the 1990's, the Federal Government embarked on a campaign to make housing more affordable for low-income families and individuals via increased regulation to enforce lower lending standards. Loads of politicians and activists, eager to leave their mark during their time in D.C., hopped on board the affordable-housing train and enacted (or re-enacted) a host of regulation in the financial and housing sectors.

The Community Reinvestment Act

Chief among these new regulations was the Community Reinvestment Act (CRA). Born in the Carter administration to force banks to give more loans to potential homebuyers who otherwise would not be able to afford a home, it was resurrected during the Clinton administration and strengthened so it had even more authority over real estate and lending. The act exposed banks to lawsuits if they did not meet high quotas of minority and lower-class customers, lawsuits with hefty fines and fees.

Fannie and Freddie...Again

In conjunction with the Community Reinvestment Act, Fannie Mae and Freddie Mac began in September 1999 to lower its standards for creditworthiness in the homebuyers that banks gave loans to. As a result, banks began giving more and more loans to people whose credit was not normally up to par, and Fannie and Freddie got more loans to buy, repackage, and sell as mortgage-backed securities to investors. Banks then had even more money to use in even more subprime loans.

Executive Lenience

Andrew Cuomo and Henry Cisneros, who were secretaries of President Clinton's Department of Housing and Urban Development, both lowered mandatory restrictions on loans from private lending institutions; Cuomo even went so far as to bring vicious legal charges on banks that didn't meet his standards for what even he admitted was "affirmative action."

Political pressure ultimately led to lowered standards in the banking industry; suddenly, anyone could get a mortgage, and "anyone" included those who simply could not afford to buy a house, with or without a loan. Demand for housing skyrocketed, suppliers surged into the real estate sector, and prices shot upward. This upward turn, however, would have been merely a blip on the economic radar of history if not for the misguided, unscrupulous, and sometimes downright sinister actions of the Federal Reserve, the central bank of the United States. While the housing bubble would indeed have taken place without the Federal Reserve, the intensity of the boom and subsequent bust were created by this institution's actions, which will be detailed in part III.