Was sub-prime lending ever a good idea?

posted at 12:55 pm on October 6, 2008 by Ed Morrissey
Share on Facebook | regular view

A new video has Barack Obama speaking in 2007 about the burgeoning crisis in the financial markets, but focusing on accounting fraud rather than the root cause of the meltdown: the widespread issuance of bad credit, securitized by Fannie Mae and Freddie Mac at the behest of Congress. In this audio clip, Obama defends the idea of subprime lending just over a year ago:

Here is the clip in full context:

Subprime lending started off as a good idea – helping Americans buy homes who couldn’t previously afford to. Financial institutions created new financial instruments that could securitize these loans, slice them into finer and finer risk categories and spread them out among investors around the country and around the world.

In theory, this should have allowed mortgage lending to be less risky and more diversified. But as certain lenders and brokers began to see how much money could be made, they began to lower their standards. Some appraisers began inflating their estimates to get the deals done. Some borrowers started claiming income they didn’t have just to qualify for the loans, and some were engaging in irresponsible speculation. But many borrowers were tricked into glossing over the fine print. And ratings agencies began rating bundles of different kinds of these loans as low-risk even though they were very high-risk.

Most everyone knew that some of these deals were just too good to be true, but all that money flowing in made it tempting to look the other way and ignore the unscrupulous practice of some bad actors.

This leaves out a couple of crucial factors.  “All that money flowing” came from Fannie Mae and Freddie Mac, which created a boom market in the sub-prime market at the behest of Congress.  They wanted to increase the market for subprime loans, and they did so by essentially creating profit on every loan, whether it made sense or not.  Fannie and Freddie removed all of the normal correctives of the market by ensuring a short-term profit on almost every piece of paper written.

The second factor is that subprime lending is almost by definition not a good idea.  While most people would agree that home ownership is a benefit to the individual as well as the community, the lending of money to people who can’t afford it is a fundamentally destabilizing practice.  Defaults increase bankruptcies and lower property values, and ruin the financial prospects of families for years.   Lending markets had rational criteria for lending before the government provided massive and irrational incentives for subprime lending, and the price of housing remained very stable in relation to inflation.  Government meddling created the housing bubble and its deflation has touched off a worldwide financial panic.

Barack Obama’s entire economic argument is incoherent on this point.  He argued that during the Bush years, working families went backwards economically while only a few profited.  Yet home ownership blossomed during that same period, thanks to the wildfire Fannie and Freddie set in lending markets.  If families were falling backwards as Obama claims, then subprime lending was a very bad idea.

Anyone arguing that subprime lending was essentially a good idea has obviously learned nothing from the collapse of Fannie Mae and Freddie Mac, and the poison they introduced to the investment sector.  The best way to boost home ownership is to build a strong economy in which job creation allows upward mobility throughout the entire economy, and to keep taxes low enough to encourage the kind of investment that creates jobs.  Instead of forcing or enticing lenders to take irrational risks with credit, the government would have done much better to build people into position to own homes on a rational basis.

Blowback

You must be logged in to post a comment.