The Second Parchment

On Economics, Finance, Politics and Music

Category: Financial Crisis

4 Reasons Why The Market Wasn’t That Perfect

new-york-13-exterior-night-04Before the 2008 subprime mortgage crisis happened, economic policymakers of developed countries thought they had reached a complete integration of economic theory and practice. The United States—and most of the world’s developed, mature economies, was believed to have reached its ideal state of market efficiency. The panacea for short-term fluctuations in the business cycle of developed countries was believed to have been found: it is a balanced mixture of monetary policy independence, rule-based stabilization policies, financial deregulation, and trade liberalization. Prof. Taylor prided himself in the robustness of his Taylor rule—the espousal of which had reduced macroeconomic volatility—Prof. Bernanke coined the term ‘the great moderation’ in his 2004 speech, Prof. Lucas declared that technical problems regarding recession-prevention have been resolved. ‘Bubbles’ was a misnomer. Valuation and pricing of every asset was believed to be grounded on concrete, measurable, logical economic drivers.

This belief stemmed from the idea that as an economy matures and financially modernizes, it becomes more efficient. Such was the case of the United States, as most economists and policy makers believed. Here, ‘efficiency’ was referred to as a concept whereby barriers to competition were minimal, economic agents acted on high level of rationality, information asymmetry no longer predominated, and regulation had ensured the deconstruction of unfair monopolies to allow non-coercive exchanges among members of the economy. Efficiency had also defined by how governments of developed countries had sufficiently learned from monetary, fiscal, and trade policy mishaps their counterparts made in the past. These attributes, coupled with the flawed belief that legal financial/non-financial loopholes had been addressed, justified the correctness of a strong form of an efficient market hypothesis. The term ‘bubble’ was an inaccurate designation—most economists and policy makers believed that the market knows how, why, and what it prices given the complete information available. An asset could not in a bubble. Rather, it could experience a strong upward appreciation of value owing to improving fundamentals.

Regulations of financial institutions were perceived as costly and highly unnecessary. Under the assumptions described in the aforementioned paragraph, financial institutions would thus act cautiously in making investment decisions that expose themselves to risk. Through strategic decision-making processes, they would decide on which risk-to-reward ratio to choose. Take the market of leveraged loans for private equity buyouts, for example. A group of banks deciding to syndicate loans in a highly-levered transaction simply mean that they are willing to take more risk for a higher expected return. Another example lies on the repo-to-CDO market. Intensive involvement in issuing low-yield, short-maturity debt—repo—for it to be used for financing investments in assets of high returns, longer maturity—CDOs—simply means that banks are willing to bear the risk of loss for the action they take. In a perfect market, ‘good’ corporate decisions are reciprocated with rewards, and bad ones are rewarded with losses. Policy makers, with this in mind, thus deemed financial regulation as costly. Some also believed that it would further stymie any form of financial innovation or hinder investments in profitable corporate-level projects. Prior to the crisis, they would feel that the repeal of the Glass-Steagall act of 1933 was justified.

The 2008 financial crisis proved that the belief was somewhat incorrect. The free market wasn’t free, nor was it perfect, and either coincidentally or not, some economists sensed that the perfect state of the efficiency of the financial market seems to be too utopian to be true. Prof. Roubini, Prof. Rajan, and Prof. Blinder attempted to investigate the validity of the assumptions of what makes a free market free of defects, within the context of the U.S. and other developed countries. Despite differences in the way their opinions were conveyed, they were unanimous in their belief on that bubbles are inevitable possibility in every market. In the context of the U.S. financial market, they believed that pricing of assets—particularly real estate and securitized debt obligations—were not necessarily backed by strong fundamentals. The appreciation of asset prices arose not because the market is perfect, but because it is imperfect, a case that is highly probable with transactions involving bank lending.

Sidenote: More background from a politician perspective can be found here, an article I wrote 2 years ago.

Why wasn’t it perfect?

Inspired from the explanation of these economists, I argue that these imperfections originated from the tenuousness of at least four (4) assumptions supporting the notion of a perfectly competitive market.

The first assumption relates to the incorrect notion that information asymmetry among economic agents no longer exist in developed capital markets. In a market with no information asymmetry, prices are determined based on the considerations of the seller and the buyer with equal access to information integral to asset pricing. However, prior to the 2008 calamity, banks had possessed more information regarding the actual components of the CDOs they securitized with complex financial engineering. Indeed, investors received investment prospectuses, but the triple-A stamp on the tranches they purchased made the idea of re-valuing the product for crosschecking purposes unnecessary. Furthermore, investors were unaware that banks had the right to purchase CDSs on the CDOs they purchased—another naked form of information asymmetry.

The second assumption is associated with the wrong belief that developed countries would have capital markets free of conflict of interest among economic agents. Prior to the crisis, credit rating agencies and banks performed business through an issuer-pay business model. The model arguable generated conflict of interest, as the incentive to maintain a neutral evaluation of credit quality of debt products securitized by their own clients would dissolve. The agencies were funded by their clients—mostly investment banks with securitization capabilities—to assess the credit quality of all tranches (as well as financially engineered sub-tranches) of collateralized debt obligations (CDOs) their clients intend to sell to willing institutional investors. Given the risky nature of the CDOs stemming from the subprime creditworthiness of the borrowers as well as mortgages being a majority portion constituting them, the banks arguably prefer to dispossess of them as soon as possible from their balance sheet. The agencies were aware of this, yet economists argued that they were incentivized them to improve their ratings of the CDOs they were paid to rate, under the spirit of client satisfaction and retention. According to policy makers, investors and CDS issuers were endangered by this practice as the issuer-pays model leads to the collateralized debt being over-rated—the asset value does not reflect its true risk levels.

The third assumption is connected to the erroneous view that moral hazard within the financial markets was an old cliché, as it has been successfully mitigated with existing financial regulation. In this case, moral hazard stemmed from the fact that agents lost their incentives to perform based on a risk-reward standpoint as they were allowed to shift risks to other parties without bearing any risks themselves. Before Dodd-Frank was introduced, banks need not have their risky, self-securitized risky debt in their balance sheet, before selling them to their clients or potential investors. This created moral hazard as expected profit/reward was no longer from the risk to which they were exposed; it was gained from speed: the faster risky securitized debt obligations can be sold, the more they gained.

The fourth assumption, arguably the most classic of all, derives from the inaccurate idea that economic agents are rational. Rational economic agents would evaluate their potential investments carefully and would invest in products that bring benefits both in the short-term and the long-term. In the years prior to the crisis, a large portion of investors subjected themselves to the trend of the herd, relished themselves in their own irrational exuberance, and sought for industries with short-term gains, such as the real estate market. Potential homeowners did not carefully evaluate the mechanics behind their cheap mortgages, and whether or not they were creditworthy enough to acquire the house they intended to buy. Before the crisis, there were tons amazing ads in televisions that getting a home is of utmost importance, irrespective of the need to understand that the debt they borrow were actually priced in a ‘teaser’ rate.

Perfecting the market

Regulators have taken steps toward eliminating the four issues I outlined previously. Lets dissect these steps one-by-one.

The first assumption—existence of information assymmetry—has been approached even within the international arena. G20 leaders have convened to emphasize on the importance of post-trade transparency in the trading of CDSs. In other words, second/third parties purchasing CDSs to hedge/speculate against a potential default of a particular debtor have been mandated to disclose their positions.

The second assumption—conflict of interest among economic agents—has been thought about, too. The Securities Exchange Commission (SEC) formulated new policies entitled “Amendments to Rules for Nationally Recognized Statistical Rating Organizations (NRSROs)”. The SEC has considered the following laws to enact:

  • Agencies/NRSROs are prohibited from rating debt instruments they have assisted with structuring;
  • Credit analysts of agencies/NRSROs are forbidden in fee negotiations with their clients (the CDO securitizors);
  • Agencies/NRSROs have limits on gifts they can receive from their clients;
  • Agencies/NRSROs are required to disclose the methodologies, assumptions, and criteria with which they rate the debt instruments to the SEC and/or third-party investors.

The implementation of these rules would reduce mismatched incentives arising from the issuer-pays model.

The third assumption—moral hazard/risk-shifting—has been addressed by mandating banks to have a higher minimum balance of their securitized products sellable to investors. True, the CDO market is back, but I am optimistic that this new regulation, coupled investors being more cautious in their investments, would slowly remove the issue related to the third assumption. The purpose of securitizing CDOs in the first place—risk diversification, not risk amplification—can thus be reached.

The fourth assumption—irrationality of economic agents. How do we make people more rational? Honestly…lets just ask him.

Sovereign Credit Rating Service: A Public Good?


It is inevitable that credit rating agencies partially catalyzed the credit crunch the financial system experienced in 2008. Some have attributed the recession to the way Moody’s, S&P, and Fitch Ratings rated fixed income products; one of whom is Annette Heuser of the Bertelsman Foundation. I recently stumbled on her TED talk, and got interested. In her talk, she made a bold statement: “credit rating services, especially sovereign credit ratings, should be a public good.” Watch her TED talk here.

In other words, she wants sovereign credit rating services to be free and transparent for everybody: clients, investors, non-clients, and non-investors. As an effort to realize this, she and her team have been working on a “forward-looking” credit-rating model that they name INCRA. She doesn’t want it to be a business, so operations under the project have been done under the non-profit umbrella and financing of the project has been based on endowments made voluntarily by outside contributors. Read her latest update on INCRA here.

During the talk, she justifies her decision to develop a free sovereign credit-rating model on several fundamental beliefs: i. The downgrading of sovereign credit ratings increases the cost of borrowing for governments–usually emerging countries–that are dependent on the international credit market for their infrastructure financing; ii. The market of credit rating is imperfect–it is an oligopoly–with three key players in it (Moody’s, S&P, Fitch ratings); iii. There is a ‘moral hazard’ in the credit rating business: she believes that credit rating agencies tend to deliberately overestimate the creditworthiness of a particular institution, because that institution is the one paying for the credit rating service. Since fixed-income investors might not know about this, they would trust whatever the credit rating agencies publish on their reports.

I find some of her reasons a little bit too bold. One has something to do with the assumption Ms. Heuser is making on how credit rating agencies always rate in their clients’ favor–the institutions/countries hiring them to rate their institutions/countries (refer to point iv). This might be true in the context of what happened in the 2008 mortgage-backed securities fiasco, but I don’t think the case can be extrapolated to sovereign credit ratings. I still couldn’t find any relevant studies, so here’s a question: do governments pay credit-rating agencies annually, thus making them having a voice when upgrades/downgrades of their countries ratings are being discussed? I know governments hire sell-side/buy-side financial analysts for capital restructuring reasons (i.e. Greece hired BlackRock), but do they also hire credit rating agencies?

Another point is the following (refer to point i): while it is true that a central bank’s policy to increase a country’s interest rates will directly affect the cost of borrowing, there is insufficient evidence demonstrating that the downgrading of a country’s credit rating would do the same. I cannot intuitively see any direct correlation between credit upgrades/downgrades with the central bank’s choice of interest rates. I haven’t done any research on this yet, but I believe that the argument on the correlation between credit rating upgrades and the increase in interest rates is still a matter of academic debate. In the end, American investors invest in Indonesian bonds based on what Bank Indonesia wants Indonesia’s short-term or long-term treasury bonds to be. Indonesia determines its own cost of borrowing–Moody’s, S&P, and Fitch might (potentially) just contribute to an insignificant premium of the bond rates in secondary capital markets.

Ms. Heuser is probably referring to foreign direct investments (FDIs), which are correlated with sovereign credit ratings. Investors would demand higher equity (not bond?) returns when investing in the emerging markets, or countries with ratings just slightly above the investment grade. If this is the case, it makes sense, but then again, the amount of FDI inflow has little correlation with how much the government should allocate its budget for foreign debt payments. Additionally, the central bank also has power to influence FDI. Again, take the case of Indonesia. Ever since former Federal Reserve Chairman Ben Bernanke announced its tapering off of quantitative easing, investors have been pulling out their investments out of Jakarta (Early August 2013). Weeks and months afterwards, Bank Indonesia, increased interest rates by hundreds of basis points (Late August 2013). Since local currency is used to finance local investments, a good proxy for FDI inflows/outflows would be this year’s $-Rupiah exchange rates, which can be seen here. Also since investments are made in equities, the Jakarta Composite Index serves as a good indicator, which can be viewed here. Look at the significant increase and decrease of the rate/index over August-September. This shows that ratings might alter the the outflows/inflows of direct investments, but not foreign investors’ preferences in purchasing government debt. Unless the ratings are incorporated to the calculation of the probability of sovereign debt defaults.

So far, INCRA has produced a total of 6 reports, which can be downloaded here. Most of them are produced by political scientists and economists within the academic field. While I doubt that INCRA’s presence will change the landscape of the credit-rating business, I’m still interested in where this project is going.

Basel III: An Update

It has been approximately a semester since I left my internship at the Central Bank of Indonesia’s Monetary Policy Group, in which I worked closely with senior economists on developing a proxy for measuring risk levels of Indonesia’s banking system. The discussion on the developments of Basel III was a ritual every morning, and I am pretty sure it is still today. I remember looking at the following table and wondering what will happen as members of the Bank of International Settlements gradually establishes each of the framework’s regulatory points:


As I perused the financial statements I was assigned to, I would ask myself: “How will banks respond to the increasingly ‘restrictive’ regulation proposed by the central banks involved in the formulation of Basel III?” As the year of 2013 ended, some answers have emerged.

In Indonesia, at least an issue arose due to Bank Indonesia’s minimum Capital Adequacy Ratio rule imposed on several domestic banks. Such particular rule, I believe, is highly influenced by Basel III. This has led to an additional capital injection–or colloquially, a bailout–of Bank Mutiara, after its controversial Century days. Read more here. Internationally, investment banks and regulators have constantly revised the terms of the rule to reach a point where profits and risks balance. Quoting a banking professional in an article, the concession has been a ‘win for the [financial services] industry.’ Read more here.

Roubini at NYU Abu Dhabi


Professor Nouriel Roubini is in town! (Yes, this Roubini). A group of us just had a two-hour lunch with him. Our discussion mainly revolved around the global economy and international trade, both his areas of expertise, but he also touched on several current domestic economic issues. His talk wasn’t really highlighted by value judgments (academics are often very careful about the opinions they assert, which I value very highly). He did, however, made some statements that I think are interesting: a) China should consider lowering its 40-50% savings rate, despite him acknowledging that this behavior has been partially stimulated by the ‘fear’ that the Chinese future will be dominated by the elderly not qualified for employment opportunities that boost the Chinese economy, b) there is a decline of hegemonic political power within the G-7 countries, and the global economy has been shaped by the G-20 countries instead, c) there would have been a massive collateral damage had the U.S. government not provided extra liquidity to its failing banks in 2007-2008, d) current U.S. zero-bound interest rate policy has caused a spillover over other monetary policies pursued in other countries.

He briefly talked about the Euro crisis, and I was curious as to his opinion on the European Central Bank’s role in the eurozone. Unlike the Bank of Japan and the Federal Reserve, the ECB has no privilege or prerogative to conduct quantitative easings (QEs) to lower spreads with respect to the German bunds. The Lisbon Treaty regulates this. I asked his opinion on this, considering that spreads in 7 eurozone countries have been very large over the past 3-4 years. This is a paraphrased, simplified version of what he said:

“The monetary policy objective in the Eurozone is discrepant from that of Japan or the United States. In the United States, the Federal Reserve is constitutionally mandated to focus on improving the following two variables: price stability in unemployment rates. The ECB has no similar mandate; in fact, it places a small emphasis on the latter variable. It aims to maintain price stability within the eurozone more than reducing unemployment rates of its member countries.”

I guess this makes sense—no German citizens would like to see their price of commodities being volatile in exchange for more Greek college graduates having higher level of employment (is this true?). QEs sometimes involve fiscal transfers as well, which is highly unpopular among constituents. This extrapolation is very tenuous though, one can argue that this is true if there’s actually relevant supporting polls on this particular issue.

Now, if we take Professor Roubini’s statement as granted, we can conjecture what will the ECB’s Taylor Rule look like. Since the ECB focuses on price stability more than unemployment, the parameter assigned to the former variable is expected to be much greater compared to the coefficient assigned to the latter variable. This would be an exciting econometrics project for anybody out there interested in monetary economics.

Update: Yesterday’s FT article (March 5th) indirectly corroborated Professor Roubini’s comment on ECB’s main role. “…the ECB has no formal role in managing unemployment. Its one purpose in life is to guarantee price stability by keeping inflation “close to, but below” 2 per cent over a deliberately unspecified medium term.”

A Short Note on the U.S.’ Quantitative Easing

I feel the urgency to write this post after I watched this misleading animated clip on the Federal Reserve’s quantitative easing policy. I think most economics students or current affairs aficionados can refute nearly most of the things mentioned in the clip, but I’d like to point out one good thing about Chairman Bernanke’s successful in his pursuit of purchasing what most of us would consider junk assets.

Read this post from the Economist. The Fed’s large-scale asset purchases have been profitable so far. Secretary Geithner literally received a total of $89 billion dollars in profits from the subprime assets the Fed’s purchased after QE1, QE2, and QE3. Chairman Bernanke did use Americans’ tax revenues and did utilize it capacity to print money in the beginning, but in the end, the citizens’ money have been incrementally restored.

Anti-Feds, the two fluffy bears in the clip included, would then argue that the Fed’s money printing would lead to inflation. Printing money means inflation, they’d say, disregarding the fact that the U.S. economy’s money velocity has shown a negative trend and that its GDP growth has demonstrated a positive trajectory since the 2008 financial crisis. But as shown from the graph below (quarterly), The Fed’s quantitative easing policies have not, and will not, lead to a Zimbabwean inflation that most anti-Fed zealots have claimed.


Though one can argue that mild inflation is bad, it has some positive features as well. Borrowing becomes cheaper as debt becomes less valuable as prices are expected to increase. One’s debt decreases in real terms. One last thing. It’s widely known that quantitative easings lower interest rates on selective assets (an important feature that’s not mentioned at all in the clip). Take a look at this graph showing how real investments have increased post-2008.

I acknowledge that in elaborating my arguments above I might have oversimplified some data. Furthermore, I haven’t actually done proper academic research on this. But in general, one can be positive about the Fed’s unconventional monetary policy. The unjustifiable detestation towards the Fed and Chairman Bernanke is often fueled by irrational preconceived notions and a strict adherence to an anti-government ideology. If we really want to learn or refuse to be indoctrinated, I personally think that we should refrain from committing this error.

Update: The NYTimes recently reports that the U.S. economy contracted in late 2012. This had nothing to do with the Fed’s action though. It’s mainly attributable to the significant decrease in military spending. 

The Euro Debt Graph


If anyone ever asked me about my favorite graph in economics, I would show them the graph above. My professors once said that the graph is aesthetically beautiful (look at the convergence between 1999 and 2008) but what makes it very special is the amount of information contained in just one graph.

Some have tried to explain what exactly caused the convergence. There’s a lot of economic theories being offered, but I find one particular hypothesis convincing. It’s simply carry-trading. Not the typical currency carry-trading, but government bond (10-year maturity) carry-trading. Private investors in 1999 saw the expected accession of Greece to the Eurozone as a form of risk-minimization: they believed that Greek bonds would just be as valuable as Germany’s risk-free bonds. Since Greece’s interest rates were way higher than Germany’s interest rates, they borrowed money from Germany (with low cost since Germany’s interest rates were comparatively lower than those of Greece) and invest in Greek bonds (with higher return since Greece’s interest rates were comparatively higher than those of Germany). The free market then did it job pretty miraculously: the high demand for Greek bonds increased their price and lowered their yields. Take a look at what happened in 2001-2002. At this point, those who carry-traded since 1999 must have earned tons of money. This act of carry-trading persisted until 2008, when Lehman collapsed, credit rating agencies downgraded Greece, and investors started seeing Greek bonds to be riskier than other bonds in the Eurozone.

The consequence? Private investors started panicking (a legitimate panic, not an irrational one), and each country started having its own interest rate trajectory. In 2012, Greek bonds were perceived as extremely unpredictable in its return to debt investments (notice the double-digit government bond yields), while Germany’s bonds maintained its stability. No wonder why Christine Lagarde wasn’t happy.

On Iceland: Defending Professor Mishkin


Many people assail Professor Mishkin of Columbia University for his inconsistent stance on Iceland’s economy before 2008. Especially those who have watched the widely-acclaimed documentary, ‘Inside Job’, in which Professor Mishkin was interviewed regarding his opinions on the 2008 financial crisis and how it was similar to that of Iceland’s. The shrewd interviewer found that Professor Mishkin changed the title of his report, from ‘Financial Stability in Iceland’ to ‘Financial Instability in Iceland,’ as the crisis ensued. The narrator further said that Professor Mishkin had a conflict of interest; that he published his report under the direction of the Icelandic government, to stabilize the market after Fitch downgraded Iceland banks from ‘stable’ to ‘negative.’ I read the report, and as expected, the tone was optimistic. Indeed, in the end, history disproved Professor Mishkin’s claim that “[Iceland’s] financial system remained strong.” (In the report, he did not expect, or mention the potential of, a Lehman’s collapse in 2008, which subsequently led to illiquidity in interbank lending. Which economists correctly predicted the 2008 crisis anyway? There were only a few of them).

He wasn’t completely incorrect, however, and here’s why. In addition to his exceptional analyses of Iceland’s competitive advantage, governmental and educational system, he did implicitly illustrate a hypothetical case of the Icelandic banks failing to finance their liabilities. After skimming the report, I found a chart demonstrating the relationship between CDS (Credit Default Swaps) spreads and the probability of an Icelandic financial instability. (For those not acquainted with the term CDS, Investopedia has a great description of it). CDS is basically an insurance that protects the CDS owner/speculator against a probable default or ‘failure’ of an asset. As commonly known, larger CDS spreads imply that the market perceives the Icelandic banks as having a high probability of possessing bad assets, defaulting, or becoming insolvent. Professor Mishkin did his calculation, and he found that when the spreads reach 500 basis points, there is a 100% probability that Iceland inevitably would experience a financial turmoil.

CDS Spread vs. Probability of Financial Crisis1

The paper was written in 2006. That time, CDS spreads were clearly below 500…

CDS Spreads1

… but as shown in the graph above, CDS spreads soared rapidly until 2008. It even reached above 1000 basis points. Under Professor Mishkin’s calculation, it means that a financial crisis would occur, unavoidably. And it did; the banks were insolvent, capital inflows sharply declined, the Icelandic Krona depreciated, the banks restructured, public debt increased, foreign assets frozen, and unemployment tripled. All of these were triggered by the U.S. subprime mortgage crisis in 2008, which rendered interbank lending freeze. Professor Mishkin was therefore not completely incorrect. His graph shows that he did ‘predict’ a financial instability in Iceland. He didn’t simply change the word ‘stability’ to ‘instability’ out of thin air; he had a basis for doing so.

Politicians & The 2008 Financial Crisis

My stay in New York has been primarily filled with melodies and scenes for a Theater internship I am a part of, but strangers I accidentally meet within the hustle bustle of Manhattan sometimes divert me from my main preoccupation. Just a few of days ago I encountered a group surrounding a person wearing a mask of Llyod Blankfein–the current Chairman & CEO of Goldman Sachs–and dramatized how, according to them, his avaricious mind brought the U.S. financial system into a steep precipice. I walked back to my dorm thinking that their disappointment is understandable, as a large portion of our society believe that Goldman Sachs was ‘betting’ against their own customers for profit. They purchased credit default swaps (‘insurance’) to protect the firm from suffering losses on the collateralized debt obligations-which contained subprime mortgage-backed securities-the firm sold to private investors.

In line with their fundamental opinion, I agree that people should not acquit the bankers of the crisis that happened in 2008; after all, financial intermediaries–investment banks, insurance companies, rating agencies–were the ones who, according to most economists & members of Congress, performed reckless proprietary trading and (deliberately) overvalued bonds. However, I also think that the crisis should not be solely attributed to those associated with Wall Street corporations. Politicians also played a vital role in bringing the U.S. financial system down four years ago.

Some people might speculate that one of the politicians being referred to is Alan Greenspan, Chairman of the Federal Reserve famous for his free-market philosophy on Economics, who had set interest rates to a low level ever since he assumed office. Or Larry Summers (71st U.S. Secretary of Treasury) & Roberto Rubin (70th U.S. Secretary of Treasury) who are known as Greenspan’s accomplices when he was in charge of the Fed. Indeed, they contributed to the crisis by allowing excessive spending, but I do not regard them as politicians as they do not have legitimate constituents, nor were they affiliated with a particular political party.

The politicians who signed the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 are the ones to whom I am referring. The Act reaffirms government’s commitment to supporting Fannie Mae and Freddie Mac in ensuring that Americans can achieve one of their monumental dreams: having a house. The involved politicians’ intention was undoubtedly great, providing Americans with easy credit for their housing benefited the American society as a whole. Additionally, the move is politically favorable. These politicians had proved themselves as competent representatives of their states as they successfully appeased their constituents. House affordability is one of the popular issues that constituents demand their representatives to deal with.

The Act worked flawlessly until 2008. From multiple reports garnered, it seems to me that Fannie Mae and Freddie Mac had less incentive to lend based on borrowers’ creditworthiness, as the government guaranteed the sustainability of the firms and because they were less dependent on the amount of profit gained from interest, for the government heavily sponsored them. In other terms, they had less risk to fail in managing their financials. Statistics shows that the Act made the two enterprises assist most of their customers, which resulted in approximately 18% of their loans being Alt-A loans. Another 2008 report further concluded that up to 56% of the two government-backed lenders’ acquisitions are subprime.

I suspect that this high percentage of subprime borrowers would not have existed had Congress and/or Senate not passed an Act mandating these government-sponsored enterprises to finance most of their requesters’ mortgages. While further research is still required to confirm the accuracy of the statistics, still, those protesting against Wall Street should consider channeling their energy to questioning politicians’ act of populism in exchange for kindling a predicament.