What you’re about to read is a real blood-boiler. Mortgage meltdowns and housing bubbles don’t cause themselves, they are caused. The root cause of our current housing mess was massive government intervention that went horribly wrong. In previous columns, we covered the early precipitating causes.
Now, let’s stroll back to the latter half of the 1990s decade. The Clinton Administration had already hot-wired CRA and HUD to extend home ownership to all citizens, regardless of their creditworthiness. Congress and the Federal Reserve then jumped on the bandwagon. This activism caused mortgage standards to be relaxed across the industry.
Clinton juiced-up the CRA again in 1995, to promote securitization of sub-prime mortgage loans. The idea of securitization was to spread the risk by combining a large number of loans into a security that could be sold on the market, theoretically making the security safer. This caused an 80 percent increase in the number of loans made to low and moderate income families
Clinton shifted into high gear to increase the national homeownership rate, promoting paper-thin down payments and pushing lenders to give mortgage loans to people with shaky incomes and poor finances. He even tried to permit “first-time homebuyers to freely tap their IRA and 401(k) retirement-savings plans with no penalty, to scrounge up a down payment.”
Enter Fannie Mae and Freddie Mac, government agencies created years earlier that were the main vehicles for the housing policies of Clinton and Congress to expand sub-prime housing lending. Freddie and Fannie were funded by Congress to provide financing for people who couldn’t qualify for conventional mortgages. Clinton ordered HUD to impose “affirmation action” lending quotas for Freddie and Fannie. They proceeded to buy hundreds of billions of dollars of low-quality loans, and would end up controlling 90 percent of secondary market mortgages. Their debt would become almost half the size of the debt of the entire federal government.
Racial quotas and penalties were imposed on lenders that failed to “diversify” their lending portfolios. Such lenders were given unfavorable “CRA ratings,” and Clinton changed banking rules to impose “$10,000 fines (or 1% of assets, whichever is less) per-loan-application if they discriminate against low income borrowers.” These policies mandated financial firms to give loans that previously would have been unimaginable.
By 1997, several facts were emerging: Fannie Mae was buying huge amounts of mortgages from other companies, it was backed by taxpayers for all losses but kept all profits, while Clinton and Congress continued to loosen home loan requirements. Fannie and Freddie, relying on implied taxpayer backing, were able to borrow at much lower rates than fully private corporations. They, with Clinton and Congress, promoted a campaign to “turbocharge the credit mania.” Securities brokers who sold mortgage-backed securities connected to Freddie Mac and Fannie Mae were assured by them that payments of interest and principal on their securities were “insured” or “guaranteed.”
Starting in the late 1990s, the Federal Reserve, which establishes interest rates and lends money to banks, consistently took action to lower interest rates, and to make credit easier to obtain by borrowers of all types, including low-income mortgage borrowers. This led to the creation of complicated products by mortgage firms and bankers, to feed the government’s hyped-up demand for mortgage money. Former Federal Reserve Chairman Alan Greenspan now admits to serious mistakes in judgment by the Federal Reserve Board.
Meanwhile, as the Feds pressured financial institutions in general to lend to subprime borrowers, Comptroller of the Currency Eugene Ludwig prosecuted over 2 dozen “fair-lending” cases, levying tens of millions of dollars in fines against firms that did not make loans to low-income borrowers.
By 1999, Fannie’s CEO further eased credit for loans to minorities and low-income people. During this time, it became increasingly plain that banks working with Fannie Mae were making thousands of “NINA” loans — No Income, No Assets — with no money down (or very little), no truthful documentation (“liar loans”), and that executives at Fannie were pocketing huge bonuses if loan targets were met. From 1999 to 2004, the two top Fannie executives (who came from Clinton’s Administration) earned respectively $100 million and $75 million in bonuses. Bottom line: Fannie was taking on enormous, ominous risk to taxpayers, and it would later crash and burn along with the collapse of the housing market.
(More on the causes of the crisis in the next column.)