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By Root 815 0

Federal Reserve kept interest rates low for years seemingly complacent in light of consumer lending problems in the late 1990s and the early part of the twenty-first century. In April 2005, then Fed Chairman Alan Greenspan said mortgage lenders efficiently judged the risk.24 Instead, Greenspan should have raised the alarm about foolish mortgage lending. The Fed compounded its errors when it bailed out Countrywide, the second largest subprime lender in the United States, which is regulated by the Office of Thrift Supervision. Countrywide is also a primary dealer, authorized to trade U.S. government and other select securities with the Federal Reserve System.The Fed should have revoked Countrywide’s primary dealer status and let it fend for itself.

Countrywide posted its expanded interest-only programs on its Web site in September 2003 (and appeared to remove it in 2007). Few borrowers are savvy enough for interest-only loans, since mortgage borrowers paid no principal on loans, just interest. Many hoped housing prices would rise so they could refinance or take a profit.The program included NINA (no documentation: no income verification, no asset verification), No Ratio (no income information, so no debt to income ratio is calculated allowing the borrower to assume a greater debt load than would be allowed with a traditional mortgage), and SISA (stated income, stated assets) loans. The FHA guaranteed some Countrywide loans, and presumably they conformed to FHA’s requirements. But FNMA and FHLMC were the chief buyers of Countrywide’s loans, and many of these loans were problematic.

On August 5, 2007, I told CBS’s Thalia Assuras that the mortgage lending relationship with investment banks is one of the largest “Ponzi schemes in financial history” and “risky mortgage products were made to people who couldn’t afford them.”25 I misspoke. I meant to say it is the largest Ponzi scheme in the history of the capital markets.

By the end of 2006, Countrywide’s loans showed signs of trouble. The week of August 6, 2007, rumors hit the market that Countrywide was looking for a “white knight,” a deep pocket investor to either take it over or to provide a liquidity injection, but it had no success. On August 7, 2007, the Federal Open Market Committee issued an economic outlook statement saying that inflation, not the mortgage market problems, were the chief concern, and it would not cut the federal funds rate (the borrowing rate) to inject more liquidity into the market. But just two days later, on August 9, the European Central Bank injected around $130 billion into the European banking system, and the Federal Reserve pumped $24 billion into the U.S. banking system through the Federal Reserve’s Open Market Trading Desk.

On August 10, 2007,Warren and I spoke on a different topic, and—without naming names—he mentioned that two large companies had come to him hat in hand needing billions.There would be a couple of major blow-ups since they were running out of options. I independently guessed that Countrywide was one of the beggars.

One of the ways Countrywide got money was by issuing commercial paper (asset-backed commercial paper or ABCP) backed by its loans. The week of August 13, 2007, investors shunned Countrywide’s debt. Nervous investors demanded higher interest rates. Countrywide told its creditors (investment banks) it wanted to borrow money (by drawing on its credit card-like credit lines). Countrywide wanted to borrow $11.5 billion from a 40-bank syndicate. Countrywide was in a desperate situation. Market rumors were that the banks refused to lend the money, and asked the Fed for concessions.

On August 15, 2007, I wrote Warren that investors were nervous because Canadian money market funds found their investments (not necessarily related to Countrywide) were backed by risky leveraged subprime products. Prices plummeted as investors realized they would lose principal on AAA rated products.26

The banks got their concessions, and lent to Countrywide. On Thursday, August 16, 2007, the stock market (Dow) fell more than 340 points