While collateralized mortgage obligations (CMOs) perhaps facilitated the housing bubble of 1997-2007 by allowing obfuscation and sale of low quality and high risk mortgage debt to unaware investors, their distribution was not the root cause for the inflation and collapse of the housing bubble and ensuing financial crisis in 2008. Wall Street, banks, and mortgage originators may be easy targets to lay blame for the Great Recession. However, the root cause was ultimately the affordable housing policy set forth by the U.S. federal government over the span of the preceding two decades, beginning with Title XIII of the Housing and Community Development Act of 1992 (GSE Act), followed by the U.S. Department of Housing and Urban Development’s Best Practices Initiative in 1994 and the Community Reinvestment Act of 1995.
While the intent was perhaps well meaning, desiring to increase home ownership in the U.S. particularly amongst low and moderate income persons, the U.S. federal government’s affordable housing policy forced the reduction of mortgage underwriting standards and encouraged subprime and high risk mortgage lending to meet affordable housing lending quotas, at their peak in 2008 requiring 56% of loans acquired by government-sponsored enterprises (GSEs) to be originated to low and moderate income borrowers, additionally requiring 27% to be originated to borrowers at or below 80% of area median income. Inevitably, this produced the housing bubble of 1997-2007 fueled by low quality and high risk mortgage debt, followed by collapse of the housing bubble, defaults and delinquencies on mortgage debt obligations, and the financial crisis in 2008.
For a comprehensive and evidence-based discussion of the timeline and origins of the financial crisis in 2008, please reference “Dissent from the Majority Report of the Financial Crisis Inquiry Commission” by Peter J. Wallison, published January 14, 2011.