Triggers of the Financial Crisis

This memorandum is provided in response to the request--made during a discussion with the FCIC staff--that I describe my view of the "triggers" for the financial crisis. I believe that the financial crisis had a single major cause: the accumulation of an unprecedented number of weak mortgages in the U.S. financial system. When these mortgages began to default, they caused the collapse of the worldwide market for mortgage backed securities (MBS), which in turn caused the instability and insolvency of financial institutions that we call the financial crisis. In this context, the "triggers" were those policies and actions that led to the accumulation of so many weak mortgages in our financial system. In this memorandum, I will identify the triggers and show how they eventually caused the collapse of the MBS and asset-backed market. I will also demonstrate how federal policies were directly responsible for mandating a vast increase in homeowner leverage (low or no downpayments), setting extremely high leverage levels for Fannie and Freddie, and requiring flexible underwriting standards throughout virtually entire mortgage finance industry.

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Edward Pinto is a resident scholar at AEI.

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