Wednesday, October 12, 2011

Reckless Government Policies, Not Private Greed Caused the Housing Bubble and Financial Crisis

Peter Wallison of the American Enterprise Institute writing in today's WSJ, explains that the Wall Street protesters have been grossly misled because it was "Reckless government policies, and not private greed, that brought about the housing bubble and resulting financial crisis." Here's an excerpt:

"Beginning in 1992, the government required Fannie Mae and Freddie Mac to direct a substantial portion of their mortgage financing to borrowers who were at or below the median income in their communities. The original legislative quota was 30%. But the Department of Housing and Urban Development was given authority to adjust it, and through the Bill Clinton and George W. Bush administrations HUD raised the quota to 50% by 2000 and 55% by 2007. 

It is certainly possible to find prime borrowers among people with incomes below the median. But when more than half of the mortgages Fannie and Freddie were required to buy were required to have that characteristic, these two government-sponsored enterprises had to significantly reduce their underwriting standards.

Research by Edward Pinto, a former chief credit officer of Fannie Mae (now at the American Enterprise Institute) has shown that 27 million loans—half of all mortgages in the U.S.—were subprime or otherwise weak by 2008. That is, the loans were made to borrowers with blemished credit, or were loans with no or low down payments, no documentation, or required only interest payments.

Of these, over 70% were held or guaranteed by Fannie and Freddie or some other government agency or government-regulated institution. Thus it is clear where the demand for these deficient mortgages came from.

The huge government investment in subprime mortgages achieved its purpose. Home ownership in the U.S. increased to 69% from 65% (where it had been for 30 years). But it also led to the biggest housing bubble in American history (see chart above). This bubble, which lasted from 1997 to 2007, also created a huge private market for mortgage-backed securities (MBS) based on pools of subprime loans.

As housing bubbles grow, rising prices suppress delinquencies and defaults. People who could not meet their mortgage obligations could refinance or sell, because their houses were now worth more.

When the bubble deflated in 2007, an unprecedented number of weak mortgages went into default, driving down housing prices throughout the U.S. and throwing Fannie and Freddie into insolvency. Seeing these sudden losses, investors fled from the market for privately issued MBS, and mark-to-market accounting required banks and others to write down the value of their mortgage-backed assets to the distress levels in a market that now had few buyers. This raised questions about the solvency and liquidity of the largest financial institutions and began a period of great investor anxiety.

The narrative that came out of these events—largely propagated by government officials and accepted by a credulous media—was that the private sector's greed and risk-taking caused the financial crisis and the government's policies were not responsible. This narrative stimulated the punitive Dodd-Frank Act—fittingly named after Congress's two key supporters of the government's destructive housing policies. It also gave us the occupiers of Wall Street."

MP: The chart above shows how the weakening of underwriting standards did boost the homeownership to rate to an historically unprecedented level above 69% by the end of 2004, but in the process created an unsustainable housing bubble that started unraveling in early 2007.  Now real home prices (measured by the FHFA index) are back to 2001 levels and homeownership rates are back to the levels of the late 1990s.  

35 Comments:

At 10/12/2011 9:06 AM, Blogger Bill said...

No doubt true, but let's not forget that Wall Street investment banks leveraged the loans 30:1 and made a bad situation much worse. I think there is plenty of blame to go around on this one. Let's hope the market will clear the bad loans in due course so the housing market can recover.

 
At 10/12/2011 9:56 AM, Blogger Don said...

Mark, is there a chart you could point to that shows this data back to WWII? I'm curious what things looked like before congress passed the various housing acts in the 60's and 70's. It think it would be interesting to extrapolate a projected path based on buying patterns in the 40's and 50's to what actually happened. Of course, it would ultimately be fiction, but I have a strong suspicion that the growth rate would be approximately the same, just with less variance (i.e. a fare less "exciting" ride).

 
At 10/12/2011 10:09 AM, Blogger Mark J. Perry said...

Don: I only have homeownership rates back to 1965 from the Census Bureau and home price data from FHFA back to 1975. If I can find historical data back before those starting dates, I could create a new chart over a longer time frame.

 
At 10/12/2011 10:19 AM, Blogger morganovich said...

the difference is that in 2001, very few folks were underwater on their mortgages.

that picture is very different today.

the % of mortgages underwater is 28%, up from 22% a year ago, which was already very, very high.

 
At 10/12/2011 10:24 AM, Blogger morganovich said...

bill-

while you are apportioning blame, ask yourself this:

why were MBS's rated AAA and so readily sellable.

guarantees from freddy and fannie.

this was less a problem with leverage that it was one of federal guarantees making risk assets look (correctly) riskless to many buyers.

take the GSE's out of the equation, and none of this happened.

that's why wall st has paid back tarp with interest, while freddy and fannie keep sliding deeper into the red at taxpayer expense. note also that they show no real signs of having learned their lesson. they are now 70% of the mortgage market and keep driving rates lower in what is pure and simple government price fixing.

 
At 10/12/2011 10:28 AM, Blogger Benjamin said...

Pray tell, what caused an identical collapse in the value of USA commercial real estate? Did Fannie and Freddie also cause real estate globally to shift downward?

And did the home mortgage interest tax deduction play no role? How about the ratings agencies stamping AAA on mortgage-backed securities, that were eagerly purchased globally by institutional money managers?

Really, this AEI study is ideologically driven sniping, not scholarship.

 
At 10/12/2011 10:47 AM, Blogger Zachriel said...

According the your article, primary involvement by the GSE's was from 2004. Your chart shows that the housing bubble was well on its way before then. What you have is a classic bubble. There was a huge shadow market in securities, originally designed and marketed by Wall Street. It was demand driven alright, and the GSE's were the "greater fools."

 
At 10/12/2011 11:00 AM, Blogger juandos said...

"Pray tell, what caused an identical collapse in the value of USA commercial real estate?"...

Unwarrented and unneeded judicial intervention?

 
At 10/12/2011 11:11 AM, Blogger morganovich said...

bunny-

you ask that same question over and over and seem incapable of absorbing the answer, but i'll try one more time:

markets are linked. the same banks that found themselves illiquid due to homes were illiquid for commercial. they had no money to lend. all the financing dried up. that tanked the associate market in commercial.

note that most risk based asset markets tanked. that's what systemic illiquidity does.

then, the economy tanked, which hits commercial real estate again.

this is very simple stuff bunny.

see if you can get your head around it this time.

 
At 10/12/2011 11:14 AM, Blogger rjs said...

just to note, wallison had a dissenting opinion on the findings of the Financial Crisis Inquiry Commission...

http://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_conclusions.pdf

http://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_wallison_dissent.pdf

 
At 10/12/2011 11:20 AM, Blogger morganovich said...

zach-

the GSE's were involved long before then.

they were legally required to direct loans to subprime in 1992. the requirement was 30%. it rose to 50% by 2000 and 55% by 2007 (thanks barney and dodd).

the FHA forced banks to lend to subrpime as well.

with such a need to hit these quotas, lending standards had to be repeatedly dropped.

by 2008, subprime and liar loans were half of loans outstanding and a much higher percentage of recent issuance.

you can see the curve inflect up after the .com bust as greenspan's super low interest rates fueled the new bubble.

then, predictably, they blew up, and the US treasury was called to make good on its guarantees of the gse's.

 
At 10/12/2011 12:00 PM, Blogger Larry G said...

" 84.3 percent of subprime loans in 2006 were made by financial institutions not governed by the CRA.

However, the claim that the CRA is responsible for the current crisis ignores several crucial facts: - The CRA does not cover independent mortgage companies, which issued the vast majority of the loans underlying the crisis. The act applies only to depository banks and thrifts (savings and loan associations) that are federally insured. According to University of Michigan law professor Michael Barr in testimony before the House Financial Services Committee, just 20 percent of the subprime mortgages since the late 1990s were issued by CRA-covered lenders. Thus, 80 percent subprime loans were made by lenders not regulated by the CRA"

http://howdidthishappen.org/myths/

 
At 10/12/2011 12:54 PM, Blogger Hydra said...

Give me a break.

Public policies may have enabled greed, but they did not cause it.

Just because the government allows you to do something unethical and greedy does not mean you should do it.

If anything, this is a call for more regulation in order to enforce an acceptible level of ethics.

Bill is right, there is plenty of blame to go around on this one. But who is really getting hurt here?

It is those that have done nothing wrong: the ones making payments on a mortgage that is underwater. They cannot move and they cannot take advantage of the low interest rates and refinance, even if they were willing to refinance the underwater portion.

The bank already has an unprotected mortgage, if a refi were allowed it would still be unprotected, but the homeowner would have more free cash with which to make the payments, thereby lowering the risk (and the income) for the lender.

How is that situation a result of government policy?

 
At 10/12/2011 12:57 PM, Blogger Hydra said...

take the GSE's out of the equation, and none of this happened.


Including a lot of home sales and home construction and a lot of sales to allthe business that support homes.

In short, not much of anything would have happened.

 
At 10/12/2011 1:02 PM, Blogger Hydra said...

the FHA forced banks to lend to subrpime as well.

==========================

No one forced the banks to lend, the regs only set the proportion of lending required.

Maybe the regs assisted in an unortunate situation developing, but greed is what made it develop so hugely.

 
At 10/12/2011 1:19 PM, Blogger morganovich said...

"" 84.3 percent of subprime loans in 2006 were made by financial institutions not governed by the CRA"

that stat is nonsense.

frddy and fannie alone were 45% of the market then. they were lending to 55% subprime.

that's 25% of the market right there.

it's also disingenuous. banks were forced to lend by the FHA and it's quotas. there were more programs than just the CRA.

further, the banks would lend, then immediately sell the loans to feddy and fannie.

they only initiated them to hit quotas and because they knew there was a ready buyer.

trying to not count all those loans is awfully misleading.

the straight facts are there:

by 2008, there were 27 million subprime and no doc loans, half the US market.

70% of those were held or guaranteed by F+F or another federal agency.

that is where the bubble came from.

 
At 10/12/2011 1:21 PM, Blogger morganovich said...

hydra-

"No one forced the banks to lend, the regs only set the proportion of lending required."

only you would try to spit such an absurd hair.

the FHA said "if you lend at all, you must lend x% to subprime without respect for ability to pay"

banks then faced 2 choices: go out of business or lend to subprime at prime rates.

by your logic, a mugger does not force you to give up your wallet, you could always choose to get shot instead, right?

even in that case, you have more choice than a bank with shareholders.

 
At 10/12/2011 1:23 PM, Blogger Larry G said...

the point is that FDIC and CRA did not "force" the loans...

if anyone thinks they did - provide a credible/authoritative cite.

 
At 10/12/2011 1:25 PM, Blogger Larry G said...

" the FHA forced banks to lend to subrpime as well"

80% of the subprime loans were not under the purview of FDIC nor CRA and no govt regulation required subprime loans to be securitized and sold as bundled securities.

The Conservatives are desperate to "prove" (and lies are just fine) that regulation was the cause but the truth is that it was a lack of regulation that allowed the credit default swaps to be bought and sold by non-regulated banks.

Fannie/Freddie did their thing... and I agree that Fannie/Freddie should not have been in that business at all nor should we be writing off mortgage interest especially outrageous mortgage interest on no-doc subprime loans.

but FDIC and CRA did not "force" loans to be made.

 
At 10/12/2011 2:06 PM, Blogger morganovich said...

larry-

"80% of the subprime loans were not under the purview of FDIC nor CRA and no govt regulation required subprime loans to be securitized and sold as bundled securities."

that's just flat out untrue.

as i already told you, F+F were 40% of the mortgage market and were required by federal law to make 55% of loans to subprime in 2007.

that right there is 25% of the market.

all banks were forced, by the FHA, to make at least 20% of their lons to subprime. that was also federal law. that's another 12% of the market.

add those together, and you are at well over 1/3 of mortgage federally mandated to be subprime.

your sideline into MBS's just exposes your ignorance.

why do you think banks were so desperate to get this stuff off their sheets?

and why do you think they got AAA ratings? federal guarantees.

70% of subprime loans were owned or guaranteed by the federal government or F+F (which amounted to the same thing)

repeating stuff you made up over and over won't make it true.

 
At 10/12/2011 2:09 PM, Blogger morganovich said...

btw, those number come directly from edward pinto, former chief credit officer for fannie. unlike yours, they are not made up, but come right from the horse's mouth.

and it's nothing like over:

http://www.nytimes.com/2008/12/10/business/10fannie.html

 
At 10/12/2011 2:13 PM, Blogger morganovich said...

"From 2002 to 2007, Fannie Mae and Freddie Mac loaded up on $1.73 trillion of subprime and $1.44 trillion of Alt-A loans and securities, taking the lion's share of these markets, according to mortgage market guru Edward Pinto. The agencies' share of these riskier loans and securities, then, was higher than the total for all private label mortgage-backed securities held outside the agencies' purchases -- contrary to widely-held views in the mortgage industry. The two agencies hid the level of risky lending and investment in securities by failing to classify most of the loans initially as subprime or Alt-A."

 
At 10/12/2011 2:18 PM, Blogger Larry G said...

" repeating stuff you made up over and over won't make it true"

tell you what.. you go get an authoritative cite and I'll hold mine until you provide yours and we can compare...

here's a start:

" Most subprime mortgages not issued by institutions under CRA. In a paper published on the website of the Federal Reserve Bank of San Francisco, Michigan law professor Michael Barr stated that as of 2005: “Only 25 percent of subprime loans were made by banks and thrifts, and the Federal Reserve reports that only six percent of subprime loans were CRA-eligible.” Similarly, a 2008 study by a law firm specializing in CRA compliance estimated that in the 15 most populous metropolitan areas, 84.3 percent of subprime loans in 2006 were made by financial institutions not governed by the CRA."

http://www.makingmoneyexperiment.com/2011/05/didnt-the-chairmn-of-the-fedfdic-both-say-thecommunity-reinvestment-loans-had-nothing-to-do-with-the-crisis-4.html

http://www.frbsf.org/publications/community/cra/cra_lending_during_subprime_meltdown.pdf

 
At 10/12/2011 2:20 PM, Blogger Larry G said...

" "From 2002 to 2007, Fannie Mae and Freddie Mac loaded up on $1.73 trillion of subprime"

they did. I agree.

but no one forced the loan companies to do this.

Fannie/Freddie enabled them to do it and they did just that.

 
At 10/12/2011 2:28 PM, Blogger t11s said...

"why were MBS's rated AAA and so readily sellable."

Because no one thought huge numbers of people were going to walk away from their home (by defaulting on the mortgage). Turns out they were wrong...

 
At 10/12/2011 2:34 PM, Blogger t11s said...

"No one forced the banks to lend, the regs only set the proportion of lending required."

Banks were required by Basel regulations to have backing with AAA-rated securities, so that was a large part of the demand for MBS.

Commercial banks lent, of course, but then sold those mortgages to investment banks and GSEs for bundling into MBS, which after getting an AAA-rating by the officially approved ratings agencies, the commercial banks purchased the MBS to meet their Basel requirements - as AAA-rated MBS were considered by Basel to be less risky than individual mortgages.

Today, commercial banks are sitting on a lot of sovereign debt due to Basel regulations - such as bonds of Greece, Italy, etc.

 
At 10/12/2011 2:59 PM, Blogger Paul said...

Benji,

"Pray tell, what caused an identical collapse in the value of USA commercial real estate?"

The price of oil collapsed too. Can you figure out why?

 
At 10/12/2011 3:06 PM, Blogger Paul said...

Hydra,

"Including a lot of home sales and home construction and a lot of sales to allthe business that support homes."

Classic broken window fallacy. And how did all that work out in the end?

 
At 10/12/2011 3:14 PM, Blogger t11s said...

By the way, here is a source on the HUD regulations on GSE lending to folks under median incomes, at HUD's web site:

http://www.huduser.org/periodicals/ushmc/summer98/summary-2.html

"In the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, Congress imposed certain obligations on the GSEs in exchange for the benefits they receive. In particular, Congress charged the U.S. Department of Housing and Urban Development (HUD) with setting annual goals to ensure that Fannie Mae and Freddie Mac use the benefits received from the Federal Government to help lower income and minority households and that underserved areas receive adequate mortgage financing."

"The housing goals set by HUD for 1996 through 1999 are:

A low- and moderate-income goal, which targets mortgages on housing for families with less than median income and was set at 40 percent of total units financed by each GSE in 1996 and at 42 percent for each year from 1997 through 1999."

 
At 10/12/2011 4:52 PM, Blogger PeakTrader said...

Bill, it's perfectly rational for Wall Street, along with house flippers, to make money on dumb government policies. What did you expect?

 
At 10/13/2011 7:59 AM, Blogger Zachriel said...

morganovich: the GSE's were involved long before then. they were legally required to direct loans to subprime in 1992.

You are probably referring to goals set for low-to-moderate income households. No bank was forced to make bad loans. The increased volume was due to excess demand in the shadow market for securities manufactured on Wall Street.

morganovich: with such a need to hit these quotas, lending standards had to be repeatedly dropped.

Certainly keeping the regulators happy helped grease the wheel, but then again, it was demand driven. Anyone who was aware of anything at the time knew that there was a rush to make money, to flip assets (houses, mortgages and securities) as fast as you could; a classic bubble. If no one was buying the securities, then it wouldn't have mattered what the GSE's did.

Larry G: The CRA does not cover independent mortgage companies, which issued the vast majority of the loans underlying the crisis.

Quite so.

morganovich: as i already told you, F+F were 40% of the mortgage market and were required by federal law to make 55% of loans to subprime in 2007.

You seem to be conflating subprime with other types of loans.

morganovich: the FHA said "if you lend at all, you must lend x% to subprime without respect for ability to pay"

Presumably, that's a paraphrase. Do you have an actual citation?

 
At 10/13/2011 9:49 AM, Blogger Tom said...

The low and moderate income quotas were issued by HUD. They applied to Fannie and Freddie, which complied in timely fashion. Those same quotas also applied to all the big, expanding banks. If they wanted to acquire other banks, they had to issue LMI mortgages following the same quotas as F&F.

Page 60 of Wallison's FCIC dissenting report shows the quotas in year-by-year detail. By the time of the crash in 2008, 27 million of 57 million mortgages were less than prime quality.

The subprime mortgage crash was de facto mandated by our brilliant federal bureaucracy.

The FCIC main report was a whitewash which deliberately hid the complicity of government in creating the worldwide economic collapse.

 
At 10/13/2011 11:08 AM, Blogger Zachriel said...

"We conclude that these two entities contributed to the crisis, but were not a primary cause. Importantly, GSE mortgage securities essentially maintained their value throughout the crisis and did not contribute to the significant financial firm losses that were central to the financial crisis... The GSEs participated in the expansion of subprime and other risky mortgages, but they followed rather than led Wall Street and other lenders in the rush for fool’s gold."

Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States.
http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf

 
At 10/13/2011 11:09 AM, Blogger Larry G said...

Zach - you should know better that citing facts in this blog...

it's not appreciated.

 
At 10/13/2011 11:25 AM, Blogger Peter K said...

What business would not take a deal where the other guy assumes all the risk? With the government guarantee on mortgage loans that is exactly what businesses did.

 

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