Tuesday, September 23, 2008

Flashback to 1999: Origins of the Credit Crisis

From the NY Times on September 30, 1999: "Fannie Mae Eases Credit To Aid Mortgage Lending":

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990s by reducing down payment requirements,'' said Franklin Raines, Fannie Mae's chairman and CEO. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.''

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s (MP: How prophetic!).

'From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

See Peter Wallison's article in today's WSJ

HT: Isaac Morehouse at Students for a Free Economy


At 9/23/2008 3:17 PM, Anonymous Anonymous said...

I have a question to ask, how does this crunch effect hedge funds? Did they buy any unsecured asset?

At 9/23/2008 4:21 PM, Anonymous Anonymous said...

I thought the problem is that the home prices went down and rampant fraud on mortage applications came to light and so the mortagages' value on secondary markets are now unmeasurable. Now no one trusts the ratings companies and no one will buy loans of any type on the secondary market. Now no one can make new loans because they can't sell old ones.

How much of this crisis is due to people who default on mortages and how much to problems of valuation?

Of the defaulters how many are subprime?

We heard how the mortgage brokers were encouraging fraud on mortgage applications, now all of a sudden it's because of laws requiring them to lend to poor people. If that were true why didn't they fraudliently say rich people are poor to satisfy the demand that they lend to poor people? Their commission is based on the value of the mortgage not the income level of the borrower.

At 9/23/2008 4:26 PM, Anonymous Anonymous said...

The mortgage crises is a symptom of idiotic policy at the Fed. Lowering interest rates CUTS cash supply by constricting local bank profits. Last time their dithering screwed up the money supply, the first hit, the high tech stocks, were the ones blamed for the cash contraction. This time the low equity mortgages seemed to feel the hit first, and so have been the patsy since.
Money put into stocks does not disappear, but circulates from buyer to seller and just a little bit extra cash in the system can feed an enormous bull market. Likewise when banks decide to constrict their lending practices due to reduced revenue, a small contraction of the money supply equals a huge fallout on prices in any area that it hits. The constricted interest coupled with the reduction of activity cannot help but have an insidious effect on all banking activities which will obviously be felt to everyone who holds or uses any type of banking product (ie money)

At 9/24/2008 1:00 AM, Anonymous Anonymous said...

The vast amount of mis-information and political bias on ths blog is ffin amazing. He is the real story.


"The Fannie and Freddie situation was a result of their unique roles in the economy. They had been set up to support the housing market. They helped guarantee mortgages (provided they met certain standards), and were able to fund these guarantees by issuing their own debt, which was in turn tacitly backed by the government. The government guarantees allowed Fannie and Freddie to take on far more debt than a normal company. In principle, they were also supposed to use the government guarantee to reduce the mortgage cost to the homeowners, but the Fed and others have argued that this hardly occurred. Instead, they appear to have used the funding advantage to rack up huge profits and squeeze the private sector out of the “conforming” mortgage market. Regardless, many firms and foreign governments considered the debt of Fannie and Freddie as a substitute for U.S. Treasury securities and snapped it up eagerly.
Fannie and Freddie were weakly supervised and strayed from the core mission. They began using their subsidized financing to buy mortgage-backed securities which were backed by pools of mortgages that did not meet their usual standards. Over the last year, it became clear that their thin capital was not enough to cover the losses on these subprime mortgages. The massive amount of diffusely held debt would have caused collapses everywhere if it was defaulted upon; so the Treasury announced that it would explicitly guarantee the debt.
But once the debt was guaranteed to be secure (and the government would wipe out shareholders if it carried through with the guarantee), no self-interested investor was willing to supply more equity to help buffer the losses. Hence, the Treasury ended up taking them over."

At 9/24/2008 6:00 AM, Anonymous Anonymous said...

BS flows, it would seem to me your argument supports the gist of the 1999 article. It would be interesting to break it down between the people who simply did not or could not pay due to "diversity" and the people who "flipped" houses during a boom but got caught with hefty mortgages during the downturn. My guess would be the impact of both is material.

Allan, I follow your line of thought but still, so many people are making timely mortgage payments (including myself on two homes) that something else besides interest rates is at fault. It would be interesting to find out the percentage of mortgages failing per lending institution, where they originated, what was paid for the transfer, etc.

Certainly people like Johnson and Raines and their cronies on the hill must share in the blame in my view as they were theoretically the "gate keepers".

I guess what I get out of this is just like other welfare programs, most people are not only paying their own mortgages but will end up paying for someone else's as well. The least the government could do is to redistribute the proceeds from the "bailout loan" back to those who never defaulted and paid taxes. That is if there are any proceeds from the "toxic loans".

At 9/24/2008 11:29 AM, Anonymous Anonymous said...

>"something else besides interest rates is at fault. It would be interesting to find out the percentage of mortgages failing per lending institution, where they originated, what was paid for the transfer, etc."<
The Fed declared interest rate is the moderator of the cash supply. The local bank creates money ever time it creates a loan. The money circulates and disseminates into the system. When the Fed announces a rate reduction, the profit on money creation is reduced, and so the banks must be much more vigilant on where their activities are aimed. The resulting reduction of money flow into the system is felt system wide, and pointing fingers at who it is that doesn't have enough money now is really a victimization of the victim.
Further, the Fed going around the local bank to lend directly to other institutions is really adding insult to injury. The local bank is the creator of cash, and the stepped up activities of the Fed is draining away local bank profits, and so further draining off the real cash supply.

At 9/24/2008 12:16 PM, Anonymous Anonymous said...

August 07 everything was fine. September the Fed turned the tap, and everything started to crumble. Frigin idiot! Righty tighty, lefty loosy! You're turning the WRONG WAY!!! And they just keep on cranking the handle! DUH!!
An education in economics seems to make one wholly oblivious to what's really going on!

At 9/24/2008 12:30 PM, Anonymous Anonymous said...

This misunderstanding over which way the tap goes has been responsible for every cash supply problem since Keynes conceived the notion. This includes not only the cash strapped situations of today, but also the cash swamped situations of every instance of high inflation including the 70s.


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