NYTimes reveals the real cause of the $700B
catastrophe now being blamed on “greed”
and lack of powerful government intervention
The oral history of the financial panic of 2008 is evolving rapidly in the establishment, political-media echo chamber. Many of those who should be hanging their heads in shame for their roles in bringing about the current crisis are the loudest voices in this developing oral history, deflecting just accountability away from themselves. Soon, if too few are willing to, in William F. Buckley’s words, “stand athwart history yelling stop,” oral will become written, and written will become entrenched cultural/political values leading to similar crises in the future.
The nascent narrative is that the crisis is a failure of capitalism, resulting from failure of government to field enough regulatory tanks to crush “greed” on Wall Street. Every investment decision involves weighing risk against potential gain, and it’s true enough that many on wall street miscalculated. But no regulatory regime can prevent miscalculation and still permit people to take the risks that lead to economic growth and improvement in living standards.
Under conditions of minimal government intervention the damage would have been contained within the boardrooms and cubicles of the institutions whose leaders made the bad decisions. But that’s not what has happened. If we believe the President, The Chairman of the Federal Reserve and Secretary of The Treasury, and scores of economic gurus, millions of Americans are at risk of suffering severe economic misery unless the government invests $700B in defaulting mortgages.
What caused this mess? It was certainly NOT lack of enough government intervention. Our friend and contributing writer, aaa.again, brought us this this chronicle of the roots of our immediate crisis:
Excerpts from a 1999 article in The New York Times
Excerpts are in black text and our comments are in blue text.
September 30, 1999
Fannie Mae Eases Credit To Aid Mortgage Lending
By STEVEN A. HOLMES
In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.
The action, which will begin as a pilot program involving 24 banks in 15 markets — including the New York metropolitan region — will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.
Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.
Fannie Mae and Freddie Mac are Government Sponsored Enterprises, or GSEs. The GSEs were created by government, and were jointly owned by government and stock holders. The GSEs were regulated by an independent agency that had no other responsibilities. The only mission of the Office of Federal Housing Enterprise Oversight (OFHEO) with several hundred employees was to ensure the safety and soundness of the GSEs by requiring that they were adequately capitalized and operating in a responsible manner. The GSEs and the OFHEO were in turn, directly supervised by Congress.
In short, the GSEs, whose malfeasance is at the root of the crisis, were not only regulated, they were under a greater degree of direct government control than any private sector bank or financial institution. Yet, they were scandalously mismanaged and are at the center of the current crisis.
Before the 1999 policy changes described in the NY Times article above, the GSEs generally set the highest borrower qualification standards in the mortgage lending industry. Insider Real Estate language called loans to borrowers who qualified by meeting GSE credit history and income standards “conforming” loans. Loans to borrowers who could not meet GSE credit and income standards were called “non-conforming.”
There were plenty of lenders who specialized in non-conforming loans, assuming greater risk and charging higher interest rates than the GSEs. The default/foreclosure rate for non-conforming loans was higher than the default/foreclosure rate for conforming GSE loans. But non-conforming lenders knew what they were doing, and they expected, and were prepared for more foreclosures. They charged borrowers higher interest rates to provide themselves a cushion against losses due to defaults and foreclosures.
This New York Times article describes the beginning of the GSE transition from making only the highest quality loans to making all kinds of loans. Eventually, the distinctions between the conforming and non conforming borrower largely disappeared.
In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates — anywhere from three to four percentage points higher than conventional loans.
Those companies that had specialized in higher risk mortgages, which they held in their own portfliios saw a chance to offload the risk onto the GSEs! At the peak of the go-go real estate boom, in 2005, it seemed that almost anyone could qualify for a loan in almost any amount. People with stellar credit and steady incomes were transformed from low-risk to high-risk borrowers by a system that qualified them for larger loans than they could afford.
”Fannie Mae has expanded home ownership for millions of families in the 1990′s by reducing down payment requirements,” said Franklin D. Raines, Fannie Mae’s chairman and chief executive officer. ”Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.”
Apparently Franklin Raines has been an adviser to the Obama Campaign, even though the campaign strenuously denied that he had more than a minor role.
In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980′s.
”From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. ”If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”
Even the New York Times reporter recognized the inherent risks. Yet the Clinton Administration and the semi-government, semi-private GSEs stumbled ahead.
Home ownership has, in fact, exploded among minorities during the economic boom of the 1990′s. The number of mortgages extended to Hispanic applicants jumped by 87.2 per cent from 1993 to 1998, according to Harvard University’s Joint Center for Housing Studies. During that same period the number of African Americans who got mortgages to buy a home increased by 71.9 per cent and the number of Asian Americans by 46.3 per cent. In contrast, the number of non-Hispanic whites who received loans for homes increased by 31.2 per cent.
So the private sector had already found ways to enable previously unqualified low income folks, many of whom also happened to be ethnic minorities, to pruchase their own homes. Yet the Clinton Administration couldn’t simply celebrate this success! Instead, Clinton ordered the GSEs to directly compete with private sector lenders for a larger share of low income/minority home loans.
The result is that the government and taxpayers must now put $700 Billion Dollars at risk to backstop the default/foreclosure risks that previously were taken only by private sector lenders who were prepared for them.