2003-'07: The Federal Reserve failed to use its supervisory and regulatory authority over banks, mortgage underwriters and other lenders, who abandoned such standards as employment history, income, down payments, credit rating, assets, property loan-to-value ratio and debt-servicing ability. The borrower's ability to repay these mortgages was replaced with the lender's ability to securitize and repackage them.In the comments of that post, the notion that the Community Reinvestment Act contriubuted to this problem is debated. It's worth reading. In the end, however, the fact that Fannie and Freddie bought hundreds of billions of dollars of bad loans is most certainly a key part.
2004: The SEC waived its leverage rules. Previously, broker/dealer net-capital rules limited firms to a maximum debt-to-net-capital ratio of 12 to 1. This 2004 exemption allowed them to exceed this leverage rule. Only five firms -- Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Stearns and Morgan Stanley -- were granted this exemption; they promptly levered up 20, 30 and even 40 to 1.
HUD stuck with an outdated policy that allowed Freddie Mac and Fannie Mae to count billions of dollars they invested in subprime loans as a public good that would foster affordable housing.No matter how much Fannie and Freddie drove this disaster, claiming that free market purity would have prevented this mess is clearly false.
Update: This press release from HUD put out in 2006 is pretty damning evidence that the government was using Fannie and Freddie as tools for social engineering.