As I said in a previous column, the financial sector’s crisis right now is a result of a glut of housing and a government regulation that encouraged lending to people that normally wouldn’t have qualified under more conservative regulations. But there are two other factors that played a role in the crisis and may have multiplied the effects of mortgage defaults.When a mortgage-backed security is created, it’s typically a complex investment that includes many pieces of different mortgages. It’s not something tied to an individual home but instead to many different mortgages. When these packages were created and coupled with sub prime mortgages to promise higher returns, banks created an insurance to ensure that returns were safe and consistent.Under Federal regulations, insurance must have a certain deposit to guarantee the insured asset. The banks skirted this rule by using what is called a credit default swap, which does the same thing as an insurance policy. If a credit instrument defaults, the policy insures the value of the investment and in this case, the value of the mortgage package. This unregulated market of credit default swaps is worth trillions of dollars and has multiplied the effect of the failed mortgages because companies providing these swaps aren’t able to keep up with payments, as the mortgage securities are in default.The second element that led to the glut of housing that drove up housing values and led an increase in demand for new homes was the cut in interest rates following the economic slow down of 2001 and 2002 due to the implosion of the tech industry that inflated the economy during the 1990’s.Alan Greenspan, then Chairman of the Federal Reserve, continuously cut interest rates for inter-bank lending and fed cheap money into the system. Couple that with the Community Reinvestment Act, where the government encouraged loans to people who didn’t qualify for prime interest rates for various reasons, and more banks giving interest only loans and asking for lower down payments. The housing supply was eventually going to exceed demand when the flow of cheap money was slowed by outside economical constraints. The credit crisis has had far reaching effects and has been a storm brewing underneath Wall Street for decades. Is this a blanket indictment on government regulation in the financial industry? No. But it is the result of two bad policies, one where there was too much regulation and another where there was a lack of regulation.Unfortunately, the economy is going to have to rebound and in the process the liquidity in the market is going to have to rely on government aid. Everything from student loans, mortgages, and even state government finances are on edge with the current situation, and hopefully the government’s financial package will push the nation in the right direction. Otherwise, the entire credit market could crash and the economy may come to a grinding halt.The free market is still the best way to go, but the government needs to take a long look and identify harmful loopholes and detrimental regulation.E-mail Benton your thoughts about Wall Street to [email protected].