First the Fed issued guidance which warned the banks that their capital requirements would be severely raised in response to the Subprime mortgages. In other words, banks were told that to the extent that they issued mortgages to high risk borrowers, to that extent they would not be allowed to put as much of their money into income-producing activities. The banks had already been told by the Fed that they would have to set aside more money for mortgages in general, and now they were being hit again for the Subprime variety.
Second, the Fed issued guidance on how to mix Subprime mortgage paper in with good paper and sell the resulting composite security to the general market. This is how the ‘toxic waste’ of bad debt was pumped out into the world. This is why credit markets are now having trouble clearing. This is why banks are taking massive write-downs of the loans which still exist on their books. This is why foreign investors don’t want to buy US mortgages, or bank stocks, and consequently don’t want to buy the dollars in which they are denominated either. If you add to this a Security and Exchange Commission ruling which compels banks to ‘mark to market’, which means they are forced to show large losses in times of market panic, you give a legal mandate for short-term thinking. You create a more serious crisis for the system and a fatal blow to the weaker banks.
This crisis has the fingerprints of congress and its bureaucratic enforcers all over it. It also has the fingerprints of a generation of activists and ‘fair housing’ lawyers as well, such as Barry (now known as Barack) Obama. That part of the story is yet to be told.