A surprisingly sophisticated GOP report on the Mortgage Meltdown
July 09, 2009, 02:27 AM
A+
|
a-
Print Friendly and PDF
Republican staffers on the Committee on Oversight and Government Reform (Darrell Issa (CA-49), Ranking Member) have penned a lengthy report on The Role of Government Affordable Housing Policy in Creating the Global Financial Crisis of 2008. Despite the inevitable partisan tendentiousness — no mention of George W. Bush's White House Conference on Increasing Minority Homeownership, too much blame on Fannie and Freddie, not enough blame on businesses and deregulation — it turns out to be better than you'd expect. Here's the first paragraph:
The housing bubble that burst in 2007 and led to a financial crisis can be traced back to federal government intervention in the U.S. housing market intended to help provide homeownership opportunities for more Americans. This intervention began with two government-backed corporations, Fannie Mae and Freddie Mac, which privatized their profits but socialized their risks, creating powerful incentives for them to act recklessly and exposing taxpayers to tremendous losses. Government intervention also created �affordable� but dangerous lending policies which encouraged lower down payments, looser underwriting standards and higher leverage. Finally, government intervention created a nexus of vested interests – politicians, lenders and lobbyists – who profited from the �affordable� housing market and acted to kill reforms. In the short run, this government intervention was successful in its stated goal – raising the national homeownership rate. However, the ultimate effect was to create a mortgage tsunami that wrought devastation on the American people and economy. While government intervention was not the sole cause of the financial crisis, its role was significant and has received too little attention.
This report resembles a better documented, better informed but more coy version of my June 2008 Taki article The Diversity Recession. It underplays how much the politicians were pushing on an open door among lenders, more than a few of whom thought handing out zero down liar loans was a great moneymaking idea. Some highlights:
In the early 1990s, Fannie and Freddie began to come under considerable pressure to lower their underwriting standards, particularly on the size of down payments and the credit quality of borrowers. A deeply flawed 1992 study published by the Federal Reserve Bank of Boston, purporting that minorities faced discrimination in mortgage lending, was particularly influential at the time. ... Yet the damage had been done and Congress seized on the study as part of a major legislative reorganization of the GSEs’ function. In 1992, Congress passed the Federal Housing Enterprises Financial Safety and Soundness Act, which created an �affordable housing mission� for Fannie Mae and Freddie Mac. This legislation directed HUD to establish three separate quotas requiring the GSEs to set aside a certain percentage of their yearly mortgage purchases to loans with affordable characteristics. These quotas were expressed as the minimum share of mortgages that Fannie and Freddie purchased every year which had to be made to �low and moderate-income families … low-income families in low-income areas and very low-income families,� as well as borrowers in �central cities, rural areas, and other underserved areas.� Congress granted HUD the authority to adjust these three affordable housing quotas for the GSEs over time, allowing both Democratic and Republican Administrations to consistently make campaign promises to boost homeownership through government intervention in the market. Consequently, under both the Clinton and Bush Administrations, HUD dramatically increased these quotas, which reached their zenith when the Bush Administration raised them to 56 percent, 27 percent and 39 percent, respectively. HUD’s affordable housing quotas represented major departures from the GSEs’ prior commitment to underwriting only sustainable mortgages. Fannie Mae’s original congressional charter acknowledged the risks involved in low down payment loans because it allowed Fannie to purchase loans with less than a 20 percent down payment only in concert with certain mitigating factors such as private mortgage insurance or a repurchase agreement with the mortgage originator. The establishment of the HUD quotas broke this convention and set the stage for the dramatic politicization of mortgage lending. In 1994, Fannie Mae CEO Jim Johnson announced the company’s first affordable housing initiative, the $1 trillion �Opening the Doors to Affordable Housing� program. Johnson, a long-time friend of both President Clinton and Treasury Secretary Robert Rubin, took the helm of Fannie in 1991 after a stint at Lehman Brothers. ... In 1995, Johnson seeded the Fannie Mae Foundation with $350 million of Fannie stock. The company used this foundation to spread millions of dollars around to politically connected organizations like the Congressional Hispanic Caucus Institute. It also hired well-known academics to write papers that gave an aura of academic rigor to policy positions favorable to Fannie Mae. For example, one paper coauthored by now-Director of the Office of Management and Budget Peter Orszag, concluded that the chance was minimal that the GSEs were not holding sufficient capital to cover their losses in the event of a severe economic shock. The authors suggested that �the risk to the government from a potential default on GSE debt is effectively zero,� and that �the expected cost to the government of providing an explicit government guarantee on $1 trillion in GSE debt is just $2 million." As of May 14, 2009, the taxpayers had already been exposed to $700 billion of GSE bailouts. ... While CRA [Community Reinvestment Act] cannot be directly blamed for the huge volumes of risky nonprime mortgages that were eventually purchased by Fannie, Freddie and Wall Street investment houses, CRA continued a pattern of behavior of lowering mortgage underwriting standards in order to drive up the national homeownership rate. The other important event of 1995 was the release of the Clinton Administration’s National Homeownership Strategy. The document’s foreword, penned by HUD Secretary Henry Cisneros, cited President Clinton’s directive to �lift America’s homeownership rate to an all-time high by the end of the century.� Among the methods the Strategy proposed to achieve this bump in the homeownership rate was lower down payments. In retrospect, President Clinton’s rebranding of prudent down payments of 10 to 20 percent as �barrier[s] to home purchase� takes on great significance. As with the 1995 CRA reform and the Clinton Administration’s decision to allow the GSEs to count subprime loans toward their affordable housing goals, this represented a shift in government policy from one that emphasized equity of procedure to equity of outcome. This emphasis on equity of outcome inevitably created tremendous pressure on regulated institutions to make more loans to low-income borrowers. It also created pressure for secondary market investors such as Fannie Mae and Freddie Mac to buy these loans. The correspondingly lower emphasis on how the loans were being made inevitably meant less attention would be paid to their quality and sustainability.
Let me interrupt to discuss the general question of Deep Roots for Recent Problems. Every political viewpoint has its favorite Deep Roots theories and scoffs at the other sides Deep Roots. For example, liberals denounce the idea that the 1977 CRA had anything to do with the housing crash 30 years later, while simultaneously proclaiming that the 1978 Proposition 13 is the main cause of California's current budget problems. The difficulties that minority firemen in New Haven in the 21st Century have understanding the intricacies of water pressure stem from slavery, Jim Crow, and discrimination up through the early 1970s. So, let's take a look at, say, the failure of the three ratings agencies in this decade to properly alert investors to the riskiness of complex mortgage-backed securities. The roots go back to 1970s when the rating agencies switched from getting paid by buyers of bonds to getting paid by issuers of bonds. Along with the government making the Big 3 ratings agencies into a de facto cartel in 1975, that wrecked the incentives for honest behavior. And yet, the ratings firms didn't completely whore themselves out for decades. Why? Because that would be wrong. The problem is that years of virtuous behavior resisting bad incentives just make the blow-up when the players finally embrace the Dark Side all that much worse because others built in expectations of continued goodness. Eventually, greedier owners, such as Warren Buffett, who bought 20% of Moody's, inclined the firms to prostitute themselves more. The firms could get away with it for a number of years because they had spent a long time not prostituting themselves, so the bad incentive structure didn't seem as relevant. Still, note that they screwed up worst of all in mortgage-backed securities. That was for a variety of reasons, such as less experience in a down market and, importantly, the general government and social pressure in favor of DiversityLending and anti-HateFact awareness campaigns. As Henry Canaday has pointed out, it's not a coincidence that the financial system blew a gasket at exactly the place where the most political and cultural pressure was exerted: mortgages for minority and lower income households.
Risky mortgage lending, particularly loans with very low down payments, contributed directly to the rise of a housing bubble. Had this risky lending been contained within the low-income segment of the market targeted by politicians advocating more �innovation� in �affordable lending,� the damage to the wider economy might have been minimal. ... Although the erosion of mortgage underwriting standards began in Washington with initiatives like the CRA as a way to reduce �barriers to homeownership,� this trend inevitably spread to the wider mortgage market. One observer noted:
Bank regulators, who were in charge of enforcing CRA standards, could hardly disapprove of similar loans made to better qualified borrowers. This is exactly what occurred.
Borrowers – regardless of income level – took advantage of the erosion of underwriting standards that started with government affordable housing policy. As one study observed,�[o]ver the past decade, most, if not all, the products offered to subprime borrowers have also been offered to prime borrowers.� For example, Alt-A and adjustable-rate mortgages became incredibly popular with borrowers – who were generally not low-income – engaging in housing speculation. ... Once government-sponsored efforts to decrease down payments spread to the wider market, home prices became increasingly untethered from any kind of demand limited by borrowers’ ability to pay. Government actions distorted the housing market, yet advocates of affordable housing policies, such as Congressman Barney Frank (D-MA), have asserted that those who criticize these policies seek to place blame for the financial crisis solely on borrowers of modest means. This misses the mark entirely. In fact, responsibility for the erosion of mortgage lending standards, which began with government affordable housing policy, rests squarely on the policy makers who advocated these ill-conceived policies in the first place. Borrowers quite naturally responded to the incentives they were given, irrespective of their socioeconomic status, and risky lending spread to the wider mortgage market.
Well, I think financial buccaneers like Angelo Mozilo, Roland Arnall, and Kerry Killinger who pocketed hundreds of millions from lending to deadbeats deserve some share of the blame, too. But that's just my personal opinion. The report goes on to discuss "Special Interests: The Rise of the 'Affordable' Housing Coalition:"
Fannie Mae and Freddie Mac would ultimately announce over $5 trillion in affordable housing initiatives. Many of these loans came increasingly from large non-bank mortgage lenders like Countrywide Financial Corporation, the country’s largest mortgage lender and a major innovator in pushing subprime loans. These non-bank lenders rose to fill the void in mortgage lending left in the wake of the savings and loan crisis, and they grew rapidly in response to government policies that encouraged lower lending standards. A symbiotic relationship developed between these non-bank lenders and the GSEs. For example, Fannie Mae under CEO Jim Johnson reached a �strategic agreement� with Countrywide CEO Angelo Mozilo, under which �Countrywide agreed to deliver a large portion of Fannie’s annual loan volume in exchange for special financing terms." In fact, Countrywide regularly accounted for 10 to 30 percent of all the loans purchased by Fannie Mae in a given year. In the words of Mozilo: �If Fannie and Freddie catch a cold, I catch the f***** flu."
Unlike here, the GOP report doesn't use asterisks.