Monday, March 12, 2012

How Housing Policy Caused the Financial Crisis


Reason.tv -- "AEI's Peter Wallison argues in the video above that the financial meltdown was largely a consequence of government housing policy that underwrote unsustainable economic activity. He draws heavily on the research of Fannie Mae's former chief credit officer, Edward Pinto (now at AEI), which found that federal housing agencies drastically underreported the number of high-risk mortgages on their books. According to Wallison and Pinto, there were about 28 million high-risk mortgages in the U.S. in 2008; roughly 70 percent of those mortgages were owned by government-sponsored enterprises such as Fannie Mae and Freddie Mac."

37 Comments:

At 3/13/2012 12:12 AM, Blogger juandos said...

Really?!?!

Some are coming to that conclusion regarding housing policy a few years late, don't you think?

Well good for Wallison for stepping out and making the case regarding government interference in the housing market...

Ahh but for people like Doug Ross who was all over it since 2008 maybe Congress wouldn't have called a commission...

 
At 3/13/2012 4:58 AM, Blogger rjs said...

wallison has been debunked more times than i can count...i suppose fannie & freddie were reponsible for the same bank practices in spain & ireland too

 
At 3/13/2012 5:10 AM, Blogger PeakTrader said...

Some people blame the Fed, but that would be wrong, and the opposite of reality.

Of course, some people, through politics or ignorance, continue to blame the Fed.

The Fed has attempted to offset the negative effects of poor economic policies by Congress and Administrations.

I'm sure, in the future, if stagflation takes hold, some people will blame it on monetary policy instead of fiscal policy or policies by politicians.

 
At 3/13/2012 5:29 AM, Blogger PeakTrader said...

The larger problem, or imbalance, was the U.S. private sector shifting dollars from up to $800 billion annual trade deficits to export-led economies, which bought U.S. Treasury bonds.

So, in effect, there was a shift of dollars from the U.S. private sector to the U.S. public sector (or government).

If those dollars were refunded to the private sector in the form of tax cuts, instead of spent or saved by government, the recession would've been mild at worst, and fewer Americans would've lost their jobs and houses.

 
At 3/13/2012 5:37 AM, Blogger PeakTrader said...

Also, the "moral hazard" created in the housing market would've had to been reduced through a gradual tightening of lending standards, which was the responsibility of Congress.

 
At 3/13/2012 7:18 AM, Blogger Larry G said...

looking back is comical.... especially when you ask...

how we should go forward so that it does not happen again.

then the fund begins.

If we had done with Fannie/Freddie what we already do with FDIC - what would have happened?

Does anyone think the FDIC approach is wrong or unsustainable or will lead to failure?

You know... there used to be something called MGIC.

does anyone remember it?
http://en.wikipedia.org/wiki/Mortgage_Guaranty_Insurance_Corporation

why was MGIC not required for sub-prime mortgages?

 
At 3/13/2012 9:55 AM, Blogger Che is dead said...

"wallison has been debunked more times than i can count..." -- rjs

Debunked? Where do we go to get our money back?

Taxpayers have spent more than $150 billion to prop up Fannie and Freddie, the most expensive bailout of the 2008 financial crisis. The government estimates that figure could top $259 billion to support the companies through 2014 after subtracting dividend payments. Fannie has received more than $116 billion so far from the Treasury Department, the most expensive bailout of a single company. -- Yahoo News

 
At 3/13/2012 10:34 AM, Blogger morganovich said...

rjs-

oddly, yes, they were. capital markets are GLOBAL. the us has the largest mortgage market in the world.

with fred and fan buying up huge piles of mortgages and injecting more capital into the system, it glutted the whole world.

by taking a bunch of sub prime crap, attaching the de facto us federal guarantee to it and making it AAA, and selling it as an MBS (and oh yes, they were all sold as "federally guaranteed", i know because i got the sales calls) they were the ones that broke the link between banks and the credit quality of the borrowers.

they thought they were spinning straw into gold but what they were really doing was injecting massive liquidity and risk into the whole global market.

it worked just like the VC bubble in 1999. too much capital was chasing too little opportunity. that gets you a bubble. it was a direct result of the US GSE's and it was so large it affected the whole world.

far from "debunking" his claims, those claiming this could not be global as a result of their behavior are just showing their ignorance of how linked finance is.

silicon valley and our equity markets drove a global equity bubble too.

larry, your comparison of F+F and the FDIC is inapt. it doesn't even make sense.

no amount of insurance would have helped. the problem was that F+F were pimping out the us governments credit rating. (and wound up wrecking it)

so long as F+F were allowed to put a US federal guarantee on any crap they bought and repackaged, the mess was uninsurable.

that is what the rest of TARP (to banks) has been paid back, and F+F are still digging a hole.

 
At 3/13/2012 10:48 AM, Blogger Zachriel said...

morganovich: with fred and fan buying up huge piles of mortgages and injecting more capital into the system, it glutted the whole world.

Well, they certainly threw fuel on the fire, the greater fools, but the bubble has its origins in the shadow market in securities, which rivaled the traditional banking sector in size.

“The evidence strongly suggests that without the excess demand from securitizers, subprime mortgage originations (undeniably the original source of the crisis) would have been far smaller and defaults accordingly far lower." — Alan Greenspan

 
At 3/13/2012 11:55 AM, Blogger juandos said...

"wallison has been debunked more times than i can count"...

Are you missing most of your fingers on both hands rjs?

 
At 3/13/2012 12:14 PM, Blogger geoih said...

Qoute by PeakTrader: "The Fed has attempted to offset the negative effects of poor economic policies by Congress and Administrations."

LOL! Man this blog is really becoming hilarious!

 
At 3/13/2012 12:18 PM, Blogger Larry G said...

" larry, your comparison of F+F and the FDIC is inapt. it doesn't even make sense.

no amount of insurance would have helped. the problem was that F+F were pimping out the us governments credit rating. (and wound up wrecking it)"

I think it makes perfect sense from a couple of perspectives.

for one - many fewer FDIC banks got into trouble with the mortgages than non FDIC financial orgs.

for two - MGIC used to be REQUIRED for sub-prime mortgages.

I had to pay premiums for a decade on a home that I used a completely-paid for lot as a down payment - they STILL said it did not count as part of the 20% down and I paid every month for mortgage insurance as a result.

The entire purpose of the MGIC insurance was to have an appropriate pool of money - proportional to the percent of sub-prime loans to cover the losses.

why did that practice go away?

why didn't the people who sourced the sub-prime loans REQUIRE MGIC ?

 
At 3/13/2012 12:21 PM, Blogger Che is dead said...

“The evidence strongly suggests that without the excess demand from securitizers, subprime mortgage originations (undeniably the original source of the crisis) would have been far smaller and defaults accordingly far lower." — Alan Greenspan

So says the man whose misguided interest rate policy forced a systematic mispricing of risk, igniting widespread investment in MBS, and driving the proliferation of subprime mortgage brokerages.

 
At 3/13/2012 12:22 PM, Blogger morganovich said...

zach-

you are missing the point. fred and fan WERE that demand. they were the biggest providers of amterial for MBS's. they bought up sub prime mortgages, magically turned them AAA by slapping the us federal guarantee on them, then packaged them and sold them to securitizers.

most of that crap would NEVER have sold absent the guarantee.

it was also the most profitable kind to securitize, again, ONLY because of F+F. it's like being able to buy junk bonds and sell them as AAA. the spread is HUGE. they did it by pimping out the us credit rating. it was the equivalent of a financial magic wand that took something selling at 70 and made it worth 95. it was a classic case of externality. the whole structure of F+F was doomed from the start, it just took CRA to provide raw materials and the invention of the MBS to provide a production process, but MBS's themselves would have been priced just like any other bonds absent F+F and the outlandish profit spreads they had would never have been possible.

absent the federal guarantee on loans bought by F+F, the whole process could never have happened.

 
At 3/13/2012 12:27 PM, Blogger morganovich said...

"why didn't the people who sourced the sub-prime loans REQUIRE MGIC ?"

1. the CRA required you to make the loans as if they were prime, so MGIC was not attached.

2. when F+F bought the loans, a federal guarantee got attached anyway, so why bother?

you have to realize, F+F bought up all the crap (and lied about doing it, deliberately misstating their credit quality). they wanted crap because the worse the loan, the bigger the jump in value when they made it AAA.

they were the ones doing the sourcing and they were the ones driving this.

FDIC banks did not have better quality, just lower leverage. you are only FDIC if you take deposits. lehman had no such limits.

a 5% loss at 3:1 hurts, but you can live with it. a 5% loss at 15:1 is fatal.

so again, it's really not an apt comparison. they are totally different issues.

 
At 3/13/2012 2:21 PM, Blogger Ron H. said...

"You know... there used to be something called MGIC.

does anyone remember it?
"

No need to remember it, it still exists.

"why was MGIC not required for sub-prime mortgages?"

Why not, you ask? Do you think a product offered by a private company should be required as a condition of getting a loan?

Should you be required to buy Allstate insurance for your car?

The whole idea of coercing lenders to make sub-prime loans is to put people in houses who wouldn't normally qualify. As such, they may not meet underwriting standards for mortgage insurance either. Would you then force private insurers to insure them anyway?

What about the cost? If people can't afford a conventional mortgage, how can they afford a sub-prime one with the additional cost of mortgage insurance?

Better to let all us taxpayers assume the risk, don't you think? Your elected representatives do.

 
At 3/13/2012 2:26 PM, Blogger Ron H. said...

This comment has been removed by the author.

 
At 3/13/2012 2:30 PM, Blogger Ron H. said...

"Does anyone think the FDIC approach is wrong or unsustainable or will lead to failure?""

Yes. It ultimately puts taxpayers on the hook for bank failures, and promotes the idea that depositors shouldn't worry about their bank, because their money is insured. Can you say "moral hazard"?

Insurance and pooling of risk is a great idea, but those willing to risk their own money should be involved, not taxpayers.

 
At 3/13/2012 2:39 PM, Blogger morganovich said...

ron-

fdic insurance is paid for through premiums from member banks.

run as a private co op with voluntary participation, it seems like a fine idea to me.

where things go pear shaped is when you add a federal guarantee.

if i know the feds will bail out the FDIC, well, then i have incentive to under price premiums.

that's where the mess comes from.

we need to get the federal government out of the "guaranteeing stuff" business.

 
At 3/13/2012 3:03 PM, Blogger PeakTrader said...

Geoih, if you can't handle the truth, how about:

"Obama, Pelosi, Barney Frank and other competent lawmakers have attempted to offset the negative effects of poor economic policies by the Fed."

Of course, we can include Ron Paul too.

 
At 3/13/2012 4:58 PM, Blogger Larry G said...

" Yes. It ultimately puts taxpayers on the hook for bank failures, and promotes the idea that depositors shouldn't worry about their bank, because their money is insured. Can you say "moral hazard"?"

has FDIC failed?

it appears to me that FDIC has worked for 80 years or so.

re: " 1. the CRA required you to make the loans as if they were prime, so MGIC was not attached."

ONLY in the redlined areas and ONLY for banks who did business in the redlined areas.

the vast majority of sub-prime loans were not made in red-lined areas.

and why was MGIC not required for ALL sub-prime loans no matter where the loans were made?

MGIC appears to be a non-govt agency... so why was it not required ?

 
At 3/13/2012 5:16 PM, Blogger juandos said...

"it appears to me that FDIC has worked for 80 years or so"...

I wonder about that... Did the preiums charged by the FDIC cover all the failures or were general revenues also used?

 
At 3/13/2012 6:06 PM, Blogger Larry G said...

" The FDIC receives no Congressional appropriations – it is funded by premiums that banks and thrift institutions pay for deposit insurance coverage and from earnings on investments in U.S. Treasury securities."

http://www.fdic.gov/about/learn/symbol/

so would you now agree that FDIC "works"?

 
At 3/13/2012 7:58 PM, Blogger Zachriel said...

morganovich: you are missing the point. fred and fan WERE that demand.

That is incorrect. GSE market share *decreased* during the runup to the crisis with riskier loans being made by private securitization. The GSEs followed the market. The shadow banking system was far bigger even than Fannie and Freddie. It rivaled the size of the conventional banking system at $60 trillion.
http://www.reuters.com/article/2011/10/27/g20-shadowbanking-idUSL5E7LR4FQ20111027

The Financial Crisis Inquiry Commission: "We concluded that excess liquidity, by itself, did not need to cause a crisis, and that Fannie Mae and Freddie Mac contributed to the crisis but were not a primary cause. We determined that government housing policies were not a significant factor in the crisis."

 
At 3/13/2012 8:19 PM, Blogger Tom said...

Wallison is right. Big government screwed up housing prices via overwhelming regulations - virtual socialism. They have also screwed up food prices, energy prices, education quality and prices, medical prices, and retirement savings.

 
At 3/13/2012 8:32 PM, Blogger Che is dead said...

"That is incorrect. GSE market share *decreased* during the runup to the crisis with riskier loans being made by private securitization. The GSEs followed the market." -- Zachriel

It wasn't until 2002 that Wall Street issued over $100 billion in securities backed by subprime or other weak loans. Recall that by this date, the GSEs had bought over a $1 trillion. The banks' number grew so that, by 2008, there were 7.8 million low quality mortgages backing bank-issued securities — less than 30% of the 27 million. -- Peter J. Wallison, USA Today

 
At 3/13/2012 11:26 PM, Blogger Ron H. said...

"so would you now agree that FDIC "works"?"

Do you purposefully ignore what others have written?

juandos asked you if were aware of any taxpayer money going to FDIC during the recent crises - after all, as a federal agency FDIC ultimately guarantees deposits with taxpayer money, having a $500 billion line of credit at the treasury.

Instead of responding correctly, you quote something irrelevant from the FDIC website.

 
At 3/14/2012 5:49 AM, Blogger Larry G said...

If you or Juandos have info about FDIC funding, then by all means provide it.

Otherwise, what's your point?

FDIC "works", as far as I know, without additional govt funding.
If you or others know otherwise, provide the info.

Many of the so-called "banks" that got into serious financial trouble over the securitized mortgages were not FDIC and only about 25% were CRA.

After all is said and done - how many people have advocated for the demise of FDIC?

 
At 3/14/2012 7:53 AM, Blogger Zachriel said...

Che is dead: Peter J. Wallison, USA Today

Wallison's analysis is seriously flawed as he uses Pinto's faulty definition of risky loans. This results in conclusions at odds with the facts. The entire federal government guaranteed 67% of all mortgages, but these only represent 32% of the seriously delinquent mortgages. The private-mortgage market generated just 13% of mortgages, but 42% of the serious delinquencies.

 
At 3/14/2012 10:19 AM, Blogger morganovich said...

zach-

no, you are still missing what happened.

private banks issued the loans BECAUSE they knew they could sell them on the freddie and fannie who were buying over 40% of ALL ORIGINATION.

it worked like this:

wells fargo made a subprime mortgage but, under CRA, charged a prime rate and required little or no down payment.

as a bond, such a thing would trade well under par as it is subprime risk with prime coupon.

freddy would massively overpay for it and wells would be delighted to get rid of it having met their CRA requirement without getting killed on the loan.

freddy would then slap the US federal guarantee on it allowing them to price it at par as it now WAS in the eyes of investors a prime loan.

that got bundled into an MBS and sold.

it was a massive and systematic distortion of incentives.

CRA made banks generate crap.

frdedy and fannie enabled them by buying it. they then sold it on as prime by leaving you an me and any of the other lucky few in the US that actually pay taxes holding the bag.

F+F deliberately lied about their loan quality.

http://www.ritholtz.com/blog/2011/12/fannie-freddie-execs-indicted-for-securities-fraud/

they are going to go to jail for it and deserve to.

 
At 3/14/2012 10:29 AM, Blogger morganovich said...

larry-

you mean the FDIC that needed a $500 billion federal guarantee to stop a run because it's reserves were too low?

i agree that handling it privately is the way to go, but do keep in mind that the FDIC would have imploded in 2009 without federal support and that we, the taxpayers, did pay for it.

the FDIC can draw $100 million of treasury money ANY TIME. they don't even need to ask.

in june 2009, the FDIC fund that covers $4.5tn in US deposits had dropped to $10 billion which could not protect one S+L.

you're talking about even a 0.1% draw ruining them.

congress rushed in to fill the gap.

they then also used federal credit to slap "guarantees" onto banks that got sold so the new buyers could not get hurt.

TARP got repaid, this was a fiasco of federal risk but private profit.

if i offered to sell you a stock and pay for any losses but let you keep all the gains, you'd think it was a helluva deal.

that is EXACTLY what the FDIC did.

did it "work" in the sense that massive bank runs were avoided, perhaps.

but was it self funding and a model of fiscal probity?

no. it was a morass of hidden tax payer liability and wicked moral hazard around deals.

 
At 3/14/2012 10:41 AM, Blogger morganovich said...

zach-

i think you are the one fiddling the figures.

your "federal guarantee" figure includes all manner of mortgage insurance that had nothing to do with the GSE's and or with subprime.

further, you are not counting correctly.

that figure would consider a loan that F+F guaranteed but that was still held by the issuer as and issuer default, but they only made the loan BECAUSE it was guaranteed.

thus, it's really an F+F default as they are the one paying and the only reason the loan was ever made was because of the guarantee.

a quick look at their default rates and massive losses makes this very clear.

http://seekingalpha.com/article/204265-the-disconcerting-truth-about-fannie-and-freddie-default-rates

the default rates for guarantees are even higher than those for loans and have exceeded 4% at fannie for some vintages.

that's what you are missing.

if i make a bad loan knowing that you pay if it fails, who's really the party at risk?

 
At 3/14/2012 11:18 AM, Blogger Zachriel said...

morganovich: that figure would consider a loan that F+F guaranteed but that was still held by the issuer as and issuer default, but they only made the loan BECAUSE it was guaranteed.

And those mortgages had a much lower failure rate that those on the private market.

morganovich: http://seekingalpha.com/article/204265-the-disconcerting-truth-about-fannie-and-freddie-default-rates

Your chart seems to show that GSE mortgages made in the earlier years of the run up had a much lower failure rate, even after a longer time on the books. This supports the view that GSE followed into the market.

 
At 3/14/2012 12:10 PM, Blogger morganovich said...

zach-

you are still missing this.

the point is that all those guarantees are being counted as private loan failures, but they are not.

you are counting the failed loans as private when looking at amounts, and they are not. they are freddy and fannie loans, just not in name.

if i buy a stock because you promise to pay for my losses but let me take the profit, who is the loser when it blows up?

i would never have even looked at the think had you not agreed to make me whole.

you are counting these failures on the wrong side of the ledger.

everyone's loans had a much lower failure rate early on.

what really drove the market parabloic was F+F cutting underwriting standards.

2004 vintages were still decent for everyone. you seem to be trying to compare F+F in 2003 to other banks entire average. that's not a valid comparison. it was 2006-7 that caused the disaster.

 
At 3/14/2012 12:36 PM, Blogger Zachriel said...

morganovich: you are counting the failed loans as private when looking at amounts, and they are not.

No, we're counting privately securitized mortgages as a separate category, which defaulted at six times the rate of GSE-backed loans.

Elul, Securitization and Mortgage Default, Federal Reserve Bank of Philadelphia 2009.

GSEs were not major players in the market for private mortgage backed securities.

http://www.americanprogress.org/issues/2010/12/img/fcic_column2.jpg

 
At 3/14/2012 1:40 PM, Blogger William Bruce said...

I am surprised by this discussion's relative lack of attention to interest rates and central bank policy, both in the US and in Europe. After all, an essential part of the Wallison interview was the concept of conditions which are necessary, but not sufficient, to particular outcomes.

 
At 3/14/2012 11:48 PM, Blogger juandos said...

"If you or Juandos have info about FDIC funding, then by all means provide it"...

larry g point your beady little eyes here...

 

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