There are many factors that played a role in the creation and bursting of the housing bubble and the near meltdown of the financial system. Top economists have disagreements about the role of the Fed, Fannie Mae and Freddie Mac, the ratings agencies, the banks and “liar loans”. Bestselling author Michael Lewis’s (Liar’s Poker, Moneyball and The Blind Side) new hit is called “The Big Short”, a great book that focuses on the traders who made fortunes when the bubble burst. He doesn’t mention The Community Reinvestment Act. It doesn’t detract from the book-but it doesn’t explain the roots of the crisis either. I think Lewis specifically left it out because he set out to portray Wall Street as the villain.
The government made its first move into the housing markets with the creation of the Federal National Mortgage Association in 1938 to foster mortgage lending. Freddie Mac was created in 1970 to provide “competition.” This is laughable. Remember this as we hear about government fostering competition in the health insurance markets. These two fraud-ridden agencies played a huge role in the housing mess but that will be a separate post-or collection of posts.
The Community Reinvestment Act was established by Congress in 1977 and signed by Jimmy Carter. Banks would be required to offer “equal access” to lending and banking services within a geographic zone surrounding each branch. “Community Activists” were at the forefront of the move that brought about this legislation, pressuring banks and politicians; groups like ACORN or self described “bank terrorist” Bruce Marks and the “Neighborhood Assistance Corporation of America”.
Like so many policies it started small and grew and morphed into something much bigger. It was amended in 1989, 1991, 1992, 1994, 1995, 1999, 2005, 2007 and 2008. The pressure never abated. The goal was “affordable housing”. The government had already tried building their own “affordable housing”. We know this failed experiment generally as “the projects.” So they set out to try a new way. Home ownership.
Traditionally a home buyer needed a 20% down payment, good credit and a job that paid enough to make the mortgage payments. Many in the lower income brackets paid rent but they had low FICO scores, no savings and / or shaky employment situations. What if we could just get them in a house and start making mortgage payments instead? If only we could relax the rules a bit? So they did.
The proper free market response for pricing a loan to a high risk applicant is a higher interest rate. This will offset the higher percentage of defaults. But while some call this common sense liberals call this discrimination. Regulators used the CRA like a club. If you don’t write enough “sub-prime” loans you get a low CRA score and your next request to open a new branch or issue stock may be denied. So in effect, banks were forced to make these loans. The Banks protested loudly that they would be forced to lose money. Barney Frank and the Democrats came up with this brilliant idea:
Just write the loan-we won’t make you hold it-you can sell the risky paper to scandal plagued Fannie Mae or Freddie Mac. You can even sell big bundles of them. We call it “securitization.” These bundles were later marketed in Collateralized Debt Obligations, or CDO’s. Then came Credit Default Swaps. This is the problem with a Washington compromise. Politicians imagine they’ve created a win-win situation when all they have done is created a monster that will appear sometime in the future.
Banks and mortgage brokers made money without risk. This is market distortion #1. Fan and Fred came to dominate the mortgage market. Distortion #2. To get the loans approved lending standards were lowered. Lower FICO, no job, no money down etc. = “liar loans”. Distortion #3. Teaser rate mortgages that postpone payments and back-load amortization were increased. Distortion #4. Everything works as long as prices keep going up. It is called a bubble. This policy created a structure where suddenly demand for housing increased due to this new pool of buyers. Home builders over built. Speculators were drawn in. We got a whole new vocabulary with terms like “condo flippers”.
In the end we barely moved the needle on home ownership. Poor neighborhoods have been hard hit with foreclosures. Hard working Americans in the home building business are out of work. The price of virtually every home in America spiked then dropped. If you bought a house in the last 10 years it may be worth less now than what you paid for it. Innocent victims are everywhere. “Affordable housing” remains a fantasy.
Washington politicians played a key role in all of this but they are not being held accountable-in fact they are defending CRA and keeping Fannie and Freddie alive after their bonds crashed wiping out hundreds of private banks.
Fan and Fred are fraud ridden political messes. This is the investigation that needs to be done. Without it the Goldman thing is a show trial.