Wednesday, September 24, 2008

Yes, politicians really did create the mortgage meltdown

Courtesy of Coyote Blog and Carpe Diem, this blast from the New York Times's past offers just a bit of insight into the roots of the mortgage meltdown. From September 30, 1999:

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 -- including the New York metropolitan region -- 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 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''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.''

Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan 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 1980's.

''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.''

Hmmm ... What an interesting experiment in public policy exercised via political pressure on two government-sponsored enterprises, Fannie Mae and Freddie Mac. Gee, I wonder how that turned out ...

Mr. Wallison gets to play at a bit of I-told-you-so in the pages of the Wall Street Journal, along with his co-author, Charles Calomiros, a professor of finance and economics at Columbia Business School.

It is important to understand that, as GSEs, Fannie and Freddie were viewed in the capital markets as government-backed buyers (a belief that has now been reduced to fact). Thus they were able to borrow as much as they wanted for the purpose of buying mortgages and mortgage-backed securities. Their buying patterns and interests were followed closely in the markets. If Fannie and Freddie wanted subprime or Alt-A loans, the mortgage markets would produce them. By late 2004, Fannie and Freddie very much wanted subprime and Alt-A loans. Their accounting had just been revealed as fraudulent, and they were under pressure from Congress to demonstrate that they deserved their considerable privileges.
Ouch! So this really is a mess that can be laid at the door of the politicians and their insistence at meddling in the market.

Wallison and Calomiros add:

Now the Democrats are blaming the financial crisis on "deregulation." This is a canard. There has indeed been deregulation in our economy -- in long-distance telephone rates, airline fares, securities brokerage and trucking, to name just a few -- and this has produced much innovation and lower consumer prices. But the primary "deregulation" in the financial world in the last 30 years permitted banks to diversify their risks geographically and across different products, which is one of the things that has kept banks relatively stable in this storm.

As a result, U.S. commercial banks have been able to attract more than $100 billion of new capital in the past year to replace most of their subprime-related write-downs. Deregulation of branching restrictions and limitations on bank product offerings also made possible bank acquisition of Bear Stearns and Merrill Lynch, saving billions in likely resolution costs for taxpayers.

Of course, the politicians now promise to save us all from those nasty capitalists with their greedy ways. I'm sure that our disinterested public servants will do an excellent job of salvaging something from the mess that they ... cough cough ... created.

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Anonymous Andrew said...

The only problem I have with the NY Times article is this little ditty:

"In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers."

That would lead me to believe that it was not just the gov't. Although, you could argue that the gov't did what it does best by being the enabler of bad behavior.

September 27, 2008 2:19 PM  
Blogger J.D. Tuccille said...

Oh, the banks definitely wanted to be subsidized. I mean, one of my college friends wanted her dad to pay for a sweet post-graduation apartment too. You can't blame her (too much) for trying, but he'd have been a fool if he said yes.

And the feds were fools for putting Fannie Mae in the business of backing loans that banks didn't consider worth making on their own.

September 27, 2008 8:33 PM  

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