Housing Crisis

Blame for the housing crisis rests with George Bush, who pushed for an “ownership society” and simultaneously underfunded regulatory agencies. No, wait. It was the Democrats, particularly Maxine Waters and Barney Frank, who resisted regulation of Fannie Mae and Freddie Mac, and wanted relaxed lending criteria for people with marginal credit. No, the blame is on the homeowners who bought houses they couldn’t afford. No way! It was the Federal Reserve’s policy of low interest rates that were kept low for too long after 9/11. No, it was the unscrupulous mortgage brokers who conned homebuyers into dangerous mortgages that were ticking time bombs. No, wait! It was the Wall Street fat cats who made a killing by bundling all these bad mortgages. No! It was Fannie and Freddie that distorted the private marketplace and forced Wall Street to take risks that they normally wouldn’t have! No, it was the Republicans who repealed the Glass-Steagall Act and let the Wall Street banks put this garbage together in the first place!
Or maybe, just maybe, it was all of the above.

A little background. Fannie Mae and Freddie Mac are government sponsored enterprises (GSE) that were created to underwrite mortgages. How do they work?

Fannie Mae and Freddie Mac stand behind mortgages in two ways: The first method is to purchase mortgages, bundle them together, and then sell claims on the cash flows to be generated by these bundles. These claims are known as mortgage-backed securities (MBS). The second method involves Fannie’s and Freddie’s purchasing mortgages or their own mortgage-backed securities outright and financing those purchases by selling debt directly in the name of the GSE. Both methods create publicly traded securities and thus permit a wide variety and large number of purely private investors to fund mortgages. (Footnote to a Fed Reserve testimony)

Here’s Alan Greenspan, then Chairman of the Federal Reserve, before a Committee on Banking, Housing, and Urban Affairs hearing on Feb. 24, 2004:
“The expansion of homeownership is a widely supported goal in this country. A sense of ownership and commitment to our communities imparts a degree of stability that is particularly valuable to society. But there are many ways to enhance the attractiveness of homeownership at significantly less potential cost to taxpayers than through the opaque and circuitous GSE paradigm currently in place.”

Alan Greenspan cheered on the role of GSEs in the mortgage market : “Securitization by Fannie and Freddie allows mortgage originators to separate themselves from almost all aspects of risk associated with mortgage lending.” Mr. Greenspan thought this was a good idea at the time. He has probably revised this opinion.

“The GSEs’ special advantage arises because, despite the explicit statement on the prospectus … that they are not backed by the full faith and credit of the U.S. government, most investors have apparently concluded that during a crisis the federal government will prevent the GSEs from defaulting on their debt.”

“…the existence, or even the perception, of government backing undermines the effectiveness of market discipline.”

“Because Fannie and Freddie can borrow at a subsidized rate, they have been able to pay higher prices to originators for their mortgages than can potential competitors and to gradually but inexorably take over the market for conforming mortgages.”

“While the rate of return reflects the implicit subsidy, a smaller amount of Fannie’s and Freddie’s overall profit comes from securitizing and selling mortgage-backed securities (MBS). “
Later in the year, Fannie and Freddie were about to gobble up the MBS market.

Greenspan then cited a study by Fed Reserve economist, Wayne Passmore, which “suggests that [Fannie and Freddie] pass little of the benefit of their government-sponsored status to homeowners in the form of lower mortgage rates.”

“A substantial portion of these GSEs’ implicit subsidy accrues to GSE shareholders in the form of increased dividends and stock market value. “

“Unlike many well-capitalized savings and loans and commercial banks, Fannie and Freddie have chosen not to manage that risk by holding greater capital. Instead, they have chosen heightened leverage.”

“I should emphasize that Fannie and Freddie, to date, appear to have managed these risks well and that we see nothing on the immediate horizon that is likely to create a systemic problem. But to fend off possible future systemic difficulties, which we assess as likely if GSE expansion continues unabated, preventive actions are required sooner rather than later. “
“…the GSE regulator must have authority similar to that of the banking regulators.”

Barney Frank, of Massachusetts, summed up the problem at a hearing in 2004, “the tension is between safety and soundness on the one hand, financial stability, and on the other hand getting into housing.”

Later in this blog entry, you’ll read a quote from Ron Paul that may prompt you to ask for his pick to win in the upcoming March Madness basketball tournament.

The following is from a clip of a congressional hearing, probably in 2004. There had been an accounting scandal at Freddie Mac in 2003. The Offfice of Federal Housing Enterprise Oversight, which regulates Fannie Mae, had also found some irregularities and improper campaign contributions. I haven’t been able to find the date or transcript of the hearing.

Chris Shays of Connecticut expressed his concerns that Fan Mae had a capital withholding reserve of 3%, less than the 4% minimum required of banks and savings and loans.
Franklin Raines, then Chariman and CEO of Fannie Mae, responded: “These assets [houses] are so riskless that their capital withholding should be under 2%.” In hindsight, we laugh at this “riskless” assessment but Raines’ comment reflects the thinking of many who thought that housing prices simply would not go down.

Maxine Waters, of California, has been a tireless fighter for affordable housing. Her passion for affordability often outweighs any doubts about the financial stability of a program: “We do not have a crisis at Freddie Mac, and particularly at Fannie Mae, under the outstanding leadership of Franklin Raines.”
Lacy Clay, of Missouri, called the hearing a lynching of Raines.

This is an example of blind allegiance. Frank Raines stepped down in the latter part of 2004. In 2006, he was charged with “accounting irregularities” that falsely inflated Fannie Mae’s earnings. In 2008, he settled with the government for a small fraction of the $90 million that he “earned” in bonuses as head of the company.

Barney Frank, of Massachusetts, is more mindful of financial soundness than Waters, but said “I don’t see anything in this report that raises safety and soundness problems.”

Maxine Waters: “What we need to do today is focus on the regulator and this must be done in a manner so as not to impede [Fannie and Freddie’s] affordable housing mission, a mission that has seen innovation flourish, from desktop underwriting to 100% loans.” Like Greenspan, Ms. Waters may have revised her opinion somewhat on loose underwriting standards and 100% loans.

At an oversight hearing of the Dept of Housing and Urban Development on May 20, 2004, Ms. Waters again asserts her full commitment to affordability at the expense of financial soundness,
“I join with anybody who is interested in expanding low-income housing opportunities. Let me must say that the no downpayment, low downpayment, all of that, that is good stuff, but it is a drop in the bucket.”

At a House Review of OFHEO, the regulator of Fannie Mae, on 7/13/04, the Republicans renewed their call for regulation.
Sue Kelly, of New York: “While we are pleased with the tremendous strides that OFHEO and the Finance Board have taken to strengthen their oversight role, the two agencies really remain ill-equipped to handle the oversight of the GSEs.” She is echoing the view of Alan Greenspan and others that their needs to be a banking regulator overseeing the GSEs.

Paul Kanjorski, of Pennsylvania: “I am very concerned about the failure of the Bush Administration to appoint directors to serve on Fannie Mae’s and Freddie Mac’s boards. As a result of this decision, each board has five fewer individuals to serve than they usually had.” Had the board positions been filled, there would presumably been greater board oversight of Fannie and Freddie. As Thomas Frank has documented in “The Wrecking Crew”, Bush regularly understaffed federal agencies.

David Scott, of Georgia: “There is general agreement that OFHEO needs to be strengthened in order to ensure the safety and soundness of these GSEs as they expand rapidly and rely on complicated accounting methods. As we know, legislation has stalled which would consolidate the
functions of OFHEO and the Federal Housing Finance Board at the direction of the Administration.

Richard Baker, of Louisiana: “GSEs credit loss ratios have declined due to improvements in their underwriting and risk management, meaning they are not taking as many poor people as they used to take, apparently,while loan loss reserves in the same period of review have declined principally attributable to reduced losses.”

Barney Frank, of Massachusetts: “the tension is between safety and soundness on the one hand, financial stability, and on the other hand getting into housing.” Frank is pushing for more lending in manufactured housing, even though it is more likely to be financially vulnerable. “I do not think every individual product line has to be profitable. We want a cumulative profit, so I hope we would also say, look, if there is a danger of things not going too well in the one area in the affordable housing area, that can be made up for elsewhere.”

Ron Paul, of Texas, is eerily prescient: “The only discouraging thing about our discussions that we have here in the committee is for the most part we talk about the technical solutions, the job you have as regulators, and believing that it is a technical problem. I think it is much, much more fundamental.”

Ron Paul continues: “your responsibility is to provide safety and soundness, I mean, I see it as practically an impossible task if this things starts to unwind, and I believe it is going to unwind. It involves trillions of dollars and derivatives. It is just a huge monstrosity.”

Later, Paul asks the regulators: “do you think there is a possibility of a puncture of a bubble?”
Armando Falcon, Director of OFHEO, answers: “Our economists do track it and are aware of the historical trends and causes of price bubbles. My economists who have looked at this with lots of experience, believe that we do not currently have a price bubble in home prices.”

Kanjorski asks about the criteria for selecting directors of the regulatory boards.
Alicia Castaneda, Chairman of the Federal Housing Finance Board, responds: “I think those appointments should be based on the qualifications and the skills of the individuals.”
Kanjorski responds: “Is it peculiar in your mind that maybe out of 60 or 70 appointments, that 97 percent come from one party and only about 3 percent from the other party?”
Castaneda responds that she is not aware of those figures.

Edward Royce, of California, continues his push for more regulation: “Over the past year or so, this committee has spent a great deal of its time looking at the 14 housing government-sponsored enterprises. Last year, I authored legislation to create one regulator for Fannie Mae and Freddie Mac and the federal home loan banks. I felt such legislation was needed because the GSEs are too large and too important to our nation’s housing and financial markets not to have world-class regulation.”

In 2003, the Bush Administration had called for more regulation. Republicans at these hearings in 2004 were calling for more regulation. The Republicans controlled both houses of Congress and the White House. Bills were introduced and referred to committee. None made it into law.

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