Free Markets, Free People
Despite the attempt by government and particularly Democrats, to blame the financial meltdown we’ve endured on banks and unscrupulous investment companies, the buck stops with them according to a new study just released:
Democrats and the media insist the Community Reinvestment Act, the anti-redlining law beefed up by President Clinton, had nothing to do with the subprime mortgage crisis and recession.
But a new study by the respected National Bureau of Economic Research finds, “Yes, it did. We find that adherence to that act led to riskier lending by banks.”
Added NBER: “There is a clear pattern of increased defaults for loans made by these banks in quarters around the (CRA) exam. Moreover, the effects are larger for loans made within CRA tracts,” or predominantly low-income and minority areas.
As we’ve mentioned previously any number of times, government policies can set and enforce preverse incentives. And that has nothing to do with a free market. That’s at best a mixed market. So no, the problem wasn’t a “market failure”, it was the usual result of government intruding and setting preverse incentives that are contrary to good business practices and would likely not survive or succeed in an actual free market.
Here’d the bottom line:
The strongest link between CRA lending and defaults took place in the runup to the crisis — 2004 to 2006 — when banks rapidly sold CRA mortgages for securitization by Fannie Mae and Freddie Mac and Wall Street.
CRA regulations are at the core of Fannie’s and Freddie’s so-called affordable housing mission. In the early 1990s, a Democrat Congress gave HUD the authority to set and enforce (through fines) CRA-grade loan quotas at Fannie and Freddie.
It passed a law requiring the government-backed agencies to “assist insured depository institutions to meet their obligations under the (CRA).” The goal was to help banks meet lending quotas by buying their CRA loans.
But they had to loosen underwriting standards to do it. And that’s what they did.
Not only that, they guaranteed the bad loans with your money. Why do you think so much money has had to be pumped into those two institutions?
You see the market had determined that certain standards protected their investments. The government decided to ignore reality and push a social agenda using “race” as the basis for throwing out those standards and using their coercive power to implement the social agenda they preferred.
The result was predictable.
And the coverup as well.
Two of the the institutions most responsible for the housing crisis, despite Barney Frank’s claims to the contrary, are still in crisis themselves (a third is the very institution Frank called home – Congress).
Fannie Mae said Wednesday it lost $2.4 billion during the fourth quarter of 2011 and $16.9 billion for the full year.
It has had worse years, remarkably. Fannie lost about $60 billion in 2008 and $72 billion the following year–two of the 10 largest corporate losses ever. Sibling Freddie Mac is responsible for a third, a $51 billion loss in 2008.
These two institutions, both set up by and working at the behest of the federal government, have a very checkered history.
For those who have always wondered what “Fannie Mae” stands for, it is the Federal National Mortgage Association, begun in 1938 during the Great Depression as a part of New Deal. So those who argue that it is a “private corporation” are simply uninformed.
Both organizations have a single purpose: “to expand the secondary mortgage market by securitizing mortgages in the form of mortgage-backed securities (MBS), allowing lenders to reinvest their assets into more lending and in effect increasing the number of lenders in the mortgage market by reducing the reliance on thrifts.”
As it turns out, they got way out on a limb with their purpose, driven by government policy and crony capitalism.
What set off the debacle through which we suffered? Here’s the short story:
In 1992, President George H.W. Bush signed the Housing and Community Development Act of 1992. The Act amended the charter of Fannie Mae and Freddie Mac to reflect Congress’ view that the GSEs "… have an affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families in a manner consistent with their overall public purposes, while maintaining a strong financial condition and a reasonable economic return;" For the first time, the GSEs were required to meet "affordable housing goals" set annually by the Department of Housing and Urban Development (HUD) and approved by Congress. The initial annual goal for low-income and moderate-income mortgage purchases for each GSE was 30% of the total number of dwelling units financed by mortgage purchases and increased to 55% by 2007.
In 1999, Fannie Mae came under pressure from the Clinton administration to expand mortgage loans to low and moderate income borrowers by increasing the ratios of their loan portfolios in distressed inner city areas designated in the CRA of 1977. Additionally, institutions in the primary mortgage market pressed Fannie Mae to ease credit requirements on the mortgages it was willing to purchase, enabling them to make loans to subprime borrowers at interest rates higher than conventional loans.
George H.W. Bush began the slide and Bill Clinton lit the afterburners. And while the industry attempted to take advantage of the situation it also needed an easing of credit requirements to meet the policy goals of the CRA. And anyway, the Federal government was guaranteeing this mess. Crony capitalism at its finest.
The warning signs about the eventual end were everywhere. And any number of people issued those warnings:
In 1999, The New York Times reported that with the corporation’s move towards the subprime market "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 1980s."
Also in the New York Times, Alex Berenson reported in 2003 that Fannie Mae’s risk was much larger than is commonly held.
The eventual end to such nonsense was almost precisely foretold:
In his 2006 book, America’s Financial Apocalypse, Mike Stathis also warned about the risk of Fannie Mae helping to trigger the financial crisis: “With close to $2 trillion in debt between Freddie Mac and Fannie Mae alone, as well as several trillion held by commercial banks, failure of just one GSE or related entity could create a huge disaster that would easily eclipse the Savings & Loan Crisis of the late 1980s. This would certainly devastate the stock, bond and real estate markets. Most likely, there would also be an even bigger mess in the derivatives market, leading to a global sell-off in the capital markets. Not only would investors get crushed, but taxpayers would have to bail them out since the GSEs are backed by the government. Everyone would feel the effects. At its bottom, I would estimate a 30 to 35 percent correction for the average home. And in ‘hot spots’ such as Las Vegas, selected areas of Northern and Southern California and Florida, home prices could plummet by 55 to 60 percent from peak values.”
And here we are.
The cost to you for this the mess created and driven by government policy and taken advantage of by lenders? A lot.
Both Freddie and Fannie are supposedly “for profit” corporations. Profits, however, have been in short supply (but bonuses to top cronies haven’t):
During the three years leading up to the house price peak, Fannie reported annual profits of between $4.1 billion and $6.3 billion, and Freddie, $2.1 billion to $2.9 billion. During the five years since, Fannie lost a cumulative $163 billion, and Freddie, which hasn’t yet reported fourth quarter results for 2011, $91 billion.
Both Fannie and Freddie pay dividends to the Treasury Department as a condition of their government sponsorship, but both have regularly requested larger sums than they have paid. For example, Fannie said Wednesday that it paid $2.6 billion in dividends to the Treasury during its fourth quarter, but that it would soon submit a request for $4.6 billion to offset losses.
Fannie says it requested a total of $116 billion from the Treasury since the fourth quarter of 2008 and paid about $20 billion in dividends. Fannie requested $72 billion and paid $15 billion.
Or, as the article breaks it out in the nation of 309 million, the cost is $1,300 for each American household – owner or renter.
This is what happens when government’s decide they know better than markets. When they let unsound political policies that create perverse financial incentives rule the day. When they put financial prudence behind political gain.
Hopefully we’ll learn something out of this. But we won’t if each side continues to deny its role in this mess. It was government who set the perverse policy and industry to took advantage of it. However, what should be clear to anyone is that if there had been no policy, there’d have been nothing of which to take advantage.
As usual, the tax payers is left holding the multi-trillion dollar bag for this monumental screw-up.
There are many, myself included, who believe the ’70s era Community Reinvestment Act was one of the key reasons for the financial meltdown we experienced since it required lending institutions to lend to unqualified borrowers.
Byron York reports that some Democrats in Congress refuse to acknowledge that and are now pushing to expand both the scope and power of the CRA:
This morning House Financial Services Committee chairman Rep. Barney Frank held a hearing on H.R. 1479, the “Community Reinvestment Modernization Act of 2009.” The bill’s purpose is “to close the wealth gap in the United States” by increasing “home ownership and small business ownership for low- and moderate-income borrowers and persons of color.” It would extend CRA’s strict lending requirements to non-bank institutions like credit unions, insurance companies, and mortgage lenders. It would also make CRA more explicitly race-based by requiring CRA standards to be applied to minorities, regardless of income, going beyond earlier requirements that applied solely to low- and moderate-income areas.
Barney Frank has never acknowledged the role of government in the collapse of the housing market. He’s refused to acknowledge the role of the CRA or Freddie Mac and Fanny Mae. And, apparently determined to act on his ignorance is now in the middle of trying to revive the program that was at least partly responsible for our financial woes. This makes absolutely no sense.
Republicans on the committee strongly oppose the plan. “Instead of looking to expand the number of institutions that must abide by Community Investment Act regulations,” California Rep. Ed Royce said in prepared opening remarks at today’s hearing, “I think we should reassess the role this and other government mandates played in the financial collapse and consider scaling it back.”
In private conversation, other Republicans were more emphatic. “There is clearly arguable evidence that the CRA is at the root of this financial meltdown,” says one GOP committee member. “So what do they do? They try to expand CRA.”
Republicans also made sure that the CRA’s connection to ACORN was made clear:
Republican critics point out that the Association of Community Organizations for Reform Now has used the CRA to pressure banks to pour money into ACORN and its affiliates, allowing ACORN to facilitate loans to clearly unqualified borrowers. Now, with ACORN under fire after a series of undercover videos showing ACORN workers in Baltimore, Washington DC, New York, and California openly encouraging prostitution, tax evasion, and other crimes, Republicans on the committee are citing the CRA-ACORN connection as yet another reason the Act should not be expanded.
ACORN is presently preparing to investigate itself. A clean bill of health is expected within a few weeks. In the meantime, the bill has 51 cosponsors among the most liberal members of Congress. As York points out, if Democrats in the House want to pass this they can. One wonders if the liberal caucus would be willing to trade the “public option” for passage of this expansion of the CRA and a promise treat ACORN kindly when the time comes. Of course, it would have to be approved by the Senate as well, and that’s a much more dicey prospect.
The point, of course, is this is sheer madness on the part of the Democrats in the House. The definition of insanity is doing the same thing over and over again and expecting different results. It appears that’s precisely what the liberal members of Congress are bound and determined to do.