With that many pols at the helm, it’s no wonder that most analysts have portrayed Fannie and Freddie as if they were unregulated renegades, and rarely mentioned HUD in the ongoing finger-pointing exercise that has ranged, appropriately enough, from Wall Street to Alan Greenspan. But the near-collapse of these dual pillars in recent weeks is rooted in the HUD junkyard, where every [Andrew] Cuomo decision discussed here was later ratified by his Bush successors.
And that’s not an accident: Perhaps the only domestic issue George Bush and Bill Clinton were in complete agreement about was maximizing home ownership, each trying to lay claim to a record percentage of homeowners, and both describing their efforts as a boon to blacks and Hispanics. HUD, Fannie, and Freddie were their instruments, and, as is now apparent, the more unsavory the means, the greater the growth. But, as Paul Krugman noted in the Times recently, “homeownership isn’t for everyone,” adding that as many as 10 million of the new buyers are stuck now with negative home equity””meaning that with falling house prices, their mortgages exceed the value of their homes. So many others have gone through foreclosure that there’s been a net loss in home ownership since 1998.
It is also worth remembering that the motive for this bipartisan ownership expansion probably had more to do with the legion of lobbyists working for lenders, brokers, and Wall Street than an effort to walk in MLK’s footsteps. Each mortgage was a commodity that could be sold again and again””from the brokers to the bankers to the securities market. If, at the bottom of this pyramid, the borrower collapsed under the weight of his mortgage’s impossible terms, the home could be repackaged a second or a third time and either refinanced or dumped on a new victim.
Those are the interests that surrounded Cuomo, who did more to set these forces of unregulated expansion in motion than any other secretary and then boasted about it, presenting his initiatives as crusades for racial and social justice.
This article is dated August 5, 2008. On September 22, 2008 John McCain said he wanted young Andrew to oversee the SEC. If I were a Republican I would be very worried.
yes #1, sometimes his mouth gets ahead of his brain. I’d be surprised if he was aware of the article before the 60 Minutes interview. Joe Lieberman as Sec. of State or Defense is fine, let’s leave the bi-partisanship right there…..
At the root of all of this lies the relentless push for homeownership, whether that was sensible or good for the prospective buyer or not. Although rules were changed to get people into homes they could not afford, the basic logic of spending no more than three times annual income for a home did not change. Also, homeownership can actually become a barrier to seeking opportunities for people who are not well established in careers or locations. We, as a society, need to be honest about the actual costs and benefits of homeownership.
good points #3. My brother bought into one of these “affordable” developments on the grounds of the old Denver Airport. now he wants to sell to move to the west coast but the loan restrictions are that he can only sell for a limited profit and even worse he can’t rent it. he will take a big loss most likely as the market is soft in that area. 🙁
he should have just rented until he was able to get a regular mortgage.
The article argues that government pressure caused an epidemic of unsound lending, the failure of Fannie Mae and Freddie Mac, and the broader mortgage crisis is fundamentally false.
Fannie and Freddie earned huge profits with minimal shareholder equity. Even when they had the highest possible credit ratings, they had only $1 in shareholder’s money for each $40 dollars in debt. In 2003, for example, they had $1.81 trillion in total assets, $1.76 trillion in total liabilities, and $2.05 trillion in contingent liabilities. (This is a scandal altogether separate from affordable housing goals.)
For all that, neither Fannie nor Freddie ever contributed much to making housing affordable for people at the margin of home ownership (e.g., the working poor). As Federal Reserve economists have documented, virtually all of Fannie and Freddie’s business conduct has been consistent with maximizing profits for their shareholders.
Both firms hold enormous portfolios of their own securities—portfolios that serve no purpose other than to general no-brainer profits for shareholders. How so? Fannie and Freddie borrowed cheaply in the government securities market and invested the proceeds in the higher-yielding mortgage-backed securities market. Without the overhand of these huge portfolios, Fannie and Freddie would have been much smaller firms, with much less volatile liabilities. Bailing them out would have been far cheaper.
More broadly, if government pressure caused the mortgage debacle, you would expect FDIC-insured banks—the most heavily regulated financial institutions—to have made the worst loans. That was not the case. Indeed, the evidence suggests that the worst loans were originated by nonbank mortgage brokers and mortgage companies. Those firms are essentially unregulated. (Think of those old banner advertisements about getting a mortgage loan in 10 minutes with minimal documentation. “Bad credit? No problem!”)
The worst of all subprime securitization was done—without Fannie or Freddie’s involvement—by Wall Street firms.
The truth is (as I repeatedly wrote over the past 5 years) that lenders and investors became extraordinarily complacent about credit risk—the risk that borrowers would not repay their loans. This was a broad problem, extending well beyond the mortgage market. Take a look, for example, at how readily and how cheaply corporations could borrow in the junk-bond market.
The housing bubble reflected a similarly broad insouciance about economic fundamentals. The inflation in housing prices was at least as serious at the high end (think McMansions) as at the low end.
Andrew Cuomo is a ruthlessly ambitious creep. But he didn’t cause the housing bubble, the mortgage debacle, or the failure of Fannie and Freddie. Indeed, he left office before the housing bubble really got going.
In comment #5, the first sentence should read:
“The article argues that government pressure caused an epidemic of unsound lending, the failure of Fannie Mae and Freddie Mac, and the broader mortgage crisis. THESE CHARGES ARE fundamentally false.”
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The first sentence of the 4th paragraph should read:
“Both firms hold enormous portfolios of their own securities—portfolios that serve no purpose other than to GENERATE no-brainer profits for shareholders.”
Irenaeus, I don’t think that, whatever the mistakes of the banks were, there is any possibility that they did not take their cues from the govmint:
“Only, the risk-taking was [Pelosi’s] idea — and the idea of all the other Democrats, along with a handful of Republicans, who over the past 30 years have demonized lenders as racist and passed regulation after regulation pressuring them to make more loans to unqualified borrowers in the name of diversity.
They were the ones who screamed — “REDLINING!” — and sent banks scurrying for cover in low-income neighborhoods, where they have been forced to lower long-held industry standards for judging creditworthiness to make the subprime loans.
If they don’t comply, they are threatened with stiff penalties under the Community Reinvestment Act, or CRA, a law that forces banks to make home loans to people with poor credit risks.
read it all:
http://www.ibdeditorials.com/IBDArticles.aspx?id=306544845091102
and:
“But the fact is, President Bush in 2003 tried desperately to stop Fannie Mae and Freddie Mac from metastasizing into the problem they have since become.
Here’s the lead of a New York Times story on Sept. 11, 2003: “The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago.”
Bush tried to act. Who stopped him? Congress, especially Democrats with their deep financial and patronage ties to the two government-sponsored enterprises, Fannie and Freddie.
“These two entities — Fannie Mae and Freddie Mac — are not facing any kind of financial crisis,” said Rep. Barney Frank, then ranking Democrat on the Financial Services Committee. “The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.”
It’s pretty clear who was on the right side of that debate.”
read it all:
http://www.ibdeditorials.com/IBDArticles.aspx?id=306632135350949
Agreed, #1, it was a mind-bogglingly stupid thing to say.
“I don’t think that, whatever the mistakes of the banks were, there is any possibility that they did not take their cues from the govmint”
Chris [#7]: You’re missing the point I made in #5: the worst loans were originated by unregulated firms. Those firms were, without government pressure, seeking to maximize their profits in a market heedless of credit risk.
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COMMUNITY REINVESTMENT ACT
You seek to blame the Community Reinvestment Act (CRA) for the debacle. The Act—which became law more than 3 decades ago—requires FDIC-insured banks to look for ways to serve the credit needs of the communities in which they operate, including low- and moderate-income areas. It does not require banks to make unsound loans; it does encourage banks to see if there opportunities to make good loans that might not meet traditional criteria.
Here are four examples (two historical, two more recent) of good loan opportunities that did not meet traditional criteria. First, during the 19th and early 20th century, most U.S. commercial banks did not want to deal with people of modest means (including immigrants and blue-collar workers). Yet savings banks and (later) credit unions prospered making loans to such people. Second, during the 1920s, New York State, unable to eradicate loan sharks by criminal prosecution, asked big commercial banks to start making small loans to the working poor. The predecessor to today’s Citibank did so and found the business very safe and profitable. The working poor, whom the bank had previously shunned, did a good job of repaying their loans. The bank made lots of money and the poor could get credit without depending on extortionate thugs. Third, traditional personal-loan criteria focused on the income of the applicant and his or her spouse. Yet among Asian immigrants extended families often live together and function as economic units. Encouraged by the CRA, banks found that they could make good, profitable loans by taking account of other family members’ assets and income in evaluating an applicant’s ability to repay a loan. Fourth, take the case of someone in a poor neighborhood who wants to buy an abandoned row house for $2,000, spend $20,000 to fix it up, and do all the work himself. When he finishes, he will have a house worth $80,000 that cost him $22,000 and lots of sweat. But he needs to borrow most of the $22,000. Encouraged by the CRA, banks have found that they can make “sweat equity†loans safely and soundly.
The Community Reinvestment Act itself declares that it seeks to encourage federally insured banks “to help meet the credit needs of the local communities in which they are chartered consistent with the SAFE AND SOUND operation of such institutions.†12 U.S. Code §2901(b). The Federal Reserve Board underscores that the CRA does not require banks “to make high-risk loans that jeopardize their safety. To the contrary, the law makes it clear that an institution’s CRA activities should be undertaken in a safe and sound manner.â€
If the CRA were the cause of bad-loan problems, then we’d expect that mortgage brokers and mortgage bankers (not covered by CRA) would have made better loans than federally insured commercial banks and savings institutions (covered by CRA). That is not the case. We have an epidemic of bad loans because lenders and investors became insouciant about credit risk.
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BUSH ADMINISTRATION’S RECORD: The Bush Administration has a mixed record on Fannie Mae and Freddie Mac. From 2001 to 2003, the administration did virtually nothing. In the summer of 2003, accounting scandals at Fannie and Freddie shook the administration out of its torpor—and for the next three years the administration compiled an excellent record. That ended with the arrival of Secretary Paulson, who took office with a deregulatory agenda (e.g., bolster New York City’s international standing as a financial center) and did not regard Fannie and Freddie as serious problems.
In any event, the disagreements between the administration and Congressional Democrats did not involve lending standards or the affordable-housing goals revised by Cuomo. The disagreements centered on two issues. First, creating a workable bankruptcy mechanism for Fannie and Freddie. The existence of such a mechanism would have increased market discipline on Fannie and Freddie and reduced pressure for the government to assume their debts. But the administration had won on this issue by 2006.
The second (and unresolved) issue involved curtailing Fannie and Freddie’s huge and unnecessary portfolios of mortgage-backed securities. Those portfolios ballooned the two firms and, when the firms started faltering, increased pressure for a bailout. But neither the existence nor the size of the portfolios caused lenders to make bad loans. If Fannie and Freddie had not bought the mortgage-backed securities, someone else would have; until recently, the market was exceedingly liquid.
Irenaeus provides a good background summary. But it requires a couple of corrections. It is not how the CRA read when enacted, the relevant inquiry is its form and application during the 90s and 00s, when subprime loans exploded from their prior miniscule usage.
Similarly, he does not seem to realize that many of the CRA loans by commercial banks were brokered loans. The banks gave brokers preferred pricing for CRA loans. And it is difficult to compare performance of banks’ subprime loans with those of pure subprime lenders, such as New Century, whose entire portfolios were subprime, versus the widely diversified portfolio of banks. Finally, it was not just CRA, but also the racial monitoring, applying to all lenders, that pushed the lower standards. While the official prohibition on lowering standards said one thing, political pressure created a different reality.
The Village Voice is to be commended for investigating the political pressures that led to today’s financial crisis, something the mainstream press id dodging.
Bill [#10]: If political pressures caused the mortgage debacle, then who pressured whom, when did they do it, and how did the pressure cause the debacle?
The worst loans were originated by the least regulated firms. Who pressured them and how?
Jumbo mortgages (in 2006, loans exceeding $417,000 to $625,000, depending on the region) have shown plenty of credit problems. Which government pressured lenders to finance McMansions?
And when did all this pressuring occur? The average life of a 30-year mortgage is (strange though it may seem) about 7 years because of how American homeowners move or refinance. The bulk of the mortgages originated during the 1990s have been fully repaid.
Moreover, the longer a mortgage has been outstanding, the less likely the borrower is to default. The big defaults we’re seeing now disproportionately involve mortgage loans made during the housing bubble of the past 6 years. Who did the pressuring and when?
The truth is that homebuyers, lenders, and investors succumbed to a boom mentality. They took rising home prices at face value. They assumed those prices would continue to rise. They also made optimistic assumptions about borrowers’ future incomes and refinancing opportunities.
“Predatory lending” exacerbated the problem, as unscrupulous lenders talked unsophisticated consumers (often elderly or poor) into refinancing deals that gave little benefit to the consumer but large fees to the lender.
So did “teaser” rates, interest-only mortgages, and mortgages on which borrowers could readily skip payments.
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You note that subprime lending exploded during the 1990s. It did indeed—not because of government pressure but because lenders found it feasible and profitable. Advances in information technology played a key role here. Lenders could obtain and analyze a wealth of data about prospective borrowers. (An executive of the nation’s leading credit-card issuer once told me that “by analyzing your spending patterns, we know you’ll get divorced before you do.”)
Using proprietary “credit scoring” models, lenders (e.g., Providian) found that they could make large profits issuing credit cards and making loans people previously deemed uncreditworthy. They did this, without political pressure, in an effort to maximize profits.
First I agree with much of what you say, many factors. Much of your inquiry iscovered in this link posted earlier today. http://www.nypost.com/seven/09242008/postopinion/opedcolumnists/house_of_cards_130479.htm?page=0
But your comments conflate different points.Subprime was merely the first domino. But it was a domino that became large enough to trigger the fall of more and more (e.g. Option ARMs, jumbo, and finally FNMA/FHLMC) because of the political pressures and yes, greed, as it was discovered that subprime was profitable. Had subprime remained 1-2% of the market, its collapse could have been tolerated. And remember, banks did plenty of subprime; it wasn’t just the “less-regulated”.
Bill [#12]: Sure, banks made subprime loans—but the worst subprime loans came from unregulated nonbank originators. That’s exactly the opposite of what you’d expect if the government had pressured lenders to make unsound loans.
Mortgages originated during the 1990s (including the Clinton Administration) had an excellent repayment rate. Most of them have already been fully repaid. Did all the purported political pressure suffer a massive bout of impotence?
The worst loans were evidently originated in 2003-2006, a period during which the Bush Administration controlled the Executive Branch and Republicans controlled both houses of Congress. Did these policymakers produce “regulation driven by liberals and progressives”? No. Those “liberals and progressives” had no power.
The article by Stan Liebowitz is profoundly misleading. Like a Marxist historian, he chooses the “facts” that fit his ideological bias, ignores those that do not, and goes long on innuendo.
If the government coerced regulated lenders to make unsound loans, why did unregulated lenders make worse loans? They chose their own lending standards—and adopted the stategies they believed would maximize their profits.
BTW, Fannie and Freddie long advocated relaxing the statutory loan-quality safeguards that applied to them: e.g., the rules requiring private mortgage insurance on loans with low downpayments.
PS to #13: The big credit-quality problems now in the news involve mortgage-backed securities. The market for such securities is huge and (until recently) has been liquid and efficient.
Even if the government had somehow coerced lenders into making unsound loans, how could it possibly coerce investors into buying securities backed by those loans? Investors bought mortgage-backed securities because they regarded them as an attractive investment.
Once again, the reality is that lenders and investors became insouciant about credit risk.
I think you are confused. You repeatedly refer to “unregulated” lenders. Do you mean non-Federally regulated? Not only are there no unregulated lenders (of mentionable size), state regulation can exceed Federal. E.g. a few years ago CA and Wells Fargo got into a tiff because CA wanted WF to comply with certain more restrictive CA rules; WF refused and won on the basis of preemption.
Similarly, you repeat claims that loans of “unregulated” lenders have much worse performance. First, you have to explain who are these mythical, unregulated lenders. If you mean mortgage banks, you are not comparing apples to apples. Federally-regulated banks have widely diversified loan porttfolios, as well as access to Fed loans. E.g. if 20% of WF loans are home loans and 10% go bad, that is only 2% of the total portfolio. But if 10% of ABC Mortgage goes bad, it may well fail due to capital calls on its credit lines. I have seen nothing to suggest that banks’ loan quality was any better than the others, only that they are more diversified.
You point to the excellent payment record in the 90s. I agree. The period ’92/3-2005/6 was characterized by almost uninterrupted appreciation, fueled in part by the loosening loan standards you defend.
You point to other loan categories and ask why is their foreclosure performance as bad or worse than subprime. The lowering of loan standards was a progressive phenomenon, from subprime to Alt-A and portfolio to jumbo and finally, Fannie/Freddie. So when values flattened and then dropped, then entire system had less room to absorb the decline.
Furthermore, that is why Republican control 2003-06 is virtually irrelevant. First, it was Dems who blocked all efforts to reform the GSEs, in spite of effort by McCain and others. Even Bush tried for reform, although I admit he was all too willing to take credit for the record homeownership. But, as I have noted, the problem was caused by the progressive loosening of standards for 10-15 years.
[It is similarly inappropriate to give Clinton credit for the rising economy he inherited in ’93 (in spite of his election lie that we were in a recession).]
Whatever Fannie/Freddie may have advocated, they never changed the requirement that loans >80% (e.g. the 90, 95, 97) required mortgage insurance, either borrower or lender paid.
Finally, I agree that the problem is MBS. But the reason for that problem is twofold: loss of value in homes and Wall Street slicing and dicing to make derivatives. Both factors have combined to create a crisis of confidence in MBS that is partly real and partly perception.
Bill [#15]: You started out asserting that political pressure caused the mortgage debacle [#10]. I debunked this argument by showing, among other things, that:
— FDIC-insured banks, the most heavily regulated of all relevant market participants, had a better record than mortgage brokers, nonbank mortgage companies, finance companies, and private securitizers, none of whom face significant community-reinvestment or affordable housing goals.
— Mortgages originated during the Clinton Administration have largely been repaid. So if that administration had pressured lenders to make unsound loans (which it did not), the loans have nonetheless performed well.
— The worst loans were originated during 2003-2006. I do not believe regulators pressured lenders to make bad loans. On the contrary, federal bank regulators then (as during the Clinton years) repeated urged bankers to maintain sound standards. As Republicans controlled all the levers of federal power plus a strong majority of state governorships during 2003-2006, I trust you will agree with me that the bad loans made then did not result from political pressure.
— No government forced investors worldwide to snap up U.S. mortgage-backed securities. Investors regarded them as attractive investments.
— Neither in principle nor in practice did the Community Reinvestment Act force lenders to make bad loans. On the contrary, CRA loans have a respectable record of repayment and profitability.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=306801
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=658281
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Lower mortgage credit standards for middle-class borrowers were not, as you seem to think, caused by lower mortgage credit standards for subprime borrowers. Erosion of credit standards occurred across the board, from credit-card lending to junk bonds. They reflect lenders’ and investors’ complacency about credit risk and other financial fundamentals—a complacency exacerbated by money managers’ efforts to earn higher returns in the low-interest-rate environment created by loose monetary policy.
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I refer to mortgage brokers, nonbank mortgage companies, finance companies, and the like as “least regulated” [#11] or “unregulated” [#13] because they face light, and in many respects ineffectual, regulation. They have little vulnerability to the sort of political pressure you referred to.
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Nowhere do I defend loosened lending standards. Remember the Ninth Commandment.
“Whatever Fannie/Freddie may have advocated, they never changed the requirement that loans >80% (e.g. the 90, 95, 97) required mortgage insurance, either borrower or lender paid” —Bill Matz [#15]
Fannie and Freddie couldn’t dispense with the private mortgage insurance requirement because it’s written into law. But they did try to weaken the law. At one point Freddie managed to get an anti-PMI rider into a fast-moving bill. Congress had to pass a special law repealing the rider.
Most of 16/17 simply restates your unsubstantiated claims without responding to my reasoning in 15 rendering further discussion of those items pointless.
While you have back-pedaled on your misstatement about “unregulated”, it is clear that you have no detailed knowledge of the vast array of Federal, state, and local regulation that applies to “unregulated” lenders. (And brokers are not lenders.)
Finally, I looked carefully at both your links. They have nothing to do with the repayment record of CRA loans.
Since you chose not to engage the points I raised in 15 I am closing on this thread.
Matz [#18] Your comments take the cake for insubstantial, unsubstantiated answers.
To take one of your less nebuous points, you assert that the Fed research to which I linked in #16 has “nothing to do with the repayment record of CRA loans.”
What an astonishing statement from someone who has repeatedly derided my knowledge of finance and mortgage markets!
The Federal Reserve study by Lehnert, Canner, Laderman, Passmore sought to ascertain whether the Community Reinvestment Act resulted in “a regulation-driven subsidy.” The study concluded that “CRA-eligible loans at CRA-affected institutions do carry lower mortgage spreads compared with other loans at the same institution. However, once we control for risk and benefit effects…, these differences in mortgage spreads become economically and statistically insignificant.”
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=306801
If the Community Reinvestment Act compelled banks to made bad loans, then the return on banks’ CRA-eligible loans would be negative—or at least much lower than that of banks’ non-CRA loans. Yet CRA loans yield returns comparable to those of other loans.
Remarkable that you can see no relevance in that!
For those of you who may have forgotten one of the cardinal principles of Finance 101 – leverage is a two edged sword. It magnifies your profits in an upturn, and similarly magnifies losses in a downturn. In our current case, however, the losses are worse than their corresponding profits because everybody assumed risk was normally distributed (the fallacy of the assumption that almost everything follows a bell-shaped curve). I highly recommend reading anything by Nassim Taleb for further discussion of how “rare” events can end up being not so rare. “Fooled by Randomness” and “The Black Swan” are two of his books.
#19 seems to have lost sight of the posture of this thread. He repeatedly challenged the posted article in his 5/6/9 with a number of unsubstantiated allegations before I ever posted. I then challenged his allegations as being unsubstantiated, noted some obvious errors (such as “unregulated lenders”), and pointed out that there were many other factors to consider.
His “proof” of CRA default history clearly says nothing about default history of CRA loans. It only addresses spreads. While defaults affect spreads, so do other factors, most notably pricing. All the cited study shows is that lenders apparently priced their CRA loans appropriately so that they were not being hurt, WHATEVER THE DEFAULT RATE WAS. But the study does not tell what the CRA default rate was. Furthermore, even if it did, it would be irrelevant because it does not deal with current data. As I pointed out above (without response), relying on loan performance during a period of rapid appreciation is extremely unreliable as a predictor of future default rates.
Finally, it is important to note that all of Irenaeus’ comments have focused on CRA loans, originally in response to Chris (5). In my 10 I expressly noted that there were other, similar factors contributing to the problem of lowered standards. E.g. the HMDA monitoring from the late 80s on led to intense pressure on those “unregulated lenders”. The point is that the CRA, HMDA, similar laws at the Federal, state, and local levels, and overall political pressure led to a climate in which lending standards were progressively relaxed in limited sectors and then across the board. It is the failure to address the mulitplicity of factors, together with the terminology errors, that suggests that Irenaeus lacks a close familiarity with the actual functioning of the home loan system in the US.