TheAgitator.com
Seemed Like a Good Idea at the Time
Monday, September 29th, 2008Journalist Trey Garrison wades ten years into the New York Times archives and finds warnings of what was to come:
In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.
The action, which will begin as a pilot program involving 24 banks in 15 markets — including the New York metropolitan region — will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.
Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.
In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates — anywhere from three to four percentage points higher than conventional loans.
The moment of sanity:
In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980′s.
”From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. ”If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”
Leave it to the evil free market economist to rain on the “everyone should own a home” parade. Good thing no one listened to him!
DAMN YOU BIG GOVERNMENT! If only sane, rational free market institutions like Lehman Brothers, AIG, Countrywide, Merrill Lynch, were the sole provider of mortgages. I’m sure they would have employed much stricter standards for loaning money.
Great article, Radley. It should give pause to all those who act as if the current situation is all the fault of “greedy bankers” who were pushing loans on people who couldn’t pay them back without acknowledging the role the government had in actively encouraging that bad lending.
Wow…..the next thing you know, Mr. Wallison will suggest this bailout will have long-term negative consequences. How dare he ruin Bush’s plans!!!
This strikes me as pretty sloppy thinking, Radley. Just because the government was involved in subprime lending, does not make government the cause of the crisis. Yet, you and Mr. Garrison leap to that conclusion, presumably because it fits your preconceived notions so well. The truth, as usual, is more complicated.
It’s silly to pretend that Fannie and Freddie somehow invented the notion of lending to borrowers with less-than perfect credit. Subprime lending was an innovation of the private market enabled by securitization. By 1999, the subprime market was already growing rapidly among private lenders outside the confines of the GSEs. And the thing is, it was a good innovation. Lending standards historically were far too tight, and mortgage securitization freed up capital to make loans that approached a more optimal level of risk. Of course, when a bubble formed, we at some point crossed that optimal level.
Even if you think that the government was encouraging banks to make too many bad loans, certainly no one was forcing banks to make leveraged bets on the riskiest tranches of CDOs. Those bets, which are the proximate cause of the crisis, were simply plain old bad investments. It happens.
Look, there’s plenty of blame to go around, and government subsidization of the housing market (mostly through the mortgage interest deduction) certainly worsened the housing bubble, which led to the mortgage-backed security bubble. But to just point at some particular government program (a pilot program!) which started ten years after subprime lending started its ascendancy, and say “Aha!” is simply not a persuasive argument. Every side of the debate needs to try to see around their own cognitive biases (Regulation cased the crisis! Regulation would have prevented the crisis!) and understand that a crisis like this is caused by the interaction of many forces, some private, some governmental, and some systematic.
“financial weapons of mass destruction”
Warren Buffett commenting on derivatives.
Derivatives will do more harm to the world financial markets than terrorists could ever do with bombs and bullets. The billions of dollars will not halt the derivatives market from collapsing. The sooner it happens, the faster we will get back to sound investing and banking. I don’t think we will have another great depression like we had in the 30′s, but we really need to come to grips with the fact that this market correction is going happen no matter what. The 700 Bill might cushion the blow, but the eventual payout for the cushion will be more costly in the long run than if we just don’t do it all and drag out the correction time.
But while we Gen X-ers paying this shit off in the long run, Paulson, Bernanke, and Frank will be dead along with Keynes.
DAMN YOU BIG GOVERNMENT! If only sane, rational free market institutions like Lehman Brothers, AIG, Countrywide, Merrill Lynch, were the sole provider of mortgages. I’m sure they would have employed much stricter standards for loaning money.
~
Even if you think that the government was encouraging banks to make too many bad loans, certainly no one was forcing banks to make leveraged bets on the riskiest tranches of CDOs. Those bets, which are the proximate cause of the crisis, were simply plain old bad investments. It happens.
I’m not sure where in the post I wrote that this was the only cause of the meltdown.
No one is saying corporations didn’t make bad decisions, here. They did. And they, their investors, and their employees ought to be punished for it. That’s the way free markets work. I believe the saying goes, “capitalism without loss is like religion without hell.”
It’s possible to point out that government had a hand in setting off the bad loan chain reaction without saying that without government interference, we’d still be in the real estate boom right now.
But then, if the government now turns around and bails out the companies that should go belly up for making bad decisions, it’s only going to make the next crisis that much worse. And its previous bailouts of bad lenders, airlines, pension funds, and Chrysler only perpetuated the feeling that if you’re a big enough company, you don’t really need to worry about bad risks.
Chrysler is (or at least in the recent past) a pretty healthy company. Just out of curiosity, and for the sake of arguement… did they ever pay back?
O.K. I’m in a little over my head here (o.k. a lot), but I googled Chrysler Bail Out and found this article written in 1983.
http://www.heritage.org/Research/Regulation/bg276.cfm
Might be relevant, might not. If it isn’t, sorry. If it is, does it tell us anything useful?
QDC,
Actually, whether or not the entirely invented the whole concept of subprime lending (which is a strawman, since that’s not the claim), it was the government that pushed the sub-prime market wide open for home mortgage lending. 1999? The Federal Reserve in 1992 released a study claiming that people in certain neighborhoods weren’t being approved for mortgages often enough. Though the study’s methodology was widely criticized, the Fed went ahead and released a manual for lenders downplaying traditional eligibility criteria and including such criterion as whether the applicants had participated in credit counseling programs. In 1995, the Community Reinvestment Act changed its rating system to force banks to lend to ‘underserved’ communities, with Fannie and Freddie leading the charge. The subprime market existed by 1999 largely because the government had been supporting it long before that.
Did private banks participate? Of course they did. The GSEs were buying many of those risky mortgages, lowering the risk for the private lenders. And the GSEs were effectively competing with the private lenders because the government allowed the GSEs much lower capital to back their loans than it required of private lenders (which was also destabilizing) and the GSEs got their money cheaper to start with, as their credit was based on the widely held belief that they would be bailed out if they took on too many bad loans. But there was spillover effect as private lenders took the GSEs’ lead in risky lending, as private firms wanted some of that business, too.
It may not be the whole story to say that the subprime crisis was the fault of the government, but it is an accurate assessment to say that the government was there are the start, encouraged the growth of those loans, and, in the end, is the biggest holder of those loans. The fingers pointing at government involvement in the lending market are pointing in the right direction.
I agree that there shouldn’t be a bailout. They’ve made the mess, they should clean it up. I’m against corporate welfare, so the Government shouldn’t bailout, subsidize or reward bad business practices, so I also agree with you there.
You’re right, you didn’t say it was the only reason, for that I apologize. But I feel that blaming the situation on the easing of credit requirements is like blaming the gun manufactures for bank robbers. Seems like it wasn’t the bad loans (and I really don’t know how many of the loans were to “minorities and low-income consumers”) as much as it was the bad risk assessment and risk taking by the institutions themselves.
“capitalism without loss is like religion without hell.”
Isn’t that Quakerism?
> Warren Buffett commenting on derivatives…..
Warren Buffestt has his ass in a sling.
Trust nothing he says.
so, uh, apropos of nothing, can we extrapolate from the date of the article who might be *at fault* for fannie & freddie taking the actions that pried open the lid to pandora’s sub-prime box? you know, whose actions were the “procuring cause” – as all good realtors like to say – of the current debacle?
hmmm. well, let’s see. 10 september 1999 ….. references to “increasing pressure from the clinton administration to **expand**” blah blah blah “low and moderate income people” blah blah blah (otherwise known as “poor credit risks”).
wow. y’know, if that story had been dated 2008, am pretty sure we’d be seeing lots of agitator posts blaming this on palin. since it was the democrat *CLINTON*, rather than the republican palin, who quite clearly **initiated this disaster**, we’re left to draw our own conclusions. the web is full of youtube clips featuring DEMOCRAT pols defending F&F’s actions, and fighting all attempts to rein them in. but this, too, goes unnoted here. in fact, it’s almost as if clinton and the democrats intentionally caused and defended the DE-REGULATION that enabled the banks to shoot themselves in the ass. but, sadly, this too goes unsaid. assigning blame to non-republican politicians is so bourgeois, huh?
let’s see if this can break the “minus 50″ record.
Lending standards historically were far too tight
Sez who…and why?
mortgage securitization freed up capital to make loans that approached a more optimal level of risk
You mean the optimal level of risk that caused the crash?
Of course, when a bubble formed, we at some point crossed that optimal level.
Yep.
I hope you all understand that when the politicians say they want to help the poor, they really don’t — they’re just saying they do. The actual purpose of all these things that were done to “help the poor” was to:
1. Inflate real estate prices by creating more buyers.
2. Create high-yield, “safe” securities for retirement investment out of sub-prime (i.e., high-interest-rate) loans.
That these two purposes feed off each other in a vicious cycle was probably not considered at the time.
So what do the poor get for all of this (barring a bailout which I oppose)? Nothing. But at least the middle-class has a scapegoat for its anger as the 401ks disappear.
Hmmm … not sure I get your thinking here, Radley.
Doesn’t the “market” include the pool of subprime homebuyers who suddenly had the “freedom” to borrow that didn’t exist before because the government was holding Fannie Mae back? Didn’t the government tell Fannie to go wild and loan away — be “free” in a sense. And didn’t the best and brightest free market investors get such massive hard-ons for this subprime derivative junk that it blinded them to the inevitable collapse of not just their jobs and companies, but the entire institution of subprime lending?
Are we supposed to be impressed here because an “evil” free market egghead economist presaged all this?
This whole thing is a pretty lousy advertisement for the free market.
A communist friend of mine always tries to make sense of his economic world and I just don’t get it. Maybe I just don’t get this either.
Radley,
I take your point, but, in fairness, the post you link to is entitled “Guess What’s Really Behind the Financial Crunch?,” so I, perhaps unfairly, imputed that view to you.
My main point is just that the meme that the “CRA/ACORN/miscellaneous government tinkering caused the crash” that is currently circulating on the right is just as silly as the “if only we hadn’t deregulated” meme on the left.
More importantly, though, (and this is not a response to anything in the post) it would be a shame if everyone was left with the impression that subprime lending was a bad idea from the beginning. It’s rather like blaming the dot-com crash on “investing in stocks;” it wildly overstates the problem. Somewhere between 20% down 30 year FRM with a 0.2% default rate, and 2/28 exploding ARM stated income loans with a 15% default rates, there is an equilibrium which, if given a chance, the market will find. It’s just not clear to me that government tinkering with higher-risk lending was on the wrong side of that equilibrium.
Didn’t the government tell Fannie to go wild and loan away – be “free” in a sense..
No. The government basically told Fannie to abandon reasonable lending practices. Casting aside the principles of sound risk/reward analysis to further a social engineering project is not “free” market enterprise.
Economist (and libertarian) Jeffry Miron said it best.
…to further a social engineering project …
… for the benefit of the real estate and construction industries. Follow the money, and this is where it leads.
Also, there is nothing inherently bad about sub-prime lending as long as the risk/reward analysis revolves around the borrower’s ability to pay (more risk, higher interest rate). This is really nothing new. What is new is that the analysis was shifted to favor the value of the underlying asset under the misguided belief that home prices would only go up and at an unreasonable clip. It’s no accident that the results of the aforementioned social engineering project fed into this misguided belief.
Wow … negative rep for not being a true believer. I’ll stop posting.
“QDC” — “Lending standards historically were far too tight,…
{cackle} Ladies and gentlemen, we have an “authority” with all the boldness necessary to letting you know what he would have done with other peoples’ money.
And…
“…and mortgage securitization freed up capital to make loans that approached a more optimal level of risk.”
…we really hope you’re enjoying the “more optimized level”.
All swim! Everyone in the pool!
Ps. — did everyone see this 1999 article at The City Journal?