Watching the House Burn Down: What Caused Our Economic Crisis?
What caused our economic crisis? The housing bubble caused it.
What caused the housing bubble? Sub-prime mortgages, risky mortgages, to low-income, bad-credit borrowers.
Where did they come from? The “Community Reinvestment Act” (Google it. Read its Wikipedia entry).
President Jimmy Carter and the Democrats passed it in back in 1977. It gave incentives to help low-income borrowers get a home.
Not a bad idea – if done right.
It helped a little, but only a little — until 1995.
The Clinton Administration and the Democrats in power added massive new provisions to authorize — require — sub-prime loans be made. The revisions went further, by allowing the securitization of CRA loans containing sub-prime mortgages.
That forced banks to issue $1 trillion in new “sub-prime” Loans.
The CRA requires that deposit-taking financial institutions (read: banks) offer equal access to lending investment and services to all those in an institution’s geographic assessment area — at least three to five miles from each branch. Before the CRA, many bankers excluded low-income neighborhoods and people from their lending products, investments and financial services — a practice known as “redlining”.
Community activists coined the term when they discovered that the failure of banks to make loans to some low-income neighborhoods was so geographically distinct, that it was easy to draw red lines on maps to delineate the practices.
Of course, marketers have recognized for years that the United States is a nation of multiple communities each with its own distinct education,income, and religious, social, cultural and consumer values and beliefs. You can check out your own zip-code for free using the PRIZM system (See: www.claritas.com/MyBestSegments/Default.jsp?ID=20).
By 2000, the CRA was funneling millions, perhaps billions of dollars to left-wing “community activist” groups. The Clinton Administration had turned the Community Reinvestment Act into a Democrat piggy-bank and “a scheme against the nation’s banks”.
And created sub-prime mortgage securities.
Bear Sterns was the first company to do it. Remember them?
Fannie Mae added fuel to the fire by purchasing $2 billion of dodgy “MyCommunityMortgage” loans.
And sub-prime mortgages started to grow. Between 1995 and 1999, Fannie Mae Sub-prime Alt-A & Other Purchases grew from under $2 billion to over $16 billion per year!
Now home prices started to rise – from under 2% to over 6% per year,
Fannie Mae is a “Government Sponsored Enterprise”. Fannie Mae guarantees mortgages and then Fannie Mae sells them to banks and investors. The more mortgages, the more money Fannie Mae makes.
So how do you increase the number of mortgages? You move down the ‘income ladder’
(see: Washingtonpost.com: Fannie’s Perilous Pursuit of Sub-Prime Loans).
With “affordable mortgages”, fixed-rate loans were replaced by variable-rate loans (ARMS) and in turn by interest-only loans. These new loans gave “flexibility to lenders by allowing variances that borrowers need to qualify for loans”. (CSRwire). These variances applied to: loan-to-value ratio, borrower contribution, housing expense-to-income ratio, among others. In other words, to flakes.
Remember, the banks had to issue sub-prime loans or pay big penalties to the government.
How do you keep these loans “affordable”?
No money! No money down! Interest only! Low variable rate! No income verification! Bad Credit! No credit! No problem! Just sign here! (“Moneyfor nothing — and the chicks are free!”).
By 2004, 92% of Fannie Mae’s sub-prime loans were variable rate.
Fannie Mae told the banks “Make the loans — we’ll guarantee them”.
Home ownership kept rising — and so did prices, and the demand for houses rose too.
But demand for loans caused the interest rate to rise. Basic supply and demand 101 stuff. High-school students are taught this. Apparently not Senators or Representatives.
Then, gas prices shot up. Paychecks got squeezed. Especially low-income paychecks. Some borrowers stopped paying — so banks stopped lending. New ARMS and other “affordability loans” dropped from nearly 20% of total market share in 2006 to just 10% in 2007.
So the sub-prime market collapsed. From Fourth Quarter 2006 to Fourth Quarter 2007, Sub-prime mortgage originations dropped from $140 billion to under $18 billion, a drop of 88%.
Foreclosures started pilling up. No buyers, only sellers.
Home prices started falling. Down 2%, 4%, 6%, 8%…
More borrowers stopped paying. 60 day+ delinquencies went from under 8% in 2006 to over 25% by mid-2007.
Fannie Mae “Guarantees” became worthless – because they kept overstating their assets. (See Bloomberg.com: Regulators Spin Public to Boost Fannie, Freddie).
Banks collapsed due to worthlessness. Government Sponsored Securities issued by Fannie Mae became worthless. Jobs disappeared — and here we are. (See Guardian.co.uk: ‘IMF says US crisis is largest financial shock since Great Depression’).
Why is the expansion of the Government’s Community Reinvestment Act to blame?
Before CRA expansion, home prices simply increased with the underlying inflation rate, going up by 200% from 1975 through 1995 as the dollar dropped in value by the same amount. Home prices and home ownership rates were essentially flat – after adjusting for inflation. After CRA, home prices became unhinged from inflation, jumping 100% from 1996 to 2006 while inflation increased by ‘only’ 33%.
CRA caused home prices to rise too fast. Economic fundamentals did not support this growth. Government regulation-mandated credit did.
A bubble — waiting to burst!
So, did it have to happen?
The Bush administration and some of the members of Congress (read: John McCain) proposed to create a new agency to oversee Freddie Mac and Fannie Mae (See NYT: Sept 11, 2003). “The Bush Administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and load crisis a decade ago”. “A new agency would be created within the Treasury Department to assume supervision of Fannie Mae and Freddy Mac.”
But the Democrats in Congress stopped it: “Supporters of the companies said efforts to regulate the lenders tightly under those agencies might ‘diminish their ability to finance loans for lower-income families'”. Barney Frank said everything was just fine: “The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of ‘affordable housing'”.
This, of course, was wacky. By now, the creation of dodgy loans created a demand for housing — which drove up the price of all houses — and pushed the price of housing out of reach for the very people the CRA was supposed to help. And by 2007, the home ownership rate was falling – rapidly.
The time bomb was ticking.
John McCain’s “Housing Enterprise Regulatory Act of 2005” was neatly shot down by his Democrat opponents (See: www.govtrack.us Bill S-190).
Fannie Mae had friends in the Senate: Senator Chris Dodd (D-CT) and, the new junior senator from Illinois, Barack Obama, who proceeded to appoint Jim Johnson, former head of Countrywide Mortgage, and Lehman Brothers, and – Fannie Mae – as his close personal advisor. (Johnson was also Democrat Walter Mondale’s campaign manager for the 1984 presidential race).
He’s now on the board of Goldman Sachs (which used to be run by our current Secretary of the Treasury, Democrat Hank Paulson). See: Center for Responsible Politics (www.opensecrets.org). Golly, it gets incestuous.
Nobody likes discrimination. Everybody deserves a home. Not a house of cards.
Poor people didn’t cause this debacle. Free markets didn’t cause this mess. Deregulation didn’t cause it.
A bad federal law caused it – that forced main street banks to become predatory lenders to fulfill a well-meaning but economically-bankrupt government mandate to offer souped-up, shell game “affordable mortgages”.
Self-interested lawyers continued the fiasco, along with greed and stupidity on Wall Street (and fear of powerful politicians in Congress).
So what were created were lots of “affordable mortgages” that people couldn’t afford – and the rest of us will get poorer in the process.
Bad social engineering caused this mess, creating the environment and the wrong incentives that set up low income families to fail, to have their dreams torn away by reality while getting Wall Street to finance it all – and drive itself into bankruptcy in the process.
This is what you get when you let idiots and socialists run the public policy of the United States Government – especially our fiscally-bankrupt fiscal and financial policy.
A lot of the above ideas – and the wording – were taken directly from researchers at John McCain’s election campaign. You can’t improve on the perfect. It’s amazing they got it so right. (See: www.youtube.com/watch?v=H5tZc8oH–o).
But will any of these facts make any difference?