Causes of The United States Housing Bubble - Government Policies - Mandated Loans

Mandated Loans

Many analysts, including conservatives such a Republican Senator Marco Rubio, have stated that the housing crisis was "created by reckless government policies.” Republican appointee to the Financial Crisis Inquiry Commission Peter J. Wallison and coauthor Edward Pinto have blamed the housing bubble and crash on federal mandates to promote affordable housing. These were applied through the Community Reinvestment Act and "government sponsored entities" (GSE's) "Fannie Mae" (Federal National Mortgage Association) and "Freddie Mac" (Federal Home Loan Mortgage Corporation). Journalist Daniel Indiviglio argues the two GSE's played a major role, while not denying the importance of Wall Street and others in the private sector in creating the collapse.

The Housing and Community Development Act of 1992 established an affordable housing loan purchase mandate for Fannie Mae and Freddie Mac, and that mandate was to be regulated by HUD. Initially, the 1992 legislation required that 30 percent or more of Fannie’s and Freddie’s loan purchases be related to affordable housing. However, HUD was given the power to set future requirements. In 1995 HUD mandated that 40 percent of Fannie and Freddie’s loan purchases would have to support affordable housing. In 1996, HUD directed Freddie and Fannie to provide at least 42% of their mortgage financing to borrowers with income below the median in their area. This target was increased to 50% in 2000 and 52% in 2005. Under the Bush Administration HUD continued to pressure Fannie and Freddie to increase affordable housing purchases – to as high as 56 percent by the year 2008. To satisfy these mandates, Fannie and Freddie eventually announced low-income and minority loan commitments totaling $5 trillion. Critics argue that, to meet these commitments, Fannie and Freddie promoted a loosening of lending standards - industry-wide.

Regarding the Community Reinvestment Act (CRA), Economist Stan Liebowitz wrote in the New York Post that a strengthening of the CRA in the 1990s encouraged a loosening of lending standards throughout the banking industry. He also charged the Federal Reserve with ignoring the negative impact of the CRA. American Enterprise Institute Scholar Edward Pinto noted that, in 2008, Bank of America reported that its CRA portfolio, which constituted only 7 percent of its owned residential mortgages, was responsible for 29 percent of its losses. A Cleveland Plain Dealer investigation found that "The City of Cleveland has aggravated its vexing foreclosure problems and has lost millions in tax dollars by helping people buy homes they could not afford." The newspaper added that these problem mortgages "typically came from local banks fulfilling federal requirements to lend money in poorer neighborhoods."

Others argue that "pretty much all the evidence on the housing crisis shows" that Fannie Mae, Freddie Mac, the (CRA) and their affordability goals were not a major reason for the bubble and crash.

Law professor David Min argues that view (blaming GSE's and CRA) "is clearly contradicted by the facts", namely that

  • Parallel bubble-bust cycles occurred outside of the residential housing markets (for example, in commercial real estate and consumer credit).
  • Parallel financial crises struck other countries, which did not have analogous affordable housing policies
  • The U.S. government’s market share of home mortgages was actually declining precipitously during the housing bubble of the 2000s.

In their book on the financial crisis Business journalists Bethany McLean and Joe Nocera also argue against the charge, saying it's "completely upside down; Fannie and Freddie raced to get into subprime mortgages because they feared being left behind by their nongovernment competitors."

However, according to Peter J. Wallison, other developed countries with "large bubbles during the 1997–2007 period" had "far lower ... losses associated with mortgage delinquencies and defaults" because (according to Wallison), these countries' bubbles were not supported by a huge number of government mandated substandard loans – generally with low or no downpayments" as was the case in the US.

Most early estimates showed that the subprime mortgage boom and the subsequent crash were very much concentrated in the private market, not the public market of Fannie Mae and Freddie Mac. According to an estimate made by the Federal Reserve in 2008, more than 84 percent of the subprime mortgages came from private lending institutions in 2006. The share of subprime loans insured by Fannie Mae and Freddie Mac also decreased as the bubble got bigger (from a high of insuring 48 percent to insuring 24 percent of all subprime loans in 2006). To make its estimate, the Federal Reserve did not directly analyze the characteristics of the loans (such as downpayment sizes); rather, it assumed that loans carrying interest rates 3% or more higher than normal rates were subprime and loans with lower interest rates were prime. Critics dispute the Federal Reserve's use of interest rates to distinguish prime from subprime loans. They say that subprime loan estimates based on use of the high-interest-rate proxy are distorted because government programs generally promote low-interest rate loans – even when the loans are to borrowers who are clearly subprime.

According to Min, while Fannie and Freddie did buy high-risk mortgage-backed securities,

they did not buy enough of them to be blamed for the mortgage crisis. Highly respected analysts who have looked at these data in much greater detail than Wallison, Pinto, or myself, including the nonpartisan Government Accountability Office, the Harvard Joint Center for Housing Studies, the Financial Crisis Inquiry Commission majority, the Federal Housing Finance Agency, and virtually all academics, including the University of North Carolina, Glaeser et al at Harvard, and the St. Louis Federal Reserve, have all rejected the Wallison/Pinto argument that federal affordable housing policies were responsible for the proliferation of actual high-risk mortgages over the past decade.

According to Wallison/Pinto ("Why the Left is Losing the Argument over the Financial Crisis"), the charging of 6 ex-executives of Fannie Mae and Freddie Mac with securities fraud in December 2011 shows that the two entities held over $2 trillion in substandard loans as of June 2008, even more than Wallison and Pinto had estimated earlier.

The Federal Reserve also estimated that only six percent of higher-priced loans were extended by Community Reinvestment Act-covered lenders to lower-income borrowers or CRA neighborhoods. (As it did with respect to GSE loans, the Federal Reserve assumed that all CRA loans were prime unless they carried interest rates 3% or more above the normal rate, an assumption disputed by others.) In a 2008 speech, Federal Reserve Governor Randall Kroszner, argued that the CRA could not be to blame for the subprime mortgage crisis, stating that

"first, only a small portion of subprime mortgage originations are related to the CRA. Second, CRA-related loans appear to perform comparably to other types of subprime loans. Taken together… we believe that the available evidence runs counter to the contention that the CRA contributed in any substantive way to the current mortgage crisis"

Others, such as Federal Deposit Insurance Corporation Chairman Sheila Bair, and Ellen Seidman of the New America Foundation also argue that the CRA was not to blame for the crisis. The CRA also only affected one out of the top 25 subprime lenders. According to several economists, Community Reinvestment Act loans outperformed other "subprime" mortgages, and GSE mortgages performed better than private label securitizations.

Read more about this topic:  Causes Of The United States Housing Bubble, Government Policies

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