Government meddling in the free markets is usually where all trouble starts. The Federal Housing Administration, created in 1934, were given power to insure mortgages up to 100%. It required a 20% down payment and operated just fine for 25 years with hardly any bankruptcies because borrowers had skin in the game. In 1957 the good old boys in Congress slacked up the standards to jump start the growth in housing. Down payments were deflated down to 3% from 1957 to 1961.
Housing Boom Resulted
As prophesied this resulted in a FHA boom in insured mortgages and a bubble burst in the later 60’s. This pattern keeps reoccurring and no one seems to remember the earlier mistakes. Keeping the Feds out of the game of housing would be a good start. The Feds loosen up mortgage standards, a bubble occurs, and then there’s a crash. The government deflects its involvement by using discretionary lying, obfuscation, and new sets of laws for the banking industry like it was their fault. Other than the taxpayers, who eventually wind up paying for these debacles, most of the people squeezed are those who bought in the bubble years. Then, after it was too late, when the bubble popped, they came to discover they could not afford their homes anymore.
Financial Crisis of 2008
This happened again leading up to the financial crisis of 2008. This time the federal government’s policies were so pervasive and pursued with such enthusiasm by two different administrations that they caused a collapse that was heard worldwide. The mindless wonders in Congress planted the seeds of the fiasco to come in 1992 with the enactment of what was called “affordable housing” goals for Fannie Mae and Freddie Mac. These two entities, before 1992, dominated the housing financial market, especially after the Federal Savings and Loan industry collapsed in the late 1980’s, engineered again by the geniuses in charge who of course deflected all blame away from them.
Fannie and Freddie’s Role
Their role was to conduct secondary market operations creating a liquid market in operations. They could not make loans but could buy mortgages from banks and other lenders. Their purchase provided cash for lenders thus encouraging home ownership by making more funds available for more mortgages. Fannie and Freddie being shareholder owned were chartered by Congress and granted numerous government benefits. These particular privileges gave the impression they were government backed and would be rescued if they ever went belly up. This of course, as we will learn later, was the wrong assumption.
$2.25 Billion Line of Credit
With $2.25 billion line of credit at the Treasury it was easy to see how market participants believed Fannie & Freddie were government backed. With borrowing rates only a little higher than the Treasury itself Fannie & Freddie were able to drive all competition out of the secondary market for middle class mortgages. They controlled 70% of the $11 trillion housing finance market. From this dominant position they were able to set the underwriting standards for the market as a whole. Very few mortgage lenders would make middle class mortgages that could to be sold to Fannie & Freddie.
What kept delinquencies and defaults low was the required 10% to 20% down payment, good credit history for borrowers, and low debt to income ratios after the mortgage was closed. These were the foundational elements of what was called a prime loan that kept a stable mortgage market through the 1970’s and most of the 80’s under a default of less than 1%. Despite these strict standards home ownership from 1964 through 1994 remained at 64%.
Government Backing Was Their Undoing
Community activists put pressure on the Feds arguing Fannie & Freddie underwriting standards kept many low and moderate income families from buying homes. The initial quota was 30% and HUD was given authority to increase the quota as Congress cleared the way for more ambitious requirements reducing down payments below 5%. HUD raised the targeted quota to 42% in 1996, 50% in 2000, and 56% in 2008. By 2000 Fannie & Freddie were accepting loans with zero money down and lowering the credit standards so more would sign up in order to meet the quota.
The Result – Flash Forward to 2008
As a result of the gradual deterioration in loan quality over the preceding 16 years, by 2008, just before the housing bubble pop, 56% of all mortgages in the United States – 32 million loans – were subprime loans or otherwise what is called low quality loans. Of the 32 million 76% were on the books of government agencies that were controlled by government policies. This shows absolute proof where the demand for these mortgages originated!
Home Spun Disaster
Legislators, by playing nice with community activists because that is where their bread and butter voters come from, created this home spun disaster when the economy went south in 2007. Low end earners were the first to be laid off and a large percentage just walked away from the mortgage payments leaving it to the bankers to foreclose. When the bubble deflated, these mortgages failed in unprecedented numbers, driving down housing values and values of mortgage backed securities on the balance sheets of financial institutions.
Given these facts, further rules & regs of the financial system through the Dodd – Frank Act was actually a totally wrong headed response. The vast new regulatory restrictions in the act have created uncertainty and sapped the appetite for risk taking that had once made the U.S. financial system the largest and most successful in the world. The smothering rules & regs of the Dodd – Frank Act is depressing economic growth and lending no support for the housing industry, thus a stagnant market creating a drag on the GDP. A return to sanity with credible loan standards would help buckle down the housing market and perhaps return it to solvency.
The answer is a thorough reorientation of the U.S. housing finance system away from the kind of federal government control that makes it hostage to narrow political imperatives like political activists. By cow towing to these political interests it holds the whole GDP hostage to selfish interests. When the Congress is always worried about re-election and further feathering their nest it is time to look at term limits as an answer to this good old boy system. By taking it out of the hands of Congress and letting the voters decide on term limits is the way to go if we want true representation. If it is good enough for the President it is good enough for the Congress.