A great example of how we got to the credit-market meltdown

posted at 5:00 pm on September 25, 2008 by Ed Morrissey

Sometimes the greatest blame comes from great praise when viewed in hindsight.  The Los Angeles Times proves that with an article from 1999 heaping praise on the very people most responsible for the credit-market meltdown.  Ronald Brownstein lauded the Clinton administration for boosting minority ownership by forcing lenders to offer better terms to marginally-qualified borrowers — and noted the financial creativity from Fannie Mae and Freddie Mac as a crucial component of Bill Clinton’s efforts.  It also demonstrates why Congress mandated the failure of the lending system, and why it has to act to fix it (via Hot Air reader abinitoadinfinitum):

It’s one of the hidden success stories of the Clinton era. In the great housing boom of the 1990s, black and Latino homeownership has surged to the highest level ever recorded. The number of African Americans owning their own home is now increasing nearly three times as fast as the number of whites; the number of Latino homeowners is growing nearly five times as fast as that of whites.

These numbers are dramatic enough to deserve more detail. When President Clinton took office in 1993, 42% of African Americans and 39% of Latinos owned their own home. By this spring, those figures had jumped to 46.9% of blacks and 46.2% of Latinos.

Most people would agree that higher home-ownership rates are a positive sign in any community.  They indicate investment in a community and commitment as well.  Property owners have more of a stake in their cities and towns, and also typically support property rights in general.

But how was this accomplished?  Here’s where that praise turns to condemnation (emphases mine):

Under Clinton, bank regulators have breathed the first real life into enforcement of the Community Reinvestment Act, a 20-year-old statute meant to combat “redlining” by requiring banks to serve their low-income communities. The administration also has sent a clear message by stiffening enforcement of the fair housing and fair lending laws. The bottom line: Between 1993 and 1997, home loans grew by 72% to blacks and by 45% to Latinos, far faster than the total growth rate.

Requiring banks to serve their low-income communities.  That’s shorthand for taking on more risk and lowering what had been standard prerequisites for purchasing homes.  Normally, lenders would have demanded at least 10% down, and preferred 20%, and demonstration of stable income, of which the mortgage payments would not exceed 30%.  Under threat of prosecution for bigotry, lenders had to start taking less-qualified borrowers as clients.

But the government had a way for them to spread that risk throughout the investment community:

Lenders also have opened the door wider to minorities because of new initiatives at Fannie Mae and Freddie Mac–the giant federally chartered corporations that play critical, if obscure, roles in the home finance system. Fannie Mae and Freddie Mac buy mortgages from lenders and bundle them into securities; that provides lenders the funds to lend more.

In 1992, Congress mandated that Fannie and Freddie increase their purchases of mortgages for low-income and medium-income borrowers. Operating under that requirement, Fannie Mae, in particular, has been aggressive and creative in stimulating minority gains. It has aimed extensive advertising campaigns at minorities that explain how to buy a home and opened three dozen local offices to encourage lenders to serve these markets. Most importantly, Fannie Mae has agreed to buy more loans with very low down payments–or with mortgage payments that represent an unusually high percentage of a buyer’s income. That’s made banks willing to lend to lower-income families they once might have rejected.

Got that?  Congress told the two government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, to buy up the paper and transform these marginally-qualified loans into what’s known as mortgage-backed securities (MBS).  The purchase of these loans made them much more attractive to lenders, who rushed to create more of them.  Fannie and Freddie then kept buying the paper and turning them into MBSs and selling them to investors, who assumed that the government would back the GSE securities Congress mandated into existence.

Thanks to this massive intervention in the lending marketplace, what followed was utterly predictable for anyone who had ever completed Econ 101 at a junior college:

  • The massive influx of new home buyers drove up housing prices.
  • The rising prices pushed borrowers and lenders into adjustable-rate mortgages to allow the purchase of homes for no down, on the premise that the rising prices (which reacted to massive new demand) would allow them to refinance before the ARMs adjusted to their maximum, at which point borrowers would refinance with the new-found equity as their down payment to get better rates and lower monthly payments they could afford.
  • Housing prices rose so quickly that builders invested in new houses on a massive scale to produce inventory to meet the demand.
  • As long as prices continued to rise, and as long as the two GSEs kept issuing the MBSs, investors kept buying them — with their government backing.

All of this depended on a steady and significant increase in housing prices — which came to an end late last year.  When prices fell, an entire class of overextended borrowers could no longer refinance their ARMs to get affordable mortgage payments, and they began to default.  As I wrote earlier, it was similar to the margin calls in 1929, only in slower motion.  The bottom fell out of the housing market, and thanks to the massive sale over the previous decade of MBSs based on marginal loans, the collapse didn’t just get limited to the lenders or the borrowers, but investors around the world.

I’ve written this a couple of times, but this LA Times article from 1999 makes the case clearly — and maybe even more credibly, since it praises all of the stupidity and government intervention that created the bubble and the collapse.  Clearly, this was not the fault of a free market out of control.  Congress and the executive created this problem by extorting banks into poorly-considered lending practices under the threat of prosecution as “unfair lenders”.  They compounded that extortion with an artificial mechanism to incentivize lenders by having GSEs buy the paper and resell it, with government imprimatur as its guarantee.

Normally, I’d say let the lenders drown.  Unfortunately, this isn’t completely their fault, and we should have known better.  Not too many of us complained about the rapid escalation of our own equity that came from this housing/lending bubble, and in the end most of us will still benefit from it, if not quite as much as it seemed a year ago.  Three years ago, Alan Greenspan tried to get Congress to act, and only John McCain, Chuck Hagel, John Sununu, and Elizabeth Dole responded — while politicians of both parties made sure to keep the Ponzi scheme in full swing.  And those MBSs were minted at the behest of Congress, the people’s branch of government.  We broke it, and we own it.

Government created this problem, and government will have to provide at least part of the solution.  What we need is a way to make sure that government doesn’t interfere in lending markets again.  We need to eliminate GSEs entirely and let borrowers and lenders find each other in the marketplace.  If government would quit trying to pick winners and losers, we wouldn’t find ourselves in this grave financial crisis.

Update: SeeJaneMom has further comments on this article, although I think the situation is less dire than she does.

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Don’t forget–there was more than one way to qualify as sub-prime. One way involved a poor or nonexistent credit history—and the other involved having overextended credit, such as one would have in buying multiple “investment” homes.

The subprime market created a speculative market in real estate, as it let people with overextended credit (i.e. “house flippers”) get home loans under the same lowered standards. How many sob stories about people losing their homes are actually house-flipping speculators looking to Uncle Sam for a bailout?

However, the house flippers and the honest dummies who couldn’t read the bottom line on their home loan are enough for markets to lose confidence in the MBSs, and far too many people bet their lives on MBSs, so we have to do something.

Sekhmet on September 25, 2008 at 6:32 PM

I think he gave up about $20 million in bonuses and signed something admitting to the accounting fraud. They never found a smoking gun that Raines personally ordered the accounting shenanigans. But he did sign all the financials.

rockmom on September 25, 2008 at 6:13 PM

So he gets to keep $70 million of the $90 million he paid himself while running FM into the ground? Great.

Who said crime doesn’t pay? Apparently it pays very, very well.

AZCoyote on September 25, 2008 at 6:40 PM

These people are so gung-ho for impeachment, why can’t we impeach Schumer, Frank, and Rangel for high crimes and misdemeanors?

cjs1943 on September 25, 2008 at 6:41 PM

Vince (6:28)

Well, actually, it is a big deal because we had a panic on Wall Street last week. Those big investment banks, AIG, and Freddie and Fannie being shown to be bankrupt, scared the life out of everyone who started running for the the exits.

It is possible that the Federal Reserve has already done what needed to be done to stop the panic when they stepped in to backstop Freddie/Fanny, arrange a shotgun wedding for Bear Sterns, and so forth, and .. on .. and on..

What the fed has to do is dismantle the failed businesses in an orderly manner similiar to what a bankruptcy court would do, and let the vultures pick over the remains.
Then reassure the rest that life goes on.

In my mind, it should be very similar to what the FDIC does when a bank fails, or what the SIPC does when a broker goes under. We don’t have any mechanism to stop a panic on Wall Street when it becomes a run on all the banks at the same time.

Unfortunately, politicians see an advantage, and an opportunity.

It has been fun, though. You don’t get to see this everyday.

rockhauler on September 25, 2008 at 6:43 PM

I think the words are “lousy fare.”

Dan Collins on September 25, 2008 at 6:55 PM

Yeah, and one of the first fraudulent banks that did this was the one run by Penny Pritzker and her hubby. OBTW, Penny just happens to be Obamas CHIEF financial advisor. Gee, that’ll really help things.

Webrider on September 25, 2008 at 7:01 PM

FYI, I got this link from Ab as I said in the original post. I didn’t get it from Jane. Because she’s a friend, I’ve linked her in an update — but sometimes more than one person gets to the same thing independently. I’m pretty good about linking my sources.

Ed Morrissey on September 25, 2008 at 7:01 PM

Great work abinitoadinfinitum and Ed.

The Mad Blog Rabble strikes again.

forest on September 25, 2008 at 7:09 PM

seejanemom, I did not get the article from this blog either but he wrote about it at 8:21am.

abinitioadinfinitum on September 25, 2008 at 6:20 PM
Then neither one of us should get the credit, but I sent ED a link in email about 1:00pm eastern. ANd I didn’t get it from him either, I got it from digging in a subscription news service owned by a radio station that I guest on in Northern Virginia. I wll be on again tommorow to explain this to the dumb guys in their trucks listening to the morning show.

See why I am so pissed?

Some of us WORK for our links and get PAID to find them.

Again…no harm..no foul. ;)

seejanemom on September 25, 2008 at 6:27 PM

Take a damn Midol and eat a chocolate bar. Geez.
You sound like Obama yesterday, mine mine mine mine.

HornetSting on September 25, 2008 at 7:15 PM

Any other stupid questions, or can you do your own research from now on?

Vashta.Nerada on September 25, 2008 at 5:39 PM

#1 You’re an absolute moron. The question was…..

>Can you show me any source (other than the numbers pulled out your ass) that these loans a decade ago where worth $1.5 Trillion?

Are you REALLY trying to say that the loans mentioned in the post = 1.5 Trillion?

—————-

#2 you’re an unrepentant moron. You answer was.

>The FBI says that reports of suspicious mortgage activity increased by 10-fold from 2001 through 2007….

DUH That wasn’t the loans in question… The loans in question ended in 1999 You just proved my point dimwit.

Any other stupid answers to reasonable questions you’d like to babble about?

Next time try to reach the level of intelligence of a third grader. sigh.

Diogenes of Sinope on September 25, 2008 at 7:17 PM

FYI, I got this link from Ab as I said in the original post. I didn’t get it from Jane. Because she’s a friend, I’ve linked her in an update — but sometimes more than one person gets to the same thing independently. I’m pretty good about linking my sources.

Ed Morrissey on September 25, 2008 at 7:01 PM

ED IS A PEACH, but I was railing at HOTAIR…not ED.

I just think the BIG BLOGS forget that they were little once too.

THNAK YOU ED>>>and like all gentlemen, when ladies forget themselves, you always give us a graceful way out. You are a dear, dear man.

;)Janie

:::DEEPLY embarassed for my hissy fit::::

seejanemom on September 25, 2008 at 7:20 PM

Typos…my signature…

seejanemom on September 25, 2008 at 7:21 PM

>>The FBI says that reports of suspicious mortgage activity increased by 10-fold from 2001 through 2007….

Vashta.Nerada you moron, you just pointed out that the massive fraud took place under the Bush administration…

You just shot down Ed’s post.

Way to prove your point there dimwit. Man, people as dumb as you scare me.

Diogenes of Sinope on September 25, 2008 at 7:21 PM

…..virtual chocolate bar…????

HornetSting on September 25, 2008 at 7:22 PM

The Mad Blog Rabble strikes again.

forest on September 25, 2008 at 7:09 PM

When you have my readership, forest, you can call me “rabble”.

seejanemom on September 25, 2008 at 7:23 PM

Diogenes of Sinope on September 25, 2008 at 7:21 PM

Are you suggesting that there is a connection between President Bush, his administration, and those fraudulent mortgages, and the resellers deceptions?

If so, would you lead us to your evidence for that conclusion?

rockhauler on September 25, 2008 at 7:25 PM

and that same group of people – Congress – will now gamble $700 billion of the taxpayers’ hard earn money – that they can bail out this mess.

In the meantime, right behind them comes Warren Buffet with his $6 billion in Goldman Sacs now authorized to become a bank holding company. Buffet and friends plan to wait until the government buys off the pay debt and then he and his group will buy the bank. Sound like a good deal? Well for Buffet, yes; for the taxpayer, no way!

katablog.com on September 25, 2008 at 8:03 PM

Barrack O’Reilly is on right now, blaming Cox and Bush!

dmann on September 25, 2008 at 8:07 PM

When you have my readership, forest, you can call me “rabble”.

seejanemom on September 25, 2008 at 7:23 PM

I’m working on my Mad Blog Rabble qualifications, but I’m still just in apprenticeship. I should have my MBR card by the middle of next year.

Seriously though, the posts were all great. I’m getting pretty sick of hearing Democrats claim that free market forces caused this mess.

forest on September 25, 2008 at 8:07 PM

Are you suggesting that there is a connection between President Bush, his administration, and those fraudulent mortgages, and the resellers deceptions?

If so, would you lead us to your evidence for that conclusion?

rockhauler on September 25, 2008 at 7:25 PM

No not at all Rock hauler… Read back the thread… I’m just pointing out to the moron that his answer didn’t damn Clinton it damned Bush… He was too dumb to realize it.

No Rockhauler… you’re the only on one the tread making sense… well other than me. ;-)

Diogenes of Sinope on September 25, 2008 at 8:13 PM

I have been underwriting commercial (business) P & C insurance for 10+ years. I get “pressured” to write risks in tough neighborhoods. I get “threatened” that turning a risk down would be considered “red lining”. But the pressure and the threats don’t matter to me. I am looking to protect the assets of the company…so I continue to underwrite, writing some risks while rejecting others. This wasn’t happening in the mortgage industry. There was no underwriting, no controls, and a lowering of good underwriting practices. Now the paper these mortgages are printed on are worthless.

Bail them out for not following best practices? NO WAY!

jbh45 on September 25, 2008 at 8:18 PM

Great summarization Ed.

Best one at Hot Air, yet. Other great explanations can be found at IBDeditorials, and Heritages, The Foundry.

iamse7en on September 25, 2008 at 8:28 PM

Diogenes of Sinope on September 25, 2008 at 8:13 PM

Well, my point was it didn’t really damn Bush either. The fraud and deception just happened in that time frame.

What bothers me more than anything is the rampant fraud and deception that ramped up, and was being ignored because it generated more business.

Several posters have pointed out the reckless disregard of standards.

I’m inclined to accept the premise that the democrats are complicit because of all the circumstantial evidence that leads in that direction. At the very least, democrat policies created the environment where that fraud could flourish.

rockhauler on September 25, 2008 at 8:33 PM

Most people would agree that higher home-ownership rates are a positive sign in any community.

You left out the key words: all else being equal.

Years ago, back when Clinton first proposed this, I remember Louis Gosset Jr. (of all people) on a talk show. He was railing about how black people weren’t economically responsible because they didn’t own homes. But if you put them in homes, they would then BECOME responsible citizens.

In fact of course, it works the exact opposite of that: doing the things that it takes to qualify for a home loan make you a better person – not the other way around.

There’re stories about how in the South Pacific, after WW2 ended and the small islet air bases closed down, local tribes formed “airport cults.” They would clear fields in hope that the “air gods” would deliver them all the food and goods that they’d seen arrive at US air bases. That’s the exact same kind of logic most liberal social welfare housing programs are based on.

logis on September 25, 2008 at 8:56 PM

So many signs this was going to happen and still….. it happened and we were surprised by it.

I believe Warren Buffett characterized it as a economic Pearl Harbor.

Yakko77 on September 25, 2008 at 9:57 PM

Great post, Ed. For the last couple of weeks I have been fearful that when people look back thirty years from now they will equate the legislation during Clinton with Smoot-Halley of the Hoover term and the current finagling with that of Roosevelt with similar results. This is not intended as a compliment to any of these Presidents. Hoover’s time produced a severe recession; under Roosevelt it turned into a long term depression which didn’t end until an external event, WW II, interceded. If any of these affects come to pass, it will of course follow a different time line, as you point out, since we have not even entered a recession. I don’t expect that all this will happen, but a short while ago I was confident that we would not have a recession this time.

burt on September 25, 2008 at 10:03 PM

You and Mr.Magoo can just go screw yourselves.

And what is with that GAY **eats** thing ANYWAY.

Sorry>>>I have a PMS rage comin’ on so step aside you two MORON NEWBS.

seejanemom on September 25, 2008 at 6:00 PM

I am sure you are right, but I work VERY HARD at what I do…and I do it from somewhere besides my mom’s basement, like these two cheeto eaters. I predate them, and I resent their hubris.

::thank you for the wine, upinak::: ;)

seejanemom on September 25, 2008 at 6:06 PM

I don’t know you from Adam or Eve. I don’t know if you are calling Ed and Allah or me and Grue cheeto eaters. Your qualifications, who you’re friends with, and how hard you work don’t mean jack to me. You were ranting like a spoiled child and someone mocked you. Big deal. So you are sooooo professional that your response is “go screw yourselves” and then make gay jokes? Kind of hard to take you seriously after that drama show.

And if you are referring to me as a basement dwelling cheeto eater, you are way off base. I’ve worked hard all my life too – over 40 years. Married 34 years, own a home, enjoy a cold beer when I get home, pay taxes, and am concerned about the direction my country is going.

So you stay away from me and I’ll stay away from you.

Mr_Magoo on September 25, 2008 at 10:37 PM

#1 …..

>Can you show me any source (other than the numbers pulled out your ass) that these loans a decade ago where worth $1.5 Trillion?

Are you REALLY trying to say that the loans mentioned in the post = 1.5 Trillion?

Yes, I am. That source, plus several others point out that $1.5 trillion in subprime loans were carried by Fannie Mae. Maybe you should take a third grade reading comprehension class. At the very least do some basic research, and you will find out. I’m not your babysitter.
—————-

#2 you’re an unrepentant moron. You answer was.

>The FBI says that reports of suspicious mortgage activity increased by 10-fold from 2001 through 2007….

DUH That wasn’t the loans in question… The loans in question ended in 1999 You just proved my point dimwit.

Diogenes of Sinope on September 25, 2008 at 7:17 PM

Just how stupid are you? The whole point of your argument was whether or not Clinton changed the laws in 1995 to make it not only easy to get a subprime, but that Fannie Mae would be the carrier. Any loan made from late 1995 until last Wednesday fell under those laws. Are you so daft you don’t understand this? Let me repeat it slowly for you. Clinton changed the laws to make it easier to get a subprime loan without proper qualifications. Clinton pushed Treasury Secretary Rubin to rewrite the redlining rules for banks, bypassing congressional oversight. Ergo, many bad loans were underwritten by Fannie Mae, equal to a trillion and a half dollars in a portfolio of over $5 trillion. Whether the loan was written in 1996 or 2006 is irrelevant. What is relevant is that thousands of them began to default in 2007 and 2008. What is more, his rule changes, by lowering the standards and forcing banks to make them introduced fraud on an unprecedented scale into the mortgage market. If you are really that stupid, perhaps you need to find a different blog to post on, maybe one that focuses in celebrity underwear or something.

Vashta.Nerada on September 25, 2008 at 11:15 PM

Captain, I complained several times, both over at Captain’s Quarters and here. The rapid rise in housing prices meant my kids could never ever afford to buy a house — who can spend over a million here in LA for a fixer? Once, houses cost twice your yearly income, and now they were up to 10-12 times it, and the banks were offering 50 year mortgages, because 30 years wasn’t enough.

It either had to end, or every customer had to be helped by Freddie and Fannie.

All this bailout stuff is predicated on blowing up the bubble again and going right back to doing the “magic” Congress mandated that the markets do. It’s not going to work. You are right — the government has to stop doing social engineering and leave the market alone.

It’s one thing to stop discrimination — and another to do it in reverse to the point where even your target population is priced out of the market without the aid of actuarially unsound finance.

unclesmrgol on September 26, 2008 at 12:27 AM

Holy Canoli, that’s a lot of delinquent loans! We’re with Countrywide – nothing like finding out your mortgage company is frakked-up.

This has me seriously depressed. It’s going to be bad for this family, bailout or not.

Anna on September 25, 2008 at 6:32 PM

It’s ok – Countrywide sold a lot of their subprime to Fannie and Freddie…. Fran and Fred also own 30% of the $4 Trillion active CDO business (which needs to be written down by a good 30%) as well, so that will be a nice pill to swallow.

Vashta.Nerada on September 26, 2008 at 12:48 AM

It’s one thing to stop discrimination — and another to do it in reverse to the point where even your target population is priced out of the market without the aid of actuarially unsound finance.

Agree wholeheartedly. Life, liberty and the pursuit of happiness. What part of that guarantees everyone must own a home?

Mr_Magoo on September 26, 2008 at 10:16 AM

Normally, I’d say let the lenders drown.

Instead, can we march down to D.C. and drown the politicians responsible?

Pope Linus on September 26, 2008 at 1:43 PM

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