This Past Tuesday the Republican Members of the House Committee on Oversight and Government Reform released a staff report that provides the reasons for the housing bubble burst 2007. The Report finds that the housing bubble burst that led to a financial crisis can be traced back to federal government intervention, pushed by the Democratic party, in the U.S. housing market.
“The spin on the financial crisis by those who favored government efforts to erode lending standards is that the housing bubble didn’t cause this recession,” said Rep. Darrell Issa the Committee’s Ranking Member. “The findings in this report should remind this Congress that ignoring the role of politics and government in causing the housing crisis and the economic collapse while pursing other regulatory reforms will not fix the underlying problem.”
Government intervention “created ‘affordable’ but dangerous lending policies which encouraged lower down payments, looser underwriting standards and higher leverage. Finally, government intervention created a cabal of vested interests – politicians, lenders and lobbyists – who profited from the ‘affordable’ housing market and acted to kill reforms.”
The report finds that:
- Political pressure led to the erosion of responsible lending practices. In the early 1990s, Fannie and Freddie began to come under considerable political pressure to lower their underwriting standards, particularly on the size of down payments and the credit quality of borrowers. (p.6 of report)
- Lower down payments led to an inflation of housing prices. Once government-sponsored efforts to decrease down payments spread, home prices became increasingly unconnected from the real demand, which under normal circumstances would limited by borrowers’ ability to pay. Borrowers would make smaller down payments and take on higher debt, allowing home price inflation to continue to sky rocked. Between 2001 and 2006, median home prices increased by an inflation-adjusted 50 percent, yet at the same time Americans’ income failed to keep up. (p. 11 of report)
- Members of an “affordable housing” coalition shared profits with political allies to help legitimize their business practices: Fannie Mae created and used The Fannie Mae Foundation to spread millions of dollars around to politically-connected organizations like the Congressional Hispanic Caucus Institute. It also hired well-known academics to give an aura of academic rigor to policy positions favorable to Fannie Mae. One paper coauthored by now-Director of the Office of Management and Budget Peter Orszag, concluded that the chance was minimal that the GSEs were not holding sufficient capital to cover their losses in the event of a severe economic shock. The authors suggested that “the risk to the government from a potential default on GSE debt is effectively zero,” and that “the expected cost to the government of providing an explicit government guarantee on $1 trillion in GSE debt is just $2 million.” (p.7 of report)
- Fannie and Freddie led the way into the housing crisis. Fannie Mae and Freddie Mac were leaders in risky mortgage lending. Between the two organizations, they purchased $1.9 trillion of mortgages made to borrowers with credit scores below 660, one of the definitions of “subprime” used by federal banking regulators. This represents over 54% of all such mortgages purchased during those years. (p.24 of report)
Investors Business Daily adds these observations of the report:
- With an implicit subsidy to American homeowners in the form of reduced mortgage rates, Fannie Mae and its sister government sponsored enterprise, Freddie Mac, squeezed out their competition and cornered the secondary mortgage market. They took advantage of a $2.25 billion line of credit from the U.S. Treasury.
- Congress, by statute, allowed them to operate with much lower capital requirements than private-sector competitors. They “used their congressionally-granted advantages to leverage themselves in excess of 70-to-1.”
- The two GSEs (Fannie and Freddie) were the only publicly traded corporations exempt from SEC oversight. All their securities carried an implicit AAA rating regardless of the quality of the mortgages.
- The Department of Housing and Urban Development set quotas for GSE investment in affordable housing.
- Encouraged by an inaccurate 1992 Boston Federal Reserve Bank study charging racial discrimination in mortgage lending, the two GSEs were strongly pressured to “lower their underwriting standards, particularly on the size of down payments and the credit quality of borrowers.”
- In 1992, Congress directed HUD to establish multiple quotas requiring mortgage quotes for low-income families.
- In 1995, the Clinton administration issued a National Homeownership Strategy, loosening Fannie and Freddie’s lending standards and insisting that lenders “work collaboratively to reduce homebuyer downpayment requirements.”
- The administration complained that in 1989 only 7% of mortgages had less than a 10% downpayment. By 1994, it wanted that raised to 29%.
- Reduced underwriting standards spread into the entire U.S. mortgage market to those at all income levels.
- A complete decoupling of home prices from Americans’ income fed the growth of the housing bubble as borrowers made smaller down payments and took on higher debt.
- Wall Street firms specializing “in packaging and investing in the lowest-quality tranches of mortgage-backed securities, profited hugely from the increased volume that government affordable lending policies sparked.”
- Wall Street firms, homebuilders and the GSEs used money, power and influence to block attempts at reform. Between 1998 and 2008, Fannie and Freddie spent over $176 million on lobbyists.
- In 2006, Freddie paid the largest fine in Federal Election Commission history for improperly using corporate resources to hold 85 fundraisers for congressmen, raising a total of $1.7 million.
As the Issa report points out, “the real tragedy of the government’s affordable housing policy is the impact on average Americans, particularly those of modest means.
“Millions of these borrowers, who were supposed to have been helped by federal affordable housing policy, have now been forced into delinquency and foreclosure, destroying their asset base, their credit, and in some cases their families.”
A major problem of all legislatures, is they never think through the consequences of their actions. The housing bubble and the subsequent recession that we are still trying to dig out of, is the result of that failure.