A long history of subprime lending
We have always been suspicious of “affordable housing,” rented or owned housing that is made available, through government assistance or regulation, to people with incomes not sufficient to cover the real costs of the housing. As we delve deeper into the current financial crisis, we discover that government-sponsored “affordable housing” is at the core of the problem.
A house for all
The current financial crisis did not begin with the latest housing boom and bust. The concept of “affordable housing” for homeowners goes way back in our history – to the New Deal, when Fannie Mae was first formed in 1938. As part of the New Deal, Fannie Mae (short for Federal National Mortgage Association) was a “government-sponsored enterprise” that was part of a goal to enable everyone in America to own a house. Fannie Mae bought home mortgages from banks, giving banks new inflows of cash to make more loans.
With the perceived backing of the government (and ultimately, taxpayers, as we have recently learned), Fannie Mae could buy mortgages that were riskier than normal – mortgages with lower or zero down payments, longer pay-back periods, laxer income-to-debt ratios, adjustable interest rates, and poor credit history of the borrowers. These are all devices to make housing affordable to low- and moderate-income households, all devices we now call “subprime lending.” Many of these devices only showed up recently, but Fannie Mae began by starting to use them. Mortgage standards that were considered risky in 1938 became risker and riskier over time.
During the Great Society program in the 1960s, Fannie Mae was privatized – although the government still remained involved – and a new mortgage-buying entity was created by the government: Freddie Mac, short for Federal Home Loan Mortgage Corporation. Freddie
Mac was intended to be competitive to Fannie Mae and was authorized to take on risky loans as well, with the same goal of expanding homeownership to low- and moderate-income households. The federal government’s banking regulations allowed both Fannie Mae and Freddie Mac to take on much riskier loans than any other bank.
In 1977, during another period of government expansion, the Community Reinvestment Act (CRA) was passed. It regulated banks, lowering credit standards even further and requiring local banks to give a certain percentage of loans to low- and moderate-income households and businesses. The CRA meant that many local banks had to make risky loans.
In 1992, Fannie Mae and Freddie Mac were also required to devote a set percentage of their loans to “underserved” populations – short for poor and minority households.
The advocates enter
When reforms were passed and percentages established, the performance of local banks and Fannie Mae and Freddie Mac could be publicly monitored, giving housing advocates and nonprofit groups the data they needed to show when these financial institutions were “underperforming” in the area of loans to low- and moderate-income households. Thus, government regulation itself pressured for more risky loans and brought about the growth of nonprofit advocacy groups like ACORN.
ACORN is the controversial left-wing nonprofit “community activist” organization heavily involved in affordable housing. Its name is the acronym for “Association of Community Organizations for Reform Now.” ACORN came to attention in the recent $700 billion federal bailout bill. ACORN was among a group of nonprofits that were to receive $20 billion (!) as funds from the bailout bill were returne to the government in the future. Under public pressure, this “earmark” for nonprofit advocacy groups was later dropped from the bill. But the very inclusion of it reveals how blindly the government is willing to fund affordable housing programs that will only repeat or worsen the financial crisis we are in.
Both Fannie Mae and Freddie Mac grew and grew. By 2002, they had become the fourth and fourteenth largest companies in the world, respectively. Investors believed they could never fail. There was a perception that the federal government was guaranteeing or insuring the mortgages of Fannie Mae and Freddie Mac, which further encouraged investors to buy into them. In fact, there were no government guarantees or subsidies or insurance. Fannie Mae and Freddie Mac were government “sponsored” and regulated but were otherwise totally private corporations.
Nevertheless, they grew, with an emphasis on “affordable housing.”
By the beginning of 2008, Fannie Mae and Freddie Mac owned or guaranteed about half of the U.S.’s $12 trillion home mortgage market. By the beginning of 2008, half of all the assets owned or guaranteed by Fannie Mae and Freddie Mac were risky loans. Thus, using simple arithmetic, by 2008, a quarter of all home mortgages in the U.S. were high-risk loans and represented low- and moderate-income households, many of whom would soon become unable to pay the mortgages for the houses they lived in.
Rising home prices
As long as the economy was doing well and home prices were rising, homeowners could pay their mortgages. With mortgages paid, Fannie Mae and Freddie Mac could survive, and no one wanted to regulate them. There were signs of trouble, however, but they were ignored. Six times before, according to an economist at New York University, the U.S. economy has had mortgage crises of the same nature as our current one. “We should have known,” he says. “A lot of people saw the problem.”
In 2000, the U.S. Department of Housing and Urban Development (HUD) attacked so-called “predatory lending” and disallowed risky loans from being credited towards affordable housing goals. This reform was dropped in 2004, and high-risk loans were again allowed.
In 2002, when real estate prices were booming, the Wall Street Journal wrote an editorial that predicted bankruptcy of Fannie Mae and suggested accounting fraud. The newspaper was attacked. The Bush administration sought more regulation of Fannie and Freddie.
It was opposed in the name of “affordable housing. Fannie and Freddie had become sacred cows, beyond criticism. But they were covering up their weaknesses by altering their accounting practices and “cooking the books,” subsequently exposed in scandal. In addition, they gave campaign contributions and highly favorable “VIP” loans to key politicians, which bought the favor of the politicians, again recently exposed.
The bubble bursts
Not much more than a year ago, the “bubble” burst, the house of cards collapsed. In the midst of the housing boom, a growing number of low- and moderate-income people who had overextended themselves to buy homes – with encouragement all around – suddenly could not pay their mortgages. What causes people to default? Why don’t people just keep paying the mortgage bill? Some do keep paying.
Others simply find the gap between their debt and their home value to be too wide. But often people incur bills in other areas – medical bills, auto purchases, etc. – and simply don’t have the money to pay their mortgage and have no equity in their home to borrow against. Tenants often don’t pay rent because of unexpected expenses.
So mortgage default rates rose very quickly, followed by foreclosures. The whole homeownership system slipped into a vicious downward spiral. Foreclosed properties were eyesores on the local community, tearing down the market values of surrounding properties, putting these properties at risk of foreclosure. Foreclosed properties also meant more houses on the market, which increased supply, lowered sales prices further and pushed more properties into “negative equity.”
More people defaulted and baled out of their mortgages.
All these mortgages were interlocked with the entire U.S. and world financial system. And so began the “subprime mortgage crisis,” which is really the “affordable housing” crisis that is at the heart of our current economic problems.
Learn the lesson?
We will see what happens to affordable housing programs as a result of this dramatic history. With people blaming all sorts of people, practices, and institutions, with Democrats blaming Republicans and Republicans blaming Democrats, the root cause of the current crisis may never be found.
The Federal Reserve Board has already “cracked down” on subprime lending, according to U.S. Representative Barney Frank of Massachusetts. But it may not be easy to give up on these programs. Already on October 1, the U.S. Congress unveiled the “Hope for Homeowners” program authorizing the Federal Housing Administration – which currently guarantees three in every 10 mortgages in the U.S. – to guarantee up to $300 billion of new 30-year, fixed-rate home loans for “struggling borrowers.” Yet it is already predicted that about one-third of these homeowners will fall behind again in their new loans. The program could be “setting them up for another crackup,” said one commentator.
How long will it take to learn?