THE BASIS POINT

A Brief, Non-Technical Summary Of The Financial Crisis

The financial crisis that began in August 2007 and continues today (October 2009) has—at least for now—brought consumer banking back to “savings and loan” basics. Up to the 1980s, before loan securitization found its footing, consumer banking was community focused, bank reps knew their clients’ current and projected finances intimately, and funded home loans from deposits in a context of modest home price increase expectations.

Securitization enabled banks to package groups of loans and sell them to Wall Street firms who would create bond funds out of those mortgage pools. So instead of keeping loans on their books until more deposits could be raised to lend more, banks could unload loans in bulk to raise money for more loans.

This liquidity and transfer of risk placed more emphasis on loan origination profits and less on interest income streams from servicing. As momentum built around this model, wholesaling built with it. Wholesale divisions of banks minimize fixed cost by allowing outside mortgage brokerage companies to originate loans through those banks.

Transfer of risk brought by securitization and transfer of fixed cost brought by wholesaling compounded origination income growth. Also two other trends also played a key role: a banking M&A wave changed community banking to global banking, and a deregulatory wave meant “savings and loan” banks could also become securities trading firms and package their loan originations in ever more arcane ways.

As the 1990s and 2000s progressed, home prices began an upward trajectory that—thanks to loose monetary policy, looser loan guidelines, and utterly unregulated mortgage derivatives trading—continued without interruption until mid-2006. All banks had to do was lend more.

WAMU is a relevant case study: They made their first mortgage loan in 1890 as a local Seattle bank, they made 29 acquisitions from 1990 to 2006, fostered one of the nation’s largest wholesale networks, relaxed loan approval guidelines to fuel originations which would then fuel securitizations, then became the largest bank failure in American history on September 25, 2008.

That failure was one of hundreds of consumer and investment banks that continue to fail today.