Les Jones

Who got us into this mortgage mess

Thursday, February 26th, 2009 | Economics |

Over at SayUncle’s tgirsch talks about who and what was responsible for the mortgage industry problems that are shaking the finance industry apart. In particular, he says that the Community Reinvestment Act was not the cause. Here’s my comment from over there.

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I haven’t seen any evidence that CRA was a major contributor.

However, Fannie and Freddie were major contributors, particularly in taking no-doc loans. See Congressional testimony here:

Freddie Mac’s senior executives ignored similar warnings. Donald J. Bisenius, a senior vice president, wrote in April 2004 to a colleague that “we did no-doc lending before, took inordinate losses and generated significant fraud cases.”

“I’m not sure what makes us think we’re so much smarter this time around,” he wrote.

Housing analysts say that the former heads of Fannie Mae and Freddie Mac increased their nonprime business because they felt pressure from the government and advocacy groups to meet goals for affordable housing as well as pressure to compete with Wall Street. But Mr. Pinto said one in five Alt-A loans in recent years were made to investors, not to first-time home buyers.

Other big factors:

• Securitized mortgages. Some lenders wrote shite loans and pawned them off as investments.
  Moody’s and S&P then somehow rated those investments as high quality.
• Banks were massively over-leveraged relative to deposits and investments.
• The market was wildly inflated in many areas, with some areas (like California) much worse than others.
• Federal Reserve interest rates that stayed too low too long encouraged those crazy prices. Lowering the interest rate a couple of points makes an enormous difference in how much house people can afford, which drives up rates.
• Lending institutions went nuts, with things like 100% loan to value ratios (as opposed to the traditional 80%) and options ARMs, which are insane.
• There were some instances of intentional mortgage fraud, though that was relatively rate.
• There were also cases of people buying more house than they could afford, but the banks should have simply told them no.

Overall, I rank the failings greatest at the government level, then at the banking level, and least at the individual level of honest buyers.

The government - particularly the Federal Reserve under Greenspan - tried to prop up the economy with too-easy credit for too long. Greenspan in 2004 said that fears of a speculative housing bubble were exaggerated, and that more Americans should use adjustable rate mortgages.

Banks and other lending insitutions betrayed their depositors and investors by glossing over risk and ignoring long-standing rules like the 80% loan to value ratio and the 3 to 1 annual income to mortgage ratio. Many buyers who went in seeking loans beyond their means should have been denied loans. That would have prevented many of the problems we’re seeing today.

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The next day Doctor Housing Bubble had a graphic showing who was responsible for the current mess, with the most responsible at the top. I’m in general agreement with this:

The Federal Reserve kept interest rates too low for too long and actively encouraged borrowing even as the housing market was overheating. Greenspan and Bernanke were terrified of letting the economy cool off, which in retrospect it definitely needed to do years ago. It would have been better to have a small recession and let people sober up instead of having an entire economy that was drunk on its belief in ever-appreciating real estate prices.

The banks and the investment firms who made these loans and who bought securitized debt were responsible because they were supposed to be the caretakers of their depositor’s money and investor’s money. Instead they got greedy and made their lending standards impossibly low. Now in many cases they’ll never get all of the principal back.

The rating agencies enabled much of this by giving top ratings to securitized debt, much of which is now recognized as toxic waste on the balance sheet.

One level not shown in the pyramid is Fannie Mac and Freddie Mac. As the testimony above and this internal email show, they were involved in incredibly reckless lending practices in order to maintain their growth, though certainly part of that was due to political pressure.

Tags: fannie mae, freddie mac, mortgages

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