Did the IRS Cause the Financial Crisis?

As the dust from the financial crisis begins to settle, we learn that the lack of IRS enforcement of the mortgage-backed securities industry bears blame for the financial crisis. The financial crisis began when lenders started making bad loans on a large-scale basis in the late ’90s and early ’00s. Big banks purchased these bad loans, bundled them into trusts, and sold interests in the trusts to investors worldwide. The interests in the trusts are mortgage-backed securities. The investors (financial institutions, pension and retirement plans, insurance companies, state and local governments and individuals) did not know the loans were bad, and paid inflated prices for the mortgage-backed securities. Now that the practices of lenders and banks are coming to light, borrowers and investors are seeking to recover losses through lawsuits. And it is obvious that better practices, as required by tax law and enforced through IRS audit, would have prevented or mitigated those losses.

Mortgage-backed securities are a vital part of our economy. A person who borrows to buy a house gives the lender a mortgage note. The lender often sells that note to another bank for cash. That cash allows the lender to make another loan. This process makes more money available for lending, helps keep mortgage interest rates low and makes homeownership available to more people. Banks that purchase mortgage notes bundle them, place them in trusts and sell mortgage-backed securities to investors. Banks use the cash they get from investors to purchase more mortgage notes. Thus, mortgage-backed securities support the real estate market, and doing away with them is not an alternative. Instead, we must ensure that they are properly formed and include quality mortgages — IRS oversight would have helped make this happen.

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