Thursday, March 3, 2011

The Politics of the Housing Boom

One curiosity of the housing boom and bust is the acquiescence of bank and lending regulators to the relaxation of bank lending standards, which led to the fateful explosion in, and of, sub-prime lending.  The rather shocking, but not surprising, aspect of this fateful relaxation is that "government officials were in fact the driving force behind the loosening of mortgage loan requirements."  In 1999, for instance, Fannie Mae eased the credit requirements on loans it purchased from banks and other lenders.  Fannie Mae's business was to (1) borrow money cheaply in the capital markets, (2) use it to purchase mortgages from lending institutions (thereby replenishing those institutions' supply of money to lend), (3) packaging the loans into securities, and (4) selling the securities back to financial institutions and other investors (many abroad) with a quasi-governmental guarantee.  Thus, by widening the quality range of mortgages it would buy, Fannie was putting money into the hands of lenders specifically for the purpose of making loans to borrowers of dubious creditworthiness.  Fannie and Freddie's activity did not pose a significant financial risk until they started trafficking in low quality loans.  By entering that market, it made trillions of dollars available for loans to "underserved" (risky) segments of the population.  This was precisely the object of government intervention.

The goal was to increase the supply of "affordable housing,"which in political speak meant to encourage low-income, often minority individuals to choose their housing, and the government would make it possible for them to have it.  As stated in a previous post, except in the metropolitan and coastal areas where land use restrictions drove up the cost of real estate, there was no generalized affordable housing problem in the US.  (Consider that the median price of a US home is 3.6 times the median income of a US worker.  In Great Britain, the number is 5.5 times; in Australia and New Zealand it is 6.3 times.)  Yet, the federal government acted over the years to change the process of private mortgage lending, first in 1977 with the Community Reinvestment Act (CRA).  The Clinton administration seized the initiative when in the 1990's, studies showed different loan approval rates for blacks and whites (despite the fact that substantial majorities of both groups' applicants were approved by lenders).  It pushed for quotas in home lending by having Attorney General Janet Reno threaten legal action on the basis of racial statistics, and by establishing "objective criteria" by which banks would indicate their compliance with CRA.  The failure to show a requisite number of loans to low and moderate income (LMI) borrowers would result in banks being prevented from enjoying the benefits of, say, diversification under 1999's Graham-Leach-Bliley Act, which liberalized activity within the financial sector.  New regulations in 1995 "required the use of 'innovative or flexible' lending practices to address credit needs of LMI borrowers and neighborhoods."

In 1993, HUD "began bringing legal actions against mortgage bankers that declined a higher percentage of minority applicants than white applicants.  It also pressured Fannie Mae and Freddie Mac to increase their purchases of mortgages made to LMI borrowers.  By 1996, HUD had set a target of 42% of such mortgages to be purchased by the GSEs.  In a different forum, regulators engaged in concerted actions with community activists on the streets such as ACORN, which stepped up pressure on banks to lower lending standards, using the threat of regulatory denials to merger or expansion plans.  These, and other tactics engaged in by governmental agencies and politicians had the desired affect of lowering lending standards, relaxing or eliminating down payment requirements, and otherwise debasing bank qualification standards.  "Under political pressures, traditional mortgage loans with traditional safeguards began to decline and mortgage loans made under the 'innovative' and 'flexible' standards urged by government increased."  The traditional 30-year fixed rate mortgage declined from 57% of all mortgages in 2001 to 33% by the end of 2006.  Subprime loans rose from 7% to 19% over the same period of time. Between 2005 and 2007, the GSEs acquired $1 trillion of subprime and other non-traditional mortgages, or 40% of the value of their total purchases.  The total of their mortgage guarantees at the time surpassed the GDP all but four nations.  And, the increasing riskiness of their assets posed an immediate threat to taxpayers who were oblivious to the danger posed by the "good intentions" of public officials and government agents.

Warnings were sounded from such diverse quarters as The Economist  (2003 and 2005), US Treasury Secretary John W. Snow (2003),  Fortune magazine (2004), Josh Rosner, an analyst at Medley Global Advisors in New York (2004), Peter J. Wallison, a resident scholar at the American Enterprise Institute (2005), Barron's magazine (2005) and Federal Reserve Governor Alan Greenspan (2005 and 2007).  They were met with ferocious opposition by Congressman Barney Frank, who in 2003 said, inter alia, "I want to roll the dice a little bit more in this situation towards subsidized housing."  He was seconded by Chairman Christopher Dodd of the Senate Banking Committee, who in 2004 called the GSEs "one of the great success stories of all time."  Congresswoman Maxine Waters said in 2003 that "we do not have a crisis at Freddie Mac, and in particular at Fannie Mae, under the outstanding leadership of Mr. Frank Raines" (who later resigned under the weight of an accounting scandal).  Congressman Joe Baca cautioned that "a long protracted debate on regulation" might cause "instability of the markets."

In response to President Bush's 2004 expressed concerns with GSE safety, seventy-six Democrats--including Nancy Pelosi, Barney Frank, Maxine Waters and Charles Rangel--in the House of Representatives wrote a letter admonishing the President that "an exclusive focus on safety and soundness is likely to come, in practice, at the expense of affordable housing."  The GSEs were able to funnel  their windfall profits into campaign contributions sufficient to co-opt politicians on both sides of the isle, the very politicians who were supposed to control them.  In the words of Gerald P. O'Driscoll, a scholar in residence at the Cato Institute: "At heart, Fannie and Freddie had become classic examples of 'crony capitalism.'  The 'cronies' were businessmen and politicians working together to line each other's pockets while claiming to serve the public good."

The GSEs were taken into government conservatorship in September of 2008.  The total cost to taxpayers is expected to reach $400 billion.  Noman says that was certainly one expensive dice roll.  Personally, he'll never gamble again by voting for a Democrat.

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