We currently have an anemic U.S. economy and the American taxpayer owns trillions of dollars of toxic debt courtesy of Congress and the federal government. Make no mistake that Wall Street was responsible for creating the financial instruments that allowed the crisis to unfold; however, Congress was just as liable by enacting regulation out of political popularity that gave Wall Street the foundation for creating high-risk instruments that separated the risk of these instruments from its originator.  While the credit crisis might appear to be a symptom of the bursting of the real estate bubble in 2005, the true beginning of the crisis began in 1977 with the passage of the Community Reinvestment Act. This legislation, passed by Congress, was designed to encourage lending to low and middle income neighborhoods and reduce discriminatory lending practices. The act mandates that in order for a bank to receive Federal Deposit Insurance Corporation insurance, it must meet certain criteria of the CRA to ensure loans are getting out to these communities.  The legislation, however, doesn't specify the criteria for evaluating performance. This act was further affected by The Federal Housing Enterprise Financial Safety and Soundness Act of 1992. That required Fannie Mae ( FNM - news - people ) and Freddie Mac ( FRE - news - people ) to devote a portion of their lending to low and middle income neighborhoods.  In order to help Fannie and Freddie raise funds to facilitate loans to these neighborhoods as required by the CRA, Bear Stearns securitized the first mortgage backed securities in 1997. These loans were secured by CRA loans and backed by the implied credit of Fannie and Freddie. Without the implied AAA rating of Fannie and Freddie, many investors would not have bought bonds backed by the CRA loans out of fear of default and thus securitization of such loans would be next to impossible at the stated interest rates.  As real estate prices rose in the U.S., lending standards became more lax on the assumption that the strength in real estate prices would continue indefinitely. The lack of lending standards became so preposterous that banks were willing to make negative amortization loans where the interest charges could be billed against your outstanding balance on your mortgage and could be recouped upon refinancing or resale of the property. No one considered what would happen if real estate prices dropped. The lax lending standards and ill conceived notion that real estate would go up forever led to the availability of mortgages to anyone with a pulse regardless of risk. Combine this with additional demand for capital from real estate speculators and what developed was an environment whereby mortgage lenders needed to find creative ways to finance the ever growing demand for loans.  Wall Street, at the center of financial innovation, had an idea which originated from the first MBS bond backed by CRA loans. Packaging private mortgages into bonds backed by these mortgages and selling these securities to investors thereby separating the risk of the loan from the originator and placing it on the bondholders. Unlike the MBS bonds that were originated by Bear Stearns in 1997, these bonds did not have the moral backing of the U.S. government through Fannie and Freddie. These bonds literally allowed mortgage originators to raise new capital for riskier mortgages that required no money down and no incomes guarantees and pass that risk on to the investor.  As demand for loans became disproportionate to the existing supply of mortgages available to structure new MBS bonds, Wall Street created an instrument called a synthetic collateralized debt obligation to raise the capital needed. Unlike MBS bonds, synthetic CDOs were not invested in actual loans but instead were designed to insure groups of loans against default in exchange for a regular premium. This product had the effect of further leveraging the aggregate amount of mortgage loans outstanding, therefore having a multiplier effect not only on capital available to underwrite new mortgages but also the risk associated with raising this capital. In addition, these CDOs removed the risk of default even further away from the originator thus increasing the moral hazard which led to a further reduction in lending standards.  In steps Congress to the rescue! Remember who created the original act to make mortgages available to everyone regardless of risk? Well, they are back again with new legislation, the Finance Reform Act. This act attempts to address the major causes of the current credit crisis and the lack of confidence in our financial markets.  The act requires greater transparency for structured products; however, it doesn't address how this will be done. Currently, this information is available to everyone if they know where to look for it and understand the language in which it is written. Under the new act, will this information be in plain English that the general investor will understand? Will it lead to a prospectus that is automatically sent to investors once they purchase an asset backed bond or will they have to request it or look it up online which is currently the case? Mutual funds are required to automatically send out prospecti written in plain English to each purchaser of their funds; the same should be true of asset backed securities.
Institutions will still be able to engage in risky investments under the Financial Reform Act. Further steps need to be taken.