Its origins are in the federal government.
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“Affordable Housing Goals” and the Deterioration in Underwriting Standards
RESEARCH SHOWED that the turning point came in 1992, with the enactment by Congress of what were called “affordable housing goals” for Fannie Mae and Freddie Mac. These two firms, which were shareholder-owned, had been chartered by Congress more than 20 years earlier to operate a secondary market in mortgages. The original idea was that they would buy mortgages from banks and other originators (Fannie and Freddie were not permitted to originate mortgages), standardize the mortgage document, resell those mortgages to institutional and other investors, and in that way create a national market for U.S. mortgages.
From the beginning, Fannie and Freddie’s congressional charters required them to buy only mortgages that would be acceptable to institutional investors — in other words, prime mortgages. At the time, a prime mortgage was a loan with a 10-20 percent down payment, made to a borrower with a good credit record who had sufficient income to meet his or her debt obligations after the loan was made. Fannie and Freddie operated under these standards until 1992.
The 1992 affordable housing goals required that, of all mortgages Fannie and Freddie bought in any year, at least 30 percent had to be loans made to borrowers who were at or below the median income in the places where they lived. Over succeeding years, the Department of Housing and Urban Development (HUD) increased this requirement, first to 42 percent in 1995, to 50 percent in 2000, and finally to 55 percent in 2007. It is important to note, accordingly, that this occurred during both Democratic and Republican administrations.
At the 50 percent level, Fannie and Freddie had to acquire at least one goal-eligible loan for every prime loan that they acquired, and since not all subprime loans were goals-eligible Fannie and Freddie were in effect required to buy many more subprime loans than prime loans to meet the goals. As a result of this process, by 2008, Fannie and Freddie held the credit risk of 12 million subprime or otherwise risky loans — almost 40 percent of their single-family book of business.
But this was not by any means the full extent of the problem. HUD took Congress’s enactment of the affordable housing goals as an expression of a congressional policy to reduce underwriting standards so that low-income borrowers would have greater access to mortgage credit. As outlined in my dissent, by tightening the affordable housing goals, HUD put Fannie and Freddie into competition with the Federal Housing Administration (FHA), a government agency with an explicit mission to provide credit to low-income borrowers, and with subprime lenders such as Countrywide, that had pledged to reduce underwriting standards in order to make more mortgage credit available to low-income borrowers. Moreover, all these organizations were joined by insured banks and S&Ls, which as noted above were required under the CRA to make mortgage credit available to borrowers who are at or below 80 percent of the median income in the areas where they live.
Of course, it is possible to find borrowers who meet prime loan standards among low-income families, but it is far more difficult to find such loans among these borrowers than among middle-income groups. And when Fannie, Freddie, FHA, subprime lenders like Countrywide, and insured banks and S&Ls are all competing to find loans to borrowers in the low-income category, the inevitable result was a significant deterioration in underwriting standards.
So, for example, while one in 200 mortgages involved a down payment of 3 percent or less in 1990, by 2007 it was one in less than three. Other credit standards had also declined. As a result of this government-induced competition, by 2008 19.2 million out of the total of 27 million subprime and other weak loans in the U.S. financial system could be traced directly or indirectly to U.S. government housing policies.
Private Sector Securitization of Subprime Loans
IF THE GOVERNMENT was responsible for 19.2 million of the 27 million subprime and other risky loans, that leaves 7.8 million similar loans that came from other sources. These were mortgages securitized by the private sector (often called Wall Street in the Commission’s report) and held by financial institutions around the world. How were these mortgages the result of U.S. government housing policy?
This is an important question. Even though these privately securitized mortgages were less than one-third of the total number of subprime and other risky loans outstanding, they are the reason that banks and other loan originators generally have been blamed — in the media, in most books and films about the financial crisis, and of course by the Commission — for the financial crisis.
The securitization of subprime and other risky loans was also a new phenomenon in the housing bubble that ended in 2007, and it was a direct result of the extraordinary growth of the bubble itself. Most bubbles in the past lasted three or four years. In that time, delinquencies begin to appear and the inflow of speculative funds begins to dry up. The bubble that deflated in 2007, however, had an unprecedentedly long 10-year life. The reason was that the money flow into that bubble was not from private speculators looking for profit, but primarily from the government pursuing a social policy by directing the investments of companies or agencies it regulated or otherwise controlled.
Housing bubbles tend to suppress defaults. As housing prices rise, people who can’t meet their obligations can sell the house for more than they paid, or can refinance, so delinquencies are limited. By 2002, five years into the bubble that began in 1997, investors were beginning to notice that subprime and other risky loans — which usually carried higher than normal interest rates because of their risk — were not showing delinquencies or defaults commensurate with their risks. In other words, the data suggested that mortgage-backed securities (MBS) made of these loans were offering unusually high risk-adjusted yields. This stimulated the development of a private market in securitized subprime loans — something that had never existed before.
This market was about 4 percent of all mortgages made in 2002, but by 2004 had grown to 15 percent. It kept growing through 2005 and 2006, but completely collapsed in 2007, when the 10-year bubble finally topped out and began to deflate.
Thus, the 7.8 million subprime and other risky loans that were securitized during the 2000s and still outstanding in 2008 were also the indirect result of U.S. government housing policies, which had built an unprecedented bubble in the late 1990s. The bubble created the necessary conditions — a long run of subprime loans without the expected losses — for the growth of a huge securitization market in subprime and other risky loans in the mid-2000s.
A man of faith in a godless age is hitting Americans where it hurts.
Mr. and Mrs. American Spectator Reader, let P.J. O’Rourke talk sense to your kids.
In Britain, defending your property can get you life.
It won’t take long for conservatives to scratch this presidential wannabe off their 2008 scorecard.
Was the President done in by the economy, or by the politics of the economy?