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Prescient Economist: Housing Crash Result of Government Incentives
February 11, 2009 9:37 PM   Subscribe

Peter Wallison, an economist who arguably predicted the housing crash and bailout in 1999 explains his current views on the crash: "Other players...played a part" but "...government policy over many years--particularly the use of the Community Reinvestment Act and Fannie Mae and Freddie Mac to distort the housing credit system-- underlies the current crisis."
posted by shivohum (98 comments total) 6 users marked this as a favorite

 
A dwelling-house, as such, contributes nothing to the revenue of its inhabitant ; and though it is, no doubt, extremely useful to him, it is as his clothes and household furniture are useful to him, which, however, make a part of his expense, and not of his revenue. If it is to be let to a tenant for rent, as the house itself can produce nothing, the tenant must always pay the rent out of some other revenue, which he derives, either from labour, or stock, or land. Though a house, therefore, may yield a revenue to its proprietor, and thereby serve in the function of a capital to him, it cannot yield any to the public, nor serve in the function of a capital to it, and the revenue of the whole body of the people can never be in the smallest degree increased by it.

Adam Smith, Wealth of Nations
posted by amuseDetachment at 9:42 PM on February 11, 2009 [2 favorites]


Jews did WTC, Negroes did Second Great Depression. At least the proponents of the first idea will admit they're trolling.
posted by TheOnlyCoolTim at 9:45 PM on February 11, 2009 [4 favorites]


But hey, we got that $15,000 tax credit for buying a house in the stimulus bill, so that should fix all our problems!

Also, I don't know if we we really had a housing bubble back in '99.
posted by delmoi at 9:47 PM on February 11, 2009


Christ, not this nonsense again.
posted by octothorpe at 9:49 PM on February 11, 2009 [5 favorites]


Oh yay, the right wing think tank AEI is peddling more of the same bullshit the republicans have been peddling for a while, that the whole thing was caused by Carter, and especially Bill Clinton forcing banks to lend to black people, who (it goes without saying) are of course innately uncreditworthy.
posted by delmoi at 9:49 PM on February 11, 2009 [1 favorite]


delmoi:
This picture of the Case-Shiller Index shows it started going up, but it wasn't crazy then (but perhaps the beginning of a parabolic move). And yes, that means we're nowhere near done dropping in real value.
posted by amuseDetachment at 9:53 PM on February 11, 2009 [1 favorite]


Peter Wallison, an economist who arguably predicted the housing crash and bailout in 1999

Missed that dot-com bust in 2001, though, didn't he.
posted by Blazecock Pileon at 9:53 PM on February 11, 2009 [6 favorites]


That's some great foaming at the mouth from some of you. Anyone interested in actual dialogue?

Wallison says that the federal government deliberately instructed banks to relax lending standards in subprime markets. In addition, he says that Fannie and Freddie's cheap credit (based on implicit government backing) coupled with their charter to provide low income housing necessitated that they issue and purchase a lot of subprime loans (they purchased $1 trillion from 2005-2007). These two factors, he claims, were the prime movers in the massively increased issuance of subprime loans and the reduction of lending standards for prime loans, and presumably were the foundation upon which all the other complicating factors (including derivatives) built.

What is wrong with his argument?
posted by shivohum at 10:16 PM on February 11, 2009 [2 favorites]


"The Community Reinvestment Act applies to depository banks. But many of the institutions that spurred the massive growth of the subprime market weren't regulated banks. They were outfits such as Argent and American Home Mortgage, which were generally not regulated by the Federal Reserve or other entities that monitored compliance with CRA. These institutions worked hand in glove with Bear Stearns and Lehman Brothers, entities to which the CRA likewise didn't apply. There's much more. As Barry Ritholtz notes in this fine rant, the CRA didn't force mortgage companies to offer loans for no money down, or to throw underwriting standards out the window, or to encourage mortgage brokers to aggressively seek out new markets. Nor did the CRA force the credit-rating agencies to slap high-grade ratings on packages of subprime debt."

Subprime Suspects

The right blames the credit crisis on poor minority homeowners. This is not merely offensive, but entirely wrong.

By Daniel Gross
posted by jfrancis at 10:27 PM on February 11, 2009 [13 favorites]


> Peter Wallison, an economist who arguably predicted the housing crash and bailout in 1999
The housing bubble was easy to spot. 1999 may have been early I give him this.

> policy over many years--particularly the use of the Community Reinvestment Act and Fannie > Mae and Freddie Mac to distort the housing credit system-- underlies the current crisis."

Wrong. He mistakes effects for the cause. The current problems are caused not by capitalism but by the government screwing with the money supply and interests rates.

@ shivohum
"Wallison says that the federal government deliberately instructed banks to relax lending standards in subprime markets."
In my view on money (money IS credit aka "debitism") you need to contiguously create new money (new credits!) to pay off the credit and interest that is due off. Nobody takes credit anymore and the whole system collapses.

In a graph this expanding money (and credit) looks like this:
http://mdb.reiseberichte-reisefotos.de/media/20090123/28466_555_0.jpg

Hence the subprime lending has not caused the problem but might actually have delayed the collapse. Now the lender of last resort, the government tries to keep things afloat. How much debt without hyperinflation can the US bear? 10 trillion? 20? 50? I am afraid that we may find this out sooner than we would like to know.
posted by yoyo_nyc at 10:33 PM on February 11, 2009


Try this article from Business Week entitled "Community Reinvestment Act Had Nothing To Do With Subprime Crises" or this article from The Boston Globe "Subprime Scapegoats". Look at the default rate on these CRA loans vs loans given by lenders at general and you can clearly see that the Community Reinvestment loans have an extremely low default rate at large, most likely because they were actually vetted by competent regulators.

As far as Fannie and Freddie, perhaps you would trust the Wall Street Journal, when it told us that Wall Street was the blame for Fannie and Freddie's Downfall, and not the other way around. What you have posted above is the pad-for opinion of a conservative think tank. If you must do so in the future, at least try to present the other side as well.
posted by sophist at 10:38 PM on February 11, 2009 [7 favorites]


"What is wrong with his argument?"

Sure monority groups were given more credit than usual, but then again so was everyone else, but they sure as hell weren't given enough to wipe out $2 trillion and counting from the economy. And they certainly weren't the ones flipping condos in Miami/San Diego/Las Vegas/Phoenix.
posted by PenDevil at 10:41 PM on February 11, 2009 [1 favorite]


Many of the biggest flameouts in real estate have had nothing to do with subprime lending. WCI Communities, builder of highly amenitized condos in Florida (no subprime purchasers welcome there), filed for bankruptcy in August. Very few of the tens of thousands of now-surplus condominiums in Miami were conceived to be marketed to subprime borrowers, or minorities—unless you count rich Venezuelans and Colombians as minorities. The multiyear plague that has been documented in brilliant detail at IrvineHousingBlog is playing out in one of the least-subprime housing markets in the nation.

http://www.slate.com/id/2201641/pagenum/2
posted by jfrancis at 10:43 PM on February 11, 2009 [1 favorite]


Lending money to poor people and minorities isn't inherently risky. There's plenty of evidence that in fact it's not that risky at all. That's what we've learned from several decades of microlending programs, at home and abroad, with their very high repayment rates. And as the New York Times recently reported, Nehemiah Homes, a long-running initiative to build homes and sell them to the working poor in subprime areas of New York's outer boroughs, has a repayment rate that lenders in Greenwich, Conn., would envy. In 27 years, there have been fewer than 10 defaults on the project's 3,900 homes. That's a rate of 0.25 percent.

On the other hand, lending money recklessly to obscenely rich white guys, such as Richard Fuld of Lehman Bros. or Jimmy Cayne of Bear Stearns, can be really risky. In fact, it's even more risky, since they have a lot more borrowing capacity.

http://www.slate.com/id/2201641/pagenum/2
posted by jfrancis at 10:44 PM on February 11, 2009 [4 favorites]


Also, I don't see anything in the first article where he predicted a crash, certainly not 9 years out. He clearly identified the problem early on, but there were plenty of others who did the same. Business and real estate publications have been talking about the subprime situation for years, what few people predicated was the extent to which its collapse would effect the economy.
posted by sophist at 10:44 PM on February 11, 2009


That's some great foaming at the mouth from some of you. Anyone interested in actual dialogue?

The interesting thing about the market crash is that it's brought out every crack-pot cockamamie nutbar theory. This is one of those, but in particular this one has a nice racist patina.

There are a couple of reasons why this is false. #1) CRA loans actually have better repayment rates then non CRA mortgages, and #2) "Subprime" actually means a mortgage not good enough for Freddy and Fannie. Those two agencies were not involved in making "subprime" loans by definition. The subprime mortgages were just a symptom of the overall mortgage/home value bubble anyway.

The reasons those loans got made was because, at the time, they were valueable. Mortgage brokers would try to flip them immediately. Wallstreet was desperate for these loans, no one forced them to weaken lending standards, they did it voluntarily, and in fact went to great lengths to cover up what they were even doing from the government.
posted by delmoi at 10:51 PM on February 11, 2009 [1 favorite]


delmoi, read the article. Stop assuming that a) you're smarter than the author, and b) that he's a racist crank.
The point here is not that low-income borrowers received mortgage loans that they could not afford. That is probably true to some extent but cannot account for the large number of sub-prime and Alt-A loans that currently pollute the banking system. It was the spreading of these looser standards to the prime loan market that vastly increased the availability of credit for mortgages, the speculation in housing, and ultimately the bubble in housing prices.
He is not claiming that brown people who stopped paying caused the problem.
By 2007, Fannie and Freddie were required to show that 55 percent of their mortgage purchases were LMI loans and, within that goal, 38 percent of all purchases were to come from underserved areas (usually inner cities) and 25 percent were to be loans to low-income and very-low-income borrowers. Meeting these goals almost certainly required Fannie and Freddie to purchase loans with low down payments and other deficiencies that would mark them as sub-prime or Alt-A.
He's saying that the very definition of "sub-prime" moved during the GSE expansion.
posted by FuManchu at 11:12 PM on February 11, 2009 [1 favorite]


Thank you for reading the article, FuManchu! Those were two of the points I was going to make before I previewed. To add to what you've pointed out:

1. As I read it, Wallison's argument re: the CRA's early-90s relaxation of lending standards is that it influenced regulators to approve riskier loans in other markets that in earlier days they would have disallowed, and riskier loans even for institutions that did not fall under the CRA.

Of course, banks wanted to make those risky loans once they were so permitted. But that's not surprising, since the assumption for heavily-regulated institutions like banks might justifiably be that what the regulators permit is not going to be mortally dangerous. But since we give regulators the ultimate responsibility of governing lending standards for banks, this was a failure of some regulations through the loosening of others (not a particularly conservative point, actually!).

---

* Wallison also claims that Fannie and Freddie's purchases of subprime loans for their portfolio (this must have been the AAA-rated tranche stuff) crowded out private lenders who didn't have access to the GSE's cheap credit and therefore both increased the value of subprime loans (encouraging originations) and encouraged private lenders to lower their standards even further to keep market share. This exacerbated the Fannie/Freddie issuance of subprime and Alt-A loans that occurred as a result of shifting standards (again, per FuManchu's quote).

What seems compelling to me is that Fannie and Freddie's share of the market at its low in 2006 seems to have DROPPED to 40-some percent of the new mortgages--they've obviously always been gigantic players. Therefore if they relaxed their lending standards on such a large percentage of the market and also purchased $1.6 trillion in subprime bonds, doesn't it seem plausible that there might have been the crowding-out and risk premium effects that Wallison suggests?
posted by shivohum at 11:32 PM on February 11, 2009


Sorry for the strange numbering and bulleting.
posted by shivohum at 11:34 PM on February 11, 2009


From what I know, this article is entirely true, but he's pointing at the wrong thing. These regulatory changes were the match that sparked the tinder, but the tinder itself was supplied in great abundance by the Fed. The interest rates Greenspan chose, particularly post-2000's stock market crash, were far too low. To avoid the fallout from their earlier bubble, they set off two more, debt and real estate.

The financial games that resulted from the low lending standards would not have worked to anywhere near the same degree without the Fed stoking the fire. Without them pouring fuel on the blaze, it would have gone out years before. This article is about mechanics, but the mechanics that arose late in the property bubble wouldn't work without the illusion of infinite liquidity, which the Fed was willing to go to any length to provide. Subprime lending was the method by which the last of that liquidity found its way into the marketplace, but the Fed's stubborn refusal to recognize the bubbles and stop them is what has made the crisis so terrible.

The aftermath of generational bubbles is horrific, and the only good solution is to not have them in the first place. As I've said before, if Alan Greenspan had personally visited your house, piled half of everything you own on the lawn, and set it on fire, he would have done less damage to you than he did at the Fed.

Oh, and delmoi: the property bubble was well underway in many places by 1998. Ultimately, prices will fall back to somewhere below those relative values, either by house prices going down, or, if we continue our massive bailout attempts, by everything else going up.
posted by Malor at 11:40 PM on February 11, 2009 [4 favorites]


Though a house, therefore, may yield a revenue to its proprietor, and thereby serve in the function of a capital to him, it cannot yield any to the public, nor serve in the function of a capital to it, and the revenue of the whole body of the people can never be in the smallest degree increased by it.

Adam Smith apparently never owned a house, or at least never maintained one.
posted by George_Spiggott at 11:51 PM on February 11, 2009


delmoi, read the article. Stop assuming that a) you're smarter than the author, and b) that he's a racist crank.

Huh? Why would I do that? This is the American Enterprise Institute we're talking about. The article presents an argument that's already been widely debunked.

Oh, and delmoi: the property bubble was well underway in many places by 1998.

There are always going to be real estate bubbles popping up somewhere. It's certainly true that Greenspan caused a lot of these problems, particularly promoting non-fixed rate mortgages, and I'm think he was against regulating the Credit Default swaps as well.
posted by delmoi at 12:09 AM on February 12, 2009 [1 favorite]


George Spiggott: My interpretation of that, is that housing can be construed as consumption, housing projects for the sake of housing projects doesn't serve any public good as a priori. (Ignoring issues like how public housing and other safety nets encourage greater levels of risk-taking, hopefully the good kind, instead of being overly conservative.)

Ideally, one would want to expend resources which increase efficiency, etc. Housing tracts in Miami and Sacramento don't do anything beneficial to the greater economy — it's no different than paying someone $500,000 to big a really deep hole. We've spent the past ten-odd years building houses that no one wants to live in, are too big, and too far from the cities. It'd be one thing to build urban communities with public infrastructure to reduce consumption, as urban life consumes a lot less energy, but we've got a bunch of McMansions that don't address energy and the industrialization of billions these coming decades.

Saying any and all housing is good is what Adam Smith was arguing against.
posted by amuseDetachment at 12:18 AM on February 12, 2009


In 1999, this so-called economist that shivohum is giving so much credit to was campaigning against the Democratic President's efforts to make the housing market fairer by claiming it would cause a housing crash, in lockstep with Republican talking points. After eight years of a Republican President's stewardship of the economy, lookie there, it's a crash! It must have been caused by what he was complaining about all along! Certainly the greedheads who broke the banking system used and abused the CRA to their own advantage (along everything else the Fed and Bush let them get away with - which was EVERYTHING), but CRA loans have had NO HIGHER a default rate than housing loans in general. Which is pretty impressive since they were expected to be higher in risk by even their strongest supporters.

Sorry, shivohummer, but to quote one of MetaFilter's more illustrious members: MYTH BUSTED!!!
posted by wendell at 12:25 AM on February 12, 2009 [1 favorite]


shivohum, you're dredging up Ben Stein-level thinking by going to his compatriots at the infamous AEI, a bullshit-creation entity and central member of the (somewhat less) VRWC. Much like our friends on the right love the bullshit surrounding creationism, they also love the fable that gummint or GSEs caused or were a causal agent of the bubble.

But the root problem wasn't too much government, but too little.

By 2005 I had become aware that banks were packaging their loans into derivatives and selling them off to reload their capital for further lending. This innovation had begun to power the mother of all feedback loops as long as consumer-facing lenders could put together loans that didn't default in the first 6 months they could skim immense amounts of money from the trade of hooking up investors with borrowers.

In a tulip-like speculative housing market were prices were rising 20-30% per year, lenders began to increasingly artificially inflate their borrowers buying power by lowering down-payment requirements, looking the other way with "stated income" (AKA liar) loans, raising debt-to-income limits, not verifying primary residence status, qualifying borrowers on the lower-rate teaser period not the back-end taser rates, and finally increasing the availability of IO offerings, essentially turning what were buyers under the previous regime into just renters and/or speculators.

The poster child of this mess is rightfully Casey Serin, not a minority buyer in eg. E Oakland or N Long Beach. Casey took out $2.1M in loans in one go; in 2005-2006 over a quarter of home purchases in California were going to speculators and flippers.

Additionally, behind the scenes, the "saving glut" and "world awash in liquidity" was fueling the fire (graph of M3, Balance of Merchandise Trade graphs courtesy the St Louis Fed) give some picture of the force of monetary policy driving this lending looking for yield.
posted by troy at 1:18 AM on February 12, 2009 [1 favorite]


I find it fascinating that poorer people are better mortgage risks than rich white dudes. You know, like that Donald Trump* guy whose company files for bankruptcy at the end of every cycle.

Did I say fascinating? I meant infuriating.

*He has stated that to be successful and rich like him requires certain genes. Yet he had a get rich book/seminar/scam going on for years supposedly teaching the technicals of his empire building. No word if any DNA testing was required before they ran your credit card. Also, in his case, genetics did matter--Donald's genes were handed down from his father who himself was a rich real estate investor. I imagine his seminars covered building a time machine to teach your father these sekrit real estate techniques.
posted by Tacodog at 1:18 AM on February 12, 2009


Man, what a waste of a thread.

Guys, you are arguing against strawmen. The article didn't claim that CRA was the source of the toxic assets. The article can best be summed up by: "Gov't incentives distort market." A discussion of this would have been interesting in light of the recent $15k housing credit.

A good analogy would the the California energy crisis. Traders or arbitrageurs looked at the proposed half-deregulation as a free lunch, Enron execs even bragged about how they could exploit it before it was enacted. One could say that the gov't ignighted a horrible boondoggle, while another argues it was the traders taking unfair advantage. A discussion like that would be pretty cool here. But apparently the MeFi line is that effects of gov't regulations are not to be faulted or reconsidered. And also to call anyone who does a crack-pot.

I really need to learn to ignore MeFi economics threads.
posted by FuManchu at 1:25 AM on February 12, 2009 [1 favorite]


Guys, you are arguing against strawmen. The article didn't claim that CRA was the source of the toxic assets. The article can best be summed up by: "Gov't incentives distort market."

If Fannie Mae and Freddie Mac were distorting the housing market by lowering their lending standards, then their share of the mortgage market should have went up. In fact the opposite happened, so his whole argument pretty much falls apart. Fannie Mae and Freddie Mac were bit players in the whole subprime mess and a lot of politicians have dirty fingers from dealing with them, but they were far from the prime movers.

The blame lies with the major financial corporations, who discovered they could use CDOs to fraudulently package a bad loan as a good one and make a shit load of money, who then went on to buy up a bunch of shady subprime lenders and encouraged them to make loans by any means neccessary, and then to top things off used CDSs to leverage all hell out of the fraudulent loans they just made.
posted by afu at 1:45 AM on February 12, 2009 [2 favorites]


Wallison is an interesting guy, but I'm not really sure that he "predicted" the current crisis. After all, in the link he's quoted as saying "''If they fail, the government will have to step up and bail them out ..", not when they fail, but if.

And this is a drum he's been beating for almost three decades.

In the early 1980s, he was a top official in the Reagan Treasury Department. And Fannie Mae, at least by some measures, was insolvent, thanks to the economic storms that were then roaring through the savings-and-loan industry.


If you keep predicting doomsday, you're going to be right eventually. But to be fair to the guy, he's been against subsidised government lending of any sort for a long time.

Curious he would pop up as a "I told you so". I've seen Wallison's name many times as he is well known (at least in the banking circles I move in) as someone who is actually a proponent of decreased financial deregulation, and in fact has been working to this end for pretty much his entire career.


FuManchu -- "I really need to learn to ignore MeFi economics threads."

Ha! Obama himself couldn't have said it better.

"You've got some economists and some folks who think they're economists. By the way, these days everybody thinks they're economists".

I've been in this biz since the 80's, and have seem this cycle many, many times. When the economy is roaring ahead nobody wants to know nothing about economics. I go to a party and all folks want to talk about is the equity markets, how to make money, etc. Yeh, that's ok, that's what I do, so I honestly don't mind talking about the markets (fortunate enough to be married to a banker as well so I guess our pillow talk isn't for everyone)

But when things hit the skids not only does everyone want to talk about economics but they've all got the answers.

Me? I just wanna talk about the markets. Lots of money to be made in times like this, when fear is dominating valuation and volatility is high.

I presented to a UK Local Council Monday night on some aspects of the Housing Crisis, and in spite of the prep our the PR people did beforehand, most of the questions I got pitched afterwards were all macro, stuff absolutely nobody has a reasonable handle on. Still didn't stop all these Councilors from asking where the UK Housing Market would be in a decade.

I just wanna buy some cheap stocks, so don't ask me.

As I've said many times on MeFi, I'm not an economist. I'm an econometrician by education and profession. I took enough economics at Business School (three semesters, two more than the program required) to know better than to try to work in that field and, to be honest, I find trading much more immediately gratifying.

So there you go. But it works for some so who am I to judge?
posted by Mutant at 1:51 AM on February 12, 2009 [2 favorites]


the best response [1,2] i've heard was basically: 'well then how do you explain phoenix, san diego and miami?' (or like other housing bubbles around the world) and like now jumbo prime is coming due -- you can't blame it all on the CRA and GSEs... and, like malor, i think you have to go higher -- to absent regulators, deluded central bankers and, like felix salmon pointed out the other day, mortgage tax deductions (and housing and credit subsidies in general) or like how lewis pins it on salomon bros going public, misaligned incentives and 'bonus culture'* -- the aleph blog btw had a great three part series on everyone he's blaming :P

---
*also btw the FT ed's characteristically concise: What the Geithner Obama bank plan must do, cf.
posted by kliuless at 2:11 AM on February 12, 2009 [1 favorite]


i'm not sure "this cycle" is one we've seen before mutant, at least for post-WWII (north) americans :P as soros sez this one might be different...

cheers!
posted by kliuless at 2:25 AM on February 12, 2009


""...government policy over many years--particularly the use of the Community Reinvestment Act and Fannie Mae and Freddie Mac to distort the housing credit system-- underlies the current crisis."

A truely assinine, uninformed position to hold, cranked out by the oh-so-conservative American Enterprise Institute...

Don't know them? They're the same people who helped bring you much of the Bush administration's foriegn policy expertise, pushed for regime change in Iraq, and who continue to agitate against Iran.

They offered to pay $10k to scientists who openly opposed global warming findings, and lauded Michael Crichton as a brilliant climate scientist.

AEI has received more than $1.6m from ExxonMobil, and more than 20 of its staff have worked as consultants to the Bush administration.

Peter Wallison himself is a major donor to Bush and McCain, and "codirector of AEI's Financial Deregulation Project"... clearly, the most knowledgeable person to fairly tell us how this current crisis came about. as he supported all the deregulation that got us into this mess.

To make matters worse, Mr. Wallison simply doesn't accurately represent the facts of the matter. To whit...

1> The Community Reinvestment Act functioned just fine for a long, long time -- since the '90s -- with the changes that Mr. Wallison likes to scapegoat as the cause of the mess, and despite his phony claims that the CRA forced Fanny Mae to give out irresponsible low-income loans to people who couldn't pay for them and to move into the irresponsible subprime / derivatives market, the fact of the matter is that the Fannie Mae exceeded all of its low-income housing requirements just fine all the way up through the end of 2004 without exposing themselves to any kind of significant subprime loan or derivatives exposure, relying instead on standard, tried-and-true loan methods, carefully screening their applicants, and placing them in low-income housing that they could afford. Indeed, prior to about 2005, the major companies with subprime exposure were people like Countrywide, who were completely deregulated and had no obligations to abide by the CRA at all!

That is why it's particularly disingenuous for Mr. Wallison to say that "from 2001 through 2006, the share of all mortgage originations that were made up of conventional mortgages . . . fell from 57.1 percent in 2001 to 33.1 percent in the fourth quarter of 2006."

It's a true statement, yes, but the fact of the matter is, he is talking about "ALL mortgage originations", without pointing out that most mortgage originations weren't adequately regulated and had no requirements to comply with the CRA at all!

Worse still, the Republicans point routinely to "shocking testimony" from Democrats defending limited investigations of Fannie Mae, without pointing out that the testimony in question came from investigations into former Fannie Mae chief Franklin Raines, who was investigated in late 2004 and replaced about then by Daniel H. Mudd, a Republican appointee to the position.

Quoting the Washington post on the matter:
"Discussing the company's successes, Mudd said one of Fannie Mae's achievements in 2006 was expanding its involvement in the market for subprime and other nontraditional mortgages. He called it a step "toward optimizing our business." A month later, Fannie Mae outlined plans to further expand its activities in the subprime market. The company recognized the already weak performance of subprime loans but predicted that they would get better in 2007, according to another Fannie Mae document. . . This month, Fannie Mae reported that loans from 2006 and 2007 accounted for almost 60 percent of its second-quarter credit losses."

In short, risky subprime loans, authorized by a Republican appointee.
posted by markkraft at 3:34 AM on February 12, 2009 [6 favorites]


I recently investigated the possibility of refinancing in order to get some cash to weatherize my home. I have excellent credit, and less than 8 years left on my mortgage. The bank's form instructed me to deduct from my income payments on any non-mortgage consumer debt (cars, college, home equity, and credit cards but only the "monthly minimum payment") and then posited the entire remaining balance as the amount I had available to pay a mortgage. So, I guess according to banks, I don't need to eat, use transportation (except for my car payment), pay for any college expenses out of pocket, buy clothes, or god forbid minor luxuries like the occasional book (unless I put it on a credit card on which I am only paying the monthly minimum.)

This is what got us into trouble.

(And no, I decided not to take out the loan. In eight years I'll just use the money I now spend on my mortgage to upgrade my home. Using cash. Which I guess means that the terrorists have won.)
posted by nax at 4:00 AM on February 12, 2009 [1 favorite]


Of course the wealthy default on mortgages more than the poor. The reason is simple: the cost to a wealthy person on his credit score for being foreclosed, while annoying, isn't really all that very life-impacting. One of the perks of being wealthy is that you don't NEED credit. Need a new car and can't get credit? Hey, cash always works. For someone middle-class or poor though, they can't easily walk away from a bad credit score; it will hurt them, cause them some misery. They can't just whip out a wad of hundreds for a new car on a whim. So walking away from a bad mortgage isn't so easy or painless for anyone who *isn't* wealthy.

I place the bulk of the blame for our current predicament on the folks who valued some of these assets as AAA, when they had no idea if that was true or not. Once the assets made it past that point, they infected everything. Had they been valued appropriately, people wouldn't have bought them for ostensibly 'safe' purposes like retirement funds. When you take gold to an assayer, you want to know what the purity of the gold IS, not what someone THINKS it is. Our 'asset assayers' were just guessing at the purity of the 'gold', but telling people it was 24k. Then everyone found out, too late, that it was just gold-plated lead and the hard-earned money they had paid for it is now mostly gone.
posted by jamstigator at 4:18 AM on February 12, 2009


I decided not to take out the loan.

If you believe the market will get worse you'd actually be better-off if you took the loan.
posted by Civil_Disobedient at 4:45 AM on February 12, 2009


Man, what a waste of a thread.

Yeah, pretty much. Hardly anyone actually responds to the article or to diligent comments rebutting mischaracterizations. Everyone just takes potshots at the caricature of the argument in their head, and at AEI.

Curious he would pop up as a "I told you so". I've seen Wallison's name many times as he is well known (at least in the banking circles I move in) as someone who is actually a proponent of decreased financial deregulation


Oh good. I'm glad my interpretation of him seems to hold water.
posted by shivohum at 5:01 AM on February 12, 2009


Flexible lending standard for the CRA wasn't just "lower number ok" it was "lower number + alternative evidence of affordability ok". His assertion that the latter implied that banks HAD to use the former (or worse, Alt-A) is without any support. Lending standards are not an infectious disease.

The slightly easier credit available to GSEs and the CRA also has nothing to do with ARMs coming to the fore. That was all about the assumption of infinite liquidity from the private sector, and the assumption of dramatically rising values. He contrasts numbers from 2006; that's confusing cause with effect.

The idea that there was an insufficient supply of valid lenders (because GSEs took them all) is also a bit bonkers. The problem there was laziness and the actions at the fed creating infinite money. GSEs didn't make Countrywide buy all that crap because there were no other lending opportunities left in the world; Countrywide did that as deliberate strategy. GSEs also didn't make banks over-leverage themselves to get deeper and deeper into the market.

The value of a bad mortgage went up because of GSEs? The value of a loan is what you expect to get paid on it. The supply went up, and pricing models were wholly inadequate. Again, the blame for that lies elsewhere.

Regulators allowing something as causal is also strange. Countrywide was (and you are) free to put its money in a pile and burn it; that didn't MAKE them do that. The whole point of private lending was that they got to set their own standards.
posted by a robot made out of meat at 5:02 AM on February 12, 2009 [2 favorites]


They was victims of society! They was entrapped! They was set up to fail! Somethin evil was a-incentivizin all them bad irresponsible choices.

The idea that the private sector will merrily walk itself off a cliff if the government doesn't put up a fence is no argument for the idea that free market capitalism works great.
posted by fleacircus at 5:03 AM on February 12, 2009 [2 favorites]


Metafilter: diligent comments rebutting mischaracterizations.
posted by Slap*Happy at 5:20 AM on February 12, 2009


Another viewpoint.
posted by ZenMasterThis at 6:18 AM on February 12, 2009


What is wrong with his argument?

Pigpile! What is wrong with this argument is that it doesn't jive with reality, as has been detailed many times in many places, including here.

Zombie lies will not die!
posted by diogenes at 6:42 AM on February 12, 2009 [1 favorite]


Poor people are the reason we're in this mess. I knew it!
posted by 0xdeadc0de at 6:44 AM on February 12, 2009


This has been the standard Republican line going back practically all the way to FDR (not really--but that's how long they've had it in for the GSE on purely ideological grounds) and its been debunked so many times its not even worth talking about again. Though it's probably pointless to bring this zombie idea back from the dead yet again, let me take a quick stab.

First, Freddie and Fannie weren't the ones creating the extraordinarily complex derivatives that caused the mess--their relatively more straightforward securitized debt instruments were purchased by Goldman Sachs and other investment banks who then further securitized them into the inscrutable derivative investments that have caused the deep insecurity pervading the markets. And they weren't the only ones. Countrywide and other private banks collectively actually issued far more of the bad debt than Freddie and Fannie did.

Second, Freddie and Fannie don't make loans: they underwrite them. They buy debt from other lenders. That's all. It should be at least as much the responsibility of the loan originators and lenders to do due diligence in ensuring that the loans they issue have a reasonable chance of being paid back. But they didn't. In fact, they just dropped all the standards and started lending to anybody willing to put a signature (any signature, as it turns out) on paper.

Why? Because they were cynically exploiting the fact that Democratic policies meant to increase low-income home-ownership could be used to rake in money hand over fist and leave the GSEs on the hook with a lot of bad debt. Had the ordinary regulatory mechanisms been in place elsewhere in the system--i.e., if lenders and loan originators had still exercised reasonable caution in issuing loans and the regulatory regime hadn't been almost completely dismantled under the Republican leadership at the Federal level and in key states like Florida, California and Nevada--then those policies wouldn't have caused a problem. But the foxes realized no one was watching the hen house, with the Republicans in charge, and so now all the chickens are gone.
posted by saulgoodman at 7:05 AM on February 12, 2009 [3 favorites]


So good intentions were trumped by human nature; no one could have forseen that.
posted by ZenMasterThis at 7:18 AM on February 12, 2009


If you believe the market will get worse you'd actually be better-off if you took the loan.

Not if we get into a deflationary spiral, that would only make the cost of his loans go up! If, on the other hand, we end up with lots of inflation, then that leverage would have paid off.
posted by delmoi at 7:18 AM on February 12, 2009


So good intentions were trumped by human nature; no one could have forseen that.

Um, no. Republicans are lying and claiming good intentions were trumped by human nature, when in fact what happened is that financial deregulation lead to complex 'securitized' mortgage backed securities, credit default swaps, and fake bond ratings on crappy assets, which in turn caused real losses to be hidden. The Subprime loans themselves were just a drop in the bucket.
posted by delmoi at 7:25 AM on February 12, 2009 [1 favorite]


Well, ZenMasterThis: That's ordinarily why we have laws and regulations. Because unchecked human nature leads to mischief. But when the country's being run by a bunch of closeted anarchists who don't recognize the necessity of laws and regulations (while, ironically, pandering like mad to the law-and-order crowd), then yeah, nothing works as intended.
posted by saulgoodman at 7:26 AM on February 12, 2009


Keep fighting the good fight saulgoodman and delmoi :)
posted by diogenes at 7:26 AM on February 12, 2009


(and what delmoi said)
posted by saulgoodman at 7:27 AM on February 12, 2009


Some of you are erroneously connecting the criticism he has of the lowered lending standards imposed by CRA with him blaming minority owners. THAT IS NOT WHAT HE IS SAYING. That argument, that minorities are to blame, is one I've criticized before.

What he is saying is that the CRA, by trying to extend loans to a small percentage of home buyers, lowered the standards for everyone. It was that lowered standard that enabled Casey Serin and his greedy ilk to the point where by 2005 40% of home sales were for second homes.

Now I have no doubt that the shitheads at FNC will take this report, misconstrue it in exactly the same way many of you are and blame early-period low income homeowners. THAT ARGUMENT IS WRONG, BUT THAT IS NOT THE SUBJECT OF THE LINKED ARTICLES.

The purpose of the report is to show that the way they opened up lending to another segment of the market distorted the rest of the market. Specifically:
Once the standards were relaxed for low-income borrowers, it would seem impossible to deny these benefits to the prime market. Indeed, bank regulators, who were in charge of enforcing CRA standards, could hardly disapprove of similar loans made to better-qualified borrowers. "
Those lowered standards enabled house-flipping. The lowered standards were not predatory--no one made people take out mortgages. The greed in the consumer, the upper middle class consumer specifically, is what drove the actual flipping. People had to want to buy that second home to flip. Low-income homeowners were not flipping, the middle class was. It drove prices up, which drove lending up, etc etc and here were are. You create all those risky loans, it will invariably lead to the creation of a markets to spread around that risk because you have to manage it somehow.

Please set aside your biases against anyone who worked for Reagan, or anything that's from AEI, and read the article.
posted by Pastabagel at 7:28 AM on February 12, 2009 [1 favorite]


Fannie Mae and Freddie Mac were distorting

maybe i'm the only one that's amazed by this (and i pointed it out here ;) but if you want to travel further down the chain of causation and path dependency, it's worth noting a relationship greenspan actually observed in 2005 that: "Interestingly, the change in U.S. home mortgage debt over the past half-century correlates significantly with our current account deficit." in order to finance our trade deficit, there was big foreign (central bank) buying of fannie/freddie debt over the last several years; this was in part because as caballero sez...
since the late 1990s, the world has experienced a chronic shortage of financial assets to store value. The reasons behind this shortage are varied. They include the rise in savings needs by aging populations in Japan and Europe, the fast growth and global integration of high-saving economies, the precautionary response of emerging markets to earlier financial crises, and the intertemporal smoothing of commodity producing economies. The immediate consequence of the high demand for store-of-value instruments was a sustained decline in real interest rates.
setser concludes:
As central bank demand pushed yields on Treasuries and Agencies down (and as the fed raised rates), a host of financial institutions took on more risk. Other financial institutions supplied the product that they wanted. And when it blew up, the financial sector – not the world’s central banks – was left with big losses... low yields on traditional, safe assets triggered a surge in demand for assets that appeared safe but offered the kinds of returns private investors were used to...

Incidentally, One implication of Caballero’s argument is that the US should have been running bigger budget deficits to meet the rise in demand for safe assets. That would have kept yields up and reduced incentives to create “synthetic” triple AAA. Rather than following Dr. Chinn’s advice and trying to bring about rebalancing with a tight fiscal policy, the US should have met the world’s growing demand for truly safe reserve assets by running large fiscal and current account deficits.

Who knows - that could be where we are heading...

Had China allowed its currency to rise in 2004 rather than tightening fiscal policy and limiting lending to avoid inflation, I rather suspect that Chinese demand for safe US and European financial assets would have become demand for US and European goods. That would have produced a more balanced – and ultimately less risky – global economy.

And, well, if the US and UK governments hadn’t looked the other was as leverage in the financial sector rose — as financial institutions made bigger bets to keep profits up as spreads fell — that too would have produced a more balanced and ultimately less risky global global economy.
also btw, dunno if they're going to be shocked to find gambling going on but here's hoping!
posted by kliuless at 7:30 AM on February 12, 2009 [1 favorite]


Once the standards were relaxed for low-income borrowers, it would seem impossible to deny these benefits to the prime market.

FDIC Chairman Sheila Bair: “Point in fact,” she said, “only one in four higher-priced first mortgage loans were made by CRA-covered banks during the hey-day years of subprime mortgage lending. The rest were made by private independent mortgage companies and large bank affiliates not covered by CRA rules.”

And “Let me ask you,” she proceeded. “Where in the CRA does it say to make loans to people who can’t afford to repay? Nowhere.” The facts are simple, Bair said. The lending practices that are causing problems today were driven by a desire for more market share and revenue growth, not because the government encouraged certain lending practices.
posted by diogenes at 7:40 AM on February 12, 2009


What he is saying is that the CRA, by trying to extend loans to a small percentage of home buyers, lowered the standards for everyone.

It doesn't matter if that's true or not, the roots of the financial crisis go much deeper than high default rates.

Because it's not the default rate on subprime or other debt that has contributed most to the crisis in the first place--it's the complexity of the derivative investments that caused the market insecurity that started the downward spiral.

This crisis wasn't caused merely by higher than predicted debt default rates; it was caused by higher than predicted default rates coupled with no one really being sure how to assess the impact to the value of their own investments. It was the panic that resulted when people realized there was no way to accurately price these "toxic assets" (complex derivative instruments) that most contributed to the unwinding of the crisis. It was the fact that these debt instruments had clearly been given unrealistically favorable ratings by all the credible ratings agencies--they were rated as being as solid investments as treasury bonds, for chrissake!

Hell, even Greenspan now admits, he didn't really understand the full scope of the mortgage securities and derivatives market, that it had grown far larger and more complex than he realized, and he notes:

“What we have created in this world is an aura around the credit rating agencies about certification from them is the Good Housekeeping Seal of Approval, ” Mr. Greenspan said. “I will tell you the record of a lot of the forecasters of ratings have not been distinguished. They never were.”

And Credit Default Swap securities speculation and all the uncertainty that crossed over into those markets also played a major role.

All of these factors are at least as causally significant as anything that happened in the subprime housing market.
posted by saulgoodman at 7:54 AM on February 12, 2009


"you're dredging up Ben Stein-level thinking"

To be fair, Stein has found religion and is a card-carrying Keynesian now. He's saying we need a gigantic government intervention to save the economy, and the worst thing would be to go too small. So, lump him in with Roubini as far as how he sees the crisis now.
posted by krinklyfig at 8:00 AM on February 12, 2009


FDIC Chairman Sheila Bair: “Point in fact,” she said, “only one in four higher-priced first mortgage loans were made by CRA-covered banks during the hey-day years of subprime mortgage lending. The rest were made by private independent mortgage companies and large bank affiliates not covered by CRA rules.”

Which completely misses the point about market distortions.

Period 1: Bank A is covered by CRA. Bank A has to make higher risk loans than it would have absent CRA, yes? Bank A makes CRA-type loans to low income borrowers, which is the stanted intent of the legislation.

Period 2: Bank A cannot reasonably deny higher income borrowers from taking out risky loans. Note that income is not the only factor in determining risk.

Period 3: Bank B is not covered by CRA loans, and will not lend to low-income borrowers. However Bank B must compete with Bank A for higher income borrowers. So they have top match what Bank A is doing to serve at least that segment of the market.

The market is distorted because non CRA-banks have to compete with CRA banks over the same set of customers.
posted by Pastabagel at 8:03 AM on February 12, 2009


"Those lowered standards enabled house-flipping. The lowered standards were not predatory--no one made people take out mortgages. The greed in the consumer, the upper middle class consumer specifically, is what drove the actual flipping."

That is backwards. Without the originator seeking out the loans with such sketchy terms, this never happens, and without the opaque securitization, there would not have been the capital to back up such speculation. The borrower does not force the lender's hand, and the leverage needed for such transactions does not come out of the borrower's ass.
posted by krinklyfig at 8:06 AM on February 12, 2009 [1 favorite]


"The market is distorted because non CRA-banks have to compete with CRA banks over the same set of customers."

The finger is not the moon.
posted by krinklyfig at 8:08 AM on February 12, 2009


It doesn't matter if that's true or not, the roots of the financial crisis go much deeper than high default rates.

Because it's not the default rate on subprime or other debt that has contributed most to the crisis in the first place--it's the complexity of the derivative investments that caused the market insecurity that started the downward spiral.
posted by saulgoodman at 10:54 AM on February 12


Okay, I actually don't disagree with what you said in that comment, except that I would call those "contributing factors" that came later. The derivative instruments in the complexity you are describing were not really present at the root of the problem in the 1995-1999 timeframe.

Once we get into contributing factors, I'd add to your list a whole laundry list of other factors.

I think the purpose of this article is to identify where and when the first mistakes were made that created the environment in which other mistakes were made. But I also think we have an interlocking set of negligence and screw-ups on an epic, once-in-a-lifetime scale. For example, it did not help any of this that Freddie and Fannie were cooking their books. Perhaps had we known the truth about them a year or two prior, it would have triggered more scrutiny elsewhere in the system.
posted by Pastabagel at 8:10 AM on February 12, 2009


The market is distorted because non CRA-banks have to compete with CRA banks over the same set of customers.

Then why are the following things true?

1. There was no credit/housing meltdown from 1977 to 2005.

2. 30 other countries, none of which have are covered by the CRA, had a remarkably similar housing boom and bust.

(Points stolen from The Big Picture)
posted by diogenes at 8:15 AM on February 12, 2009


"Okay, I actually don't disagree with what you said in that comment, except that I would call those 'contributing factors' that came later. The derivative instruments in the complexity you are describing were not really present at the root of the problem in the 1995-1999 timeframe."

The rampant speculation that went on in the housing market was directly related to these instruments. There may have been a bubble anyway; securitization in the manner it was done made it far worse, and had large and devastating effects on the rest of the market, which had invested in these instruments, even granny's mutual fund she's been putting money in for 40 years, and even some municipal government investments, without transparency and with false valuations.
posted by krinklyfig at 8:15 AM on February 12, 2009 [1 favorite]


That is backwards. Without the originator seeking out the loans with such sketchy terms, this never happens, and without the opaque securitization, there would not have been the capital to back up such speculation. The borrower does not force the lender's hand, and the leverage needed for such transactions does not come out of the borrower's ass.
posted by krinklyfig at 11:06 AM on February 12


You are misreading what I wrote. The desire to speculate among a class of people who do not typically engage in financial speculation was the problem I was talking about. Once the demand exists, the supply will be found or created to meet it, one way or another.
posted by Pastabagel at 8:15 AM on February 12, 2009


"I think the purpose of this article is to identify where and when the first mistakes were made that created the environment in which other mistakes were made."

No, the purpose of this article is to lay the blame at the feet of Clinton and the Democrats. As if Bush and the Republicans were powerless for the last 8 years, and as if Gramm and the rest of the deregulators had nothing to do with it.
posted by krinklyfig at 8:19 AM on February 12, 2009 [5 favorites]


"You are misreading what I wrote. The desire to speculate among a class of people who do not typically engage in financial speculation was the problem I was talking about."

You can always assume that easy credit will find borrowers. If you offer people money on a loan with awful terms, particularly if they think they can make some money or if they just assume that's how it's done, or if their broker tells them this is how it's done, quite a few of them will take it whether they can afford it or not. That's human nature, not the nature of American consumers. It was true when PT Barnum said it, and it's true now. It's incumbent upon the originator to ensure their investment of a consumer loan is sound, not the borrower, and nobody forced anyone to originate loans to people who could not pay them back.
posted by krinklyfig at 8:28 AM on February 12, 2009 [1 favorite]


The market is distorted because non CRA-banks have to compete with CRA banks over the same set of customers.

Then why are the following things true?

1. There was no credit/housing meltdown from 1977 to 2005.

2. 30 other countries, none of which have are covered by the CRA, had a remarkably similar housing boom and bust.

(Points stolen from The Big Picture)
posted by diogenes at 11:15 AM on February 12


First, how about a like to that article on TBP? I can't find it.

To answer your questions:

1. There were plenty of other booms and busts up through 2000. Given the transaction costs involved in speculating in real estate, I would think that is the last place anyone would turn, and after junk bonds, dot-coms, south american currencies, asian currencies, etc. (all of which boomed and busted in the period you specified) it was the only place left (other than oil and industrial commodities, which also boomed and busted). The reason those busts didn't lead to a massive economic failure is because the equity, currency, and futures markets are all very highly regulated (because previous busts in those sectors destroyed the economy at the time and we learned from it) and because the consumer cannot easily get leverage. By contrast, a consumer gets 5-1 leverage when he puts a 20% down payment to by a house.

2. I don't know the answer to this, beyond the fact that foreign banks were buying our awful CDO's, mortgages, and other derivatives, and that brought some of them down. But that doesn't explain the boom part. So other than a general increasing of the money supply worldwide, coupled with global low interest rates, why were there housing booms in other countries? Do we know whether or not other countries with booms lowered lending standards as well?
posted by Pastabagel at 8:29 AM on February 12, 2009


What he is saying is that the CRA, by trying to extend loans to a small percentage of home buyers, lowered the standards for everyone. It was that lowered standard that enabled Casey Serin and his greedy ilk to the point where by 2005 40% of home sales were for second homes.
Maybe in 2004. But if you look at what was happening in 2005, 2006 you see that standards weren’t lowered, they were ignored. Stated income loans, liar loans, NINJA loans, no doc loans. None of these were encouraged by the government, other then that the government totally ignored them. The reason that these standards were ignored was because of the demand for the mortgage backed securities which could be 'laundered' by being put into tranches and getting a big fat AAA rating on a bunch of garbage.

It had nothing to do with good intentions, or overall creditworthiness. It was all about getting as much paper through the door as possible and taking your cut. And as this industry ramped up, while regulators were asleep at the switch, the value of homes kept rising because more and more people wanted to get in on the action. Until the ARMs started to reset and the whole thing blew up.

Again the problem wasn't the 'standards', the problem was the lack of any and all standards whatsoever, driven by insane demand for the securitized assets.
The derivative instruments in the complexity you are describing were not really present at the root of the problem in the 1995-1999 timeframe.
And... there was no housing bubble at the time either! What a coincidence!
No, the purpose of this article is to lay the blame at the feet of Clinton and the Democrats. As if Bush and the Republicans were powerless for the last 8 years, and as if Gramm and the rest of the deregulators had nothing to do with it.
Except that the Clinton and the Dems had a hand in deregulation as well.
posted by delmoi at 8:32 AM on February 12, 2009 [1 favorite]


Here's the link: More CRA Idiocy
posted by diogenes at 8:33 AM on February 12, 2009


it's the complexity

i think it's more the obfuscation... or perhaps more accurately agnotology - "Culturally constructed ignorance, purposefully created by special interest groups working hard to create confusion and suppress the truth."

'complex hard-to-value' is mostly just code for sellers holding out for a government bailout, cf. the market for lemons... and guess who the sucker is!
posted by kliuless at 8:35 AM on February 12, 2009 [2 favorites]


"Except that the Clinton and the Dems had a hand in deregulation as well."

Of course they did, but that's not where it ends, and low-income loans were not what made this market so toxic to the rest of the economy.
posted by krinklyfig at 8:35 AM on February 12, 2009


"Because they were cynically exploiting the fact that Democratic policies meant to increase low-income home-ownership could be used to rake in money hand over fist and leave the GSEs on the hook with a lot of bad debt. Had the ordinary regulatory mechanisms been in place elsewhere in the system--i.e., if lenders and loan originators had still exercised reasonable caution in issuing loans and the regulatory regime hadn't been almost completely dismantled under the Republican leadership at the Federal level and in key states like Florida, California and Nevada--then those policies wouldn't have caused a problem."

Wallison is saying that the reason the regulators didn't object to these loans is because lending standards had been lowered. That is, if CRA-lenders could issue lower-quality loans, then why shouldn't GSEs buy lower-quality loans?

As for arguments that derivatives & crappy ratings were the key driver, if the GSEs and their government-backed credit hadn't been willing to purchase giant heaps of subprime securities, subprime originations and consequent securitizations wouldn't have happened. They were the market makers, were they not?

One could read the sequence of events as being: political mandate to increase homeownership + sliding lending standards and redefinitions of prime and subprime --> urgent desire on part of bizarre public-private Freddie/Fannie entities to satisfy mandate (and make money) --> how to do this while seeming not very risky? --> giant purchases of subprime tranches...

From Wikipedia: "From 2002 to 2006 Fannie Mae and Freddie Mac combined purchases of subprime securities rose from $38 billion to around $175 billion per year before dropping to $90 billion, thus fulfilling their government mandate to help make home buying more affordable. During this time, the total market for subprime securities rose from $172 billion to nearly $500 billion only to fall back down to $450 billion. [110]"

Looks like they were a quarter to a third of the subprime market, and of course had $5 trillion in loans generally.

"1. There was no credit/housing meltdown from 1977 to 2005."

The article says that in 1992, regulations were re-written to mandate the issuance of loans to people who wouldn't have qualified earlier. In addition, Fannie/Freddie lowered lending standards in 1999, and then started to buy up subprime mortgages en masse, creating a market for the complex derivative instruments that exacerbated the crisis.

"2. 30 other countries, none of which have are covered by the CRA, had a remarkably similar housing boom and bust."

Well once the derivatives market was being backed by Fannie and Freddie (and thus the US gov't), that created a liquid worldwide market for its use, no?
posted by shivohum at 8:53 AM on February 12, 2009


Okay, I read that TBP post, and I note that (a) he isn't arguing with the point I'm making here, he is arguing against the same point that I am arguing against.

The problem is not and was not risky loans to low-income people. The problem was risky loans to middle-to-high income people.

The question is why were they making risking loans to high income people? The linked article (@ AEI) is arguing that because the government changed the rules to service a legit need in one segment of the market, the rule change applied to everyone. Changing the rules even only for some banks, and with the intent to help only one group distorted the market.

The market distortion allowed upper income people who could not afford a second house to get one.

I was sort of hoping that the TBP article would answer diogenes questions, but it doesn't. What it does do is identify a discrepancy.

The AEI article suggests that CRA did apply quotas:
In 1995, the regulators created new rules that sought to establish objective criteria for determining whether a bank was meeting CRA standards. Examiners no longer had the discretion they once had. For banks, simply proving that they were looking for qualified buyers wasn't enough. Banks now had to show that they had actually made a requisite number of loans to low- and moderate-income (LMI) borrowers. The new regulations also required the use of "innovative or flexible" lending practices to address credit needs of LMI borrowers and neighborhoods. Thus, a law that was originally intended to encourage banks to use safe and sound practices in lending now required them to be "innovative" and "flexible." In other words, it called for the relaxation of lending standards, and it was the bank regulators who were expected to enforce these relaxed standards.
But Ritholz at TBP says there weren't:
Note that there are no quotas, minimums or mandates. This is a very soft rating system.
Neither cites andy support for their statement. One of them must be wrong. I suspect that a definitive answer to these questions, "Did CRA or some related legislation have the effect of imposing quotas on the number of loans the banks made? Did they similarly require the lowering of lending standards?" would change either of their minds and get us substantially closer to the truth.

For those making the predatory lending argument, quotas would certainly explain why they suddenly chose to become predatory in the 1996-1999 timeframe. If there was a quota on the number of LMI loans they had to make, they would have pressure to meet that quota, and its obvious that some people would stretch the limits of the law and ethics to meet that quota.

Also, the presence of a quota (or something that amounts to a quota, let's not be pedantic) is the very definition of a market distortion. Anyone enacting legislation imposing a quota would be negligent in not researching the likely effects. In other words, when they changed the rules in 1995 around CRA, did anyone do a study?
posted by Pastabagel at 9:01 AM on February 12, 2009


I think the purpose of this article is to identify where and when the first mistakes were made that created the environment in which other mistakes were made.

the first mistake was to sell manhattan for 24 bucks and a bunch of beads and trinkets - everything since then has been rampant speculation
posted by pyramid termite at 9:07 AM on February 12, 2009 [1 favorite]


shivohum: I'm not convinced that you're arguing in good faith.

Pastabagel: Good catch on the quota issue. I'm interested in the result. I'll be bummed if Ritholz got that wrong.
posted by diogenes at 9:10 AM on February 12, 2009


As for arguments that derivatives & crappy ratings were the key driver, if the GSEs and their government-backed credit hadn't been willing to purchase giant heaps of subprime securities, subprime originations and consequent securitizations wouldn't have happened. They were the market makers, were they not?
This begs the question "Where the GSEs willing to purchase giant heaps of subprime securities?" And the answer is no, they were not, until 2005/2006. And there was no government pressure to do that, the companies decided to get into that market because it was profitable for the companies that were involved. Let me say that again profit motive, not government pressure, caused Freddie and Fannie to invest in subprime mortgages at the height of the bubble. And even then, subprime was only a tiny portion of their balance sheet. But what happened is that regular prime loans started to go bad because of declining home values and a bad economy. that's why the companies had problems. Subprime was just a symptom.

And furthermore, they were not "government sponsored" in any sense. They were private companies that simply told everyone the government would bail them out if needed, and hired armies of lobbyists. They are now government sponsored, having been taken over by the government and having their lobbyists fired.
One could read the sequence of events as being: political mandate to increase homeownership + sliding lending standards and redefinitions of prime and subprime -->
Why not throw in the moon landing and the Lewinsky affair as well? I mean, those things happened, then other things happened, so first must be the cause of the second! Just because you can come up with some convoluted hypothesis doesn't actually imply causality.

"A happened, then B happened, therefore A caused B" is not a real argument
posted by delmoi at 9:18 AM on February 12, 2009 [3 favorites]


From federalreserve.gov:

Neither the CRA nor its implementing regulation gives specific criteria for rating the performance of depository institutions. Rather, the law indicates that the evaluation process should accommodate an institution's individual circumstances. Nor does the law require institutions to make high-risk loans that jeopardize their safety. To the contrary, the law makes it clear that an institution's CRA activities should be undertaken in a safe and sound manner.


That doesn't sound like a quota to me. The AEI article says "Banks now had to show that they had actually made a requisite number of loans to low- and moderate-income (LMI) borrowers." The definition of requisite is "required." So the AEI says that banks were required to make a certain number of loans (a quota). It appears that this is untrue. Interesting...
posted by diogenes at 9:30 AM on February 12, 2009


Why not throw in the moon landing and the Lewinsky affair as well?

they might as well - the whole point of this exercise is to do away with the terribly old-fashioned idea that a captain, or a president, is responsible for what happens on his watch, no one else

and all this republican fingerpointing means just one thing - that the republicans aren't willing to practice responsible government - 9/11 happened but it was someone else's fault - katrina happened but it was someone else's fault - the housing market crashed, but it was someone else's fault - the investment banks went to hell, but it was someone else's fault - the stock market tanked, but it was someone else's fault

i'm tired of it
posted by pyramid termite at 9:30 AM on February 12, 2009 [6 favorites]


Well once the derivatives market was being backed by Fannie and Freddie

I can't quite parse this statement. shivohum, Fannie has been in business doing what it does for more than 75 years, since it was first established under the New Deal (Freddie came later, but similarly was established by an act of congress and has been doing its thing for a long time). The underwriting standards the GSE's employ have been relaxed in recent years, under pressure from the legislature seeking to make Fannie and Freddie play a greater role in expanding low-income home ownership. Until then, despite what ideological critics (read: right-wing ideologues) will tell you, the GSE's have mostly performed their intended functions in an exemplary fashion and have played a major role in contributing to the availability of home credit for responsible prime borrowers--in fact, their moves into the subprime market only date back to the Clinton years.

Yes, the GSE's were "encouraged" to start buying subprime loans, and so they did, but even so, that wasn't the problem.

The problem was they purchased those loans in good faith (assuming that they were what they appeared to be, that basic lending and due diligence standards had been met), but as others have pointed out up-thread, lending standards and regulations that had always been observed in the past at the point of loan origination were suddenly being completely ignored, as NINJA and no documentation loan products were allowed to flood the market without any intervention by regulatory entities. The way loans began to be originated leading up to the crisis was guaranteed to stimulate widespread fraud and irresponsible borrowing.

Is it a coincidence that loans have never been originated under such lax standards before as in the time frame leading up to the financial crisis? No. That's your damn 'cause' right there, if you insist on using such a simplistic analysis of causality (in reality, though, all we're really analyzing here are possible triggering events for the crisis; causality is complex, not reducible to any single series of 'causal' events in the way this discussion has been assuming, so most of this discussion is just fundamentally misguided from the get-go.)

In Florida, for example, for the first time in history, a new class of unlicensed operator was allowed to enter the real estate market--these new loan originators were unlicensed, unregulated, and as subsequent investigations have shown, in thousands of cases, even had previous criminal convictions for fraud. It was not market pressure that caused the market failures; it was the lack of regulatory rigor at the point of loan origination and the unscrupulous practices of brokers and lenders eager to make a dime and dump off what they knew to be bad debt on the GSEs or some other poor sap down the line.

But it was always the plan to blame the whole thing on the GSEs, given their implied status as Federally backed entities, in order to make the case for a government bailout.
posted by saulgoodman at 9:31 AM on February 12, 2009 [1 favorite]


And furthermore, they were not "government sponsored" in any sense.

Except they were established by acts of congress, which in most people's mind's constitutes a form of "sponsorship" (unless you mean strictly in the sense of "receiving funding from the government"--"sponsorship" also connotes endorsement or backing).
posted by saulgoodman at 9:34 AM on February 12, 2009


Here's an interesting article from Time about Gramm. He says he's mostly not to blame, but he's willing to admit to some culpability.
posted by krinklyfig at 9:49 AM on February 12, 2009


Period 1: Bank A is covered by CRA. Bank A has to make higher risk loans than it would have absent CRA, yes? Bank A makes CRA-type loans to low income borrowers, which is the stanted intent of the legislation.

Period 2: Bank A cannot reasonably deny higher income borrowers from taking out risky loans. Note that income is not the only factor in determining risk.

Period 3: Bank B is not covered by CRA loans, and will not lend to low-income borrowers. However Bank B must compete with Bank A for higher income borrowers. So they have top match what Bank A is doing to serve at least that segment of the market.


This makes no sense. The whole point of CRA is to force banks to make loans they don't want to make. Why would the CRA banks then extend the same loans to people they didn't have to? Why would non CRA banks start offering CRA type loans?
posted by afu at 10:00 AM on February 12, 2009


> What is wrong with his argument?
> posted by shivohum at 1:16 AM on February 12 [2 favorites +] [!]

We're the reality-based community and it doesn't fit in with reality as we would like it.

In fact the CRA has an honored place among the factors contributing to the meltdown: it signaled to the financial industry as a whole that federal regulators were no longer much concerned that lenders lend only to borrowers whose credit could withstand scrutiny--indeed that they were actively against it. Anyone able to spot other cases of deregulation which contributed to unforeseen and undesirable outcomes should be able to spot this one. Likewise, anyone capable of (moronically) claiming those other cases of deregulation were sole causes of those other undesirable outcomes has no business complaining if somebody claims (equally moronically) that CRA-style deregulation was the sole cause of the credit industry meltdown. N.b., the author of the fpp's linked essay does not make that claim, nor do I.


> The whole point of CRA is to force banks to make loans they don't want to make. Why
> would the CRA banks then extend the same loans to people they didn't have to? Why
> would non CRA banks start offering CRA type loans?

"OK, the Feds say we gotta make loans like these. How can we get rid of 'em? What's this 'securitization' I've been hearing about? Hey, and couldn't we make other junk loans and get rid of 'em the same way? The regulators can't very well complain, can they? They just finished saying 'Go wild, guys!'"


> The interesting thing about the market crash is that it's brought out
> every crack-pot cockamamie nutbar theory. This is one of those, but
> in particular this one has a nice racist patina.
posted by delmoi at 1:51 AM on February 12 [2 favorites +] [!]

delmoi, you say "racist" the way Joe McCarthy said "Communist." With exactly the same level of justification.
posted by jfuller at 10:33 AM on February 12, 2009


>They just finished saying 'Go wild, guys!'"

CRA was not about "going wild". It was about not redlining and making good-faith efforts to keep depositors' money in their community.

>With exactly the same level of justification

It can't be helped that plenty of your fellow-travellers are racist fucks, jfuller.

Apropos this stupid post, Calculated Risk posted an interesting graph of the price-to-rent ratio today.

Something happened in 2002, and it wasn't in any shape or form related to the CRA or the GSEs "distorting" the system. It was the system itself on tilt, spinning itself up in what was thought to be wealth creation of a magical kind, only to go centrifugal in March 2007.

The esteemed AEI economist featured in the FPP is full of shit on this, and you should know it.
posted by troy at 10:45 AM on February 12, 2009


Why would the CRA banks then extend the same loans to people they didn't have to?

I don't know the details of the loans, but I don't think CRA involved different kinds of loans, I think it related to the standard under which you offer regular loans. E.g. perhaps lowering the criteria for a regular 30-yr mortgage.

The reason the CRA bank would extend those practices to higher income people is logical: (1) it is inefficient to have multiple standards for different customers and (2) if the lower income person satisfies the lowered standards, obviously the higher income person does also.

Furthermore, a bank may have thought that even though the government wants it to take on this additional risk by lending to lower-income people, the bank has to offset that newer risk by making more loans to higher income people which the bank perhaps erroneously thought to be less risky in order rebalance the overall risk. I don't know that this is the case, I'm just guessing.

But once a CRA bank starts doing things to attract more upper-income people to borrow from it, that necessarily means that it is taking customers away from non CRA banks, and perhaps also means that it is expanding the market to people who would not otherwise have gotten loans. The non CRA banks have to compete. If the CRA banks are attracting high income borrowers by reducing the rates, reducing requirements to offer larger loans, etc, the non CRA banks have to follow suit simply to maintain their share of the market.

The point is that once the rules change in one part of a market, the rest of the market will react. The changes affects the rest of the system, and there is no way to avoid this.

It's clear in hindsight, given how much the government is spending to bail us out of the mess, that it would have beet better if the government had helped lower income people by entering the existing market as a participant (i.e. offered a larger tax deduction for the overall size of the mortgage rather than just the interest portion for people under a certain income level, etc.). I think this would have been better than trying to surgically alter the rules to achieve a very targeted and narrow result.

By the way, even if fiddling with CRA requirements explains the start of the problem, it does not explain how the problem spiraled out of control, and rating agency, and i-bank sloppiness does not necessarily follow from the CRA changes. Also, while something may explain the economic effects from a scientific standpoint, it is morally neutral, and does not excuse anyone's behavior, including the banks.
posted by Pastabagel at 10:47 AM on February 12, 2009


Okay, trying to get to the bottom of the CRA quota issue is difficult.

The comments on the federalreserve.org site that diogenes linked above are disingenuous I think.

I did a quick search of CRA assessments for small banks using the search facility on that page, and picked the first on the list. This is the actual assessment of a bank from 1999.
By way of comparison,
over 30 percent of all the 1997 HMDA reportable loans originated by lenders in the Little
Rock MSA were made to LMI borrowers3, indicating a demand for this type of lending
by this segment of the population. Based on these comparisons and the absence of
any impediments to the bank's ability to lend, the distribution of consumer loans reflects
a poor penetration to borrowers of different income levels, particularly LMI borrowers.
The fed is basically saying that because the bank isn't making loans to the LMI borrowers in proportion to their size and level of demand in the market, the bank fails. This is an effective quota, i.e. you must make loans to a market in proportion to that segment of the market's size. This is an odd metric to use, considering the criteria for lending includes which segment of the market the borrower is in (i.e. income).

In any case this is a cursory review, and there are issues like how the fed measures "a banks ability to lend" that are vague but drastically affect the outcome.
posted by Pastabagel at 10:55 AM on February 12, 2009


jfuller:

"In fact the CRA has an honored place among the factors contributing to the meltdown: it signaled to the financial industry as a whole that federal regulators were no longer much concerned that lenders lend only to borrowers whose credit could withstand scrutiny"

You assert that the CRA "signaled...that regulators were no longer much concerned that lenders lend only to borrowers whose credit could withstand scrutiny," when in fact the regulation, as worded, clearly does express concern that lenders not engage in excess risk-taking in order to comply with the requirements. So at best, the argument might be that the CRA sent mixed signals about regulatory expectations and that that contributed to the problem. But that's a damn line of argument.

And even then, the responsibility for irresponsible lending under any scenario still remains with the primary lenders, doesn't it? How is that not the case? The plan explicitly called for lenders to reach out to under-served communities with innovative lending programs--not to go around offering the real-estate Ponzi schemers of the world no documentation loans.
posted by saulgoodman at 11:04 AM on February 12, 2009


small>"But that's a damn weak line of argument."
posted by saulgoodman at 11:18 AM on February 12, 2009


First off, I just want to say that Shivohum's comments like this are pretty inappropriate, given that he was the one who created this post. Last I heard, you're not supposed to try to do that kind of thing.

Also, a few criticisms of particular sections:

"From 2002 to 2006 Fannie Mae and Freddie Mac combined purchases of subprime securities rose from $38 billion to around $175 billion per year before dropping to $90 billion"

Yes, but their early standards for backing a very small percentage of subprime loans were *MUCH* less risky than in 2005-2006, and they didn't get involved in derivatives until about the 2005 time period. In fact, after Republican overseers ousted Raines and replaced him with Mudd, they actually encouraged Fannie Mae to get involved with derivatives and with increased exposure to subprime loans.

"the CRA, by trying to extend loans to a small percentage of home buyers, lowered the standards for everyone."

Bull. The CRA -- which was binding only for a very limited part of the marketplace -- didn't lower loan standards at all, nor did it force anyone else to do so. Take a look at the legislation if you don't believe me.

"That lowered standard that enabled Casey Serin and his greedy ilk to the point where by 2005 40% of home sales were for second homes."

No. What enabled Casey Serin and his greedy ilk was that deregulation and underregulation allowed bad loans to be made in the first place, combined with an environment where the economy was sluggish, while Bernanke kept lowering interest rates and dumping a lot of money into the system.

That led to companies like Countrywide, jumping into the subprime market, largely unregulated, with lots of that "free money" courtesy of the Federal Reserve. Investors saw housing prices making reliable gains while the stock market was flat, and they knew a "good deal" when they saw one. This led to the "flip my house" excesses of that era.

It was a "get rich quick" scheme in the middle of a longterm period of economic sluggishness, caused by several factors, such as:

1> Tax cuts that were poorly designed to actually stimulate the economy, and which actually put a LOT of money in the hands of those most likely to create and further distort economic bubbles.
2> Deficit spending.
3> Lack of spending focus on things that would help expand the economy.
4> The lingering effects of the post-9/11 downturn and of the bursting of the dotcom bubble.
5> Too much easy money. This encouraged short-term speculation and "safe gambles", on everything from housing prices going up to oil prices going up. This gambling environment was seen in Wall Street as well, where the volume money that went towards short-term speculation and the of shorting of stocks greatly increased over time.

Ultimately, all this gambling killed the economy, once investors realized that the smart money was for betting against the long-term viability of their own gambles.

Clearly, we can't afford any more "get rich schemes". If it sound too good to be true,
posted by markkraft at 11:25 AM on February 12, 2009 [2 favorites]


(Oops. I didn't finish that last sentence... but obviously, I didn't need to.)
posted by markkraft at 11:27 AM on February 12, 2009


PastaBagel: the full text of the CRA rating from the link you posted above (emphasis mine):

"The assessment of Pinnacle Bank’s efforts to determine and meet the credit needs of its community indicates that the bank’s overall performance is in need of improvement. This conclusion is largely due to the geographic distribution of the bank’s lending that reflects a less than satisfactory dispersion across low- and moderate-income (LMI) geographies in the assessment area. In addition, the distribution of loans to borrowers of different income levels reflects a poor penetration among LMI individuals. Conversely, the distribution of loans to small businesses is reasonable. The loan-to-deposit ratio is exceptional given the institution’s size, its financial condition, the performance of its competitors, and the credit needs of the assessment area. Also, a substantial majority of the bank’s loans are extended within its assessment area. However, the bank's strong performance for these criteria is insufficient to mitigate the bank's low level of lending to LMI geographies and individuals."

...So in other words, the lending institution was criticized under CRA review for not distributing enough loan money to LMI borrowers--or on the flip side, for distributing too much to middle-and-upper-income borrowers. As has been established above, the majority of the problems occurred with the middle-and-upper-income borrowers who borrowed excessively for speculative investment, so this particular CRA review in fact demonstrates that pressure actually was being applied by authorities to focus lending on the targeted LMI populations, but that lenders like this one weren't necessarily complying with the stated intent of the act.
posted by saulgoodman at 12:27 PM on February 12, 2009


In fact the CRA has an honored place among the factors contributing to the meltdown: it signaled to the financial industry as a whole that federal regulators were...
It was a "signal"? That just seems like such a strange thing to say. The CRA was passed in 1970s and the housing bubble didn't even really get going until 2005. Presumably mortgage lenders didn't need to interpret some semaphore from decades past in order to figure out what regulators "wanted", they could talk to them directly and in fact they negotiated all the time using lobbyists.
"OK, the Feds say we gotta make loans like these. How can we get rid of 'em? What's this 'securitization' I've been hearing about? Hey, and couldn't we make other junk loans and get rid of 'em the same way? The regulators can't very well complain, can they? They just finished saying 'Go wild, guys!'"
Actually I recently read a book that talked about how Lew Ranieri created securitized mortgage products in the late 1970s. It went nothing like that. The actual reason to do the securitization was so that they could be sold like bonds with a fixed end date, whereas mortgages could be refinanced at any time. If you bundled and securitized the mortgages, you could use the average or estimated end time like the end time of a bond, which made it easier to figure out how much they were worth. This is the person who invented the term 'securitization'

Your quote, as I'm sure people can tell, is entirely fictional and has nothing to do with anything that actually happened. You don't get to just make shit up and then pretend like you have an argument.
delmoi, you say "racist" the way Joe McCarthy said "Communist." With exactly the same level of justification.
The whole point of the CRA was to help minorities get into homes. Making the claim that the CRA caused the mortgage bubble is equivalent to saying that lending to poor minorities caused the mortgage bubble.
posted by delmoi at 12:52 PM on February 12, 2009 [1 favorite]


saulgoodman:

Yes, the GSE's were "encouraged" to start buying subprime loans, and so they did, but even so, that wasn't the problem.

The problem was they purchased those loans in good faith (assuming that they were what they appeared to be, that basic lending and due diligence standards had been met)...


This doesn't make any sense to me. Isn't this practically the definition of a subprime loan? A loan which does not mean normal lending standards? Where documentation of income may be poor or incomplete? Where the meaning of basic lending and due diligence standards is radically different than for prime loans? Is this not why Fannie/Freddie were earlier prohibited from entering this market?

---

markkraft:

Yes, but their early standards for backing a very small percentage of subprime loans were *MUCH* less risky than in 2005-2006, and they didn't get involved in derivatives until about the 2005 time period.


How is it very small if in 2002 they bought $38 billion worth of subprime securities, and the whole market issued $172 billion in subprime loans? That seems like a pretty large percentage to me. And the crisis really spiked in 2006, did it not - coincident with them getting into derivatives, no?

---

delmoi:

This begs the question "Where the GSEs willing to purchase giant heaps of subprime securities?" And the answer is no, they were not, until 2005/2006.

See above.

"And there was no government pressure to do that, the companies decided to get into that market because it was profitable for the companies that were involved. Let me say that again profit motive, not government pressure, caused Freddie and Fannie to invest in subprime mortgages at the height of the bubble."

Let's be clear: Fannie and Freddie got lots of government support in part because they were increasing homeownership, a politically popular goal. Their profit motive and government pressure were not independent forces. And the guarantee of an implicit bailout obviously created moral hazard. Am I missing something?

"But what happened is that regular prime loans started to go bad because of declining home values and a bad economy."

But what's the argument that relaxed lending standards (i.e. relaxed regulations because such a relaxation supposedly increased homeownership) and a subprime loan and then derivative market, all fueled by Fannie/Freddie, were not crucial contributors? It seems to me that as a share of the market their activity seems to have been huge.
posted by shivohum at 1:52 PM on February 12, 2009


This doesn't make any sense to me. Isn't this practically the definition of a subprime loan? A loan which does not mean normal lending standards? Where documentation of income may be poor or incomplete?

No. Subprime means the borrowers have lower credit scores (around 620 or less) or lower annual income than prime borrowers. While it may mean that they have less of a credit track record (i.e., haven't taken out large loans in the past) than prime borrowers, it doesn't mean they aren't supposed to fully disclose their financial histories.
posted by saulgoodman at 2:27 PM on February 12, 2009


Let's be clear: Fannie and Freddie got lots of government support in part because they were increasing homeownership, a politically popular goal. Their profit motive and government pressure were not independent forces. And the guarantee of an implicit bailout obviously created moral hazard. Am I missing something?

Well, I'm not sure what the profit motive has to do with government pressure. They tried to increase their profits in order to better reward shareholders, and they did that, in 2005, by getting into the subprime business, which at the time was very profitable. There was no government pressure to do that.

But what's the argument that relaxed lending standards (i.e. relaxed regulations because such a relaxation supposedly increased homeownership) and a subprime loan and then derivative market, all fueled by Fannie/Freddie, were not crucial contributors?

All of those things happened, along with other things that also happened. But why does the fact that they happened matter in terms of the mortgage meltdown. Obviously, if there was no mortgage industry at all, then this wouldn't have happened, just like you can't have a drunk driving accident with no roads or cars. But that doesn't mean that Henry ford or the state government are responsible for DUI deaths. Mortgage standards can go up and down, and that's the environment that people operate in. The problem was that the mortgages were priced wrong. People thought the assets they had were worth more then they really were. Banks were so leveraged that the difference between the price they thought they were and the price they really were meant that the banks were underwater. If everything was priced correctly, it wouldn't matter who actually got loans, none of this collapse would have happened.
posted by delmoi at 2:48 PM on February 12, 2009


Period 1: Bank A is covered by CRA. Bank A has to make higher risk loans than it would have absent CRA, yes? Bank A makes CRA-type loans to low income borrowers, which is the stanted intent of the legislation.

Period 2: Bank A cannot reasonably deny higher income borrowers from taking out risky loans. Note that income is not the only factor in determining risk.


Bank A most certainly can. If it expects that it is making less money on the loans which it only makes under legal duress, then it will minimize the ability of anyone else to get them.

Furthermore, you're missing the connection between the two threads of the conversation. If the CRA mortgages defaulted less then the standards under which they were lent WERE NOT LOWER. They were definitely less appealing for a bank than pulling a number and checking a box; thorough documentation and assessment of what someone can afford. Sure, it means that some LMIs with worse credit scores are getting loans, but that doesn't mean that the standard was shifted to "the lowest credit score which got a loan".

There were no CRA stated-income and other BS loans that generated the doomed mortgages. How can you possibly suggest than banks "had" to do that because LMI loans existed? This entire argument is based on a ridiculous unsubstantiated assertion. Try to pull some quotes from 2005 from bankers saying "I hate having to give these unaffordable loans out, but the CRA required that I give loans to low income people who could afford them." You'll find a lot of mortgage officers saying "Real estate always goes up, it doesn't matter if they can afford it!"

That you don't even know what the CRA required is pretty telling. This is all out of your ass, borrowed from the AEI.
posted by a robot made out of meat at 7:33 PM on February 12, 2009 [2 favorites]


"How is it very small if in 2002 they bought $38 billion worth of subprime securities, and the whole market issued $172 billion in subprime loans? That seems like a pretty large percentage to me. And the crisis really spiked in 2006, did it not - coincident with them getting into derivatives, no?"

Note that you are pointing out exposure to subprime **securities**, while I am talking about exposure to subprime loans, which Fannie Mae did not do significantly until the very end of 2004. The securities are designed to ideally reduce risk, and are rated by type of risk, from AAA down to levels that aren't investment grade.

The fact remains that Fannie Mae experienced the vast majority of their losses based on bad subprime loans made during the 2005-2007 timespan, as the WaPo article I cited mentioned.

As for the security issues, I would suggest you read this well-researched article written by economist Mark Thoma.

As for my basic facts, it should be pointed out that it was Peter Wallison himself who led a presentation by Reagan-era conservative economist and former Fannie VP Ed Pinto, who said the following:

You need to think of Fannie and Freddie and the impact on this whole question is, really, they have two portfolios. They have their prime portfolio, which is called the other 66 percent or the good portfolio, and it’s performing, up to now, quite well. . . you can conclude that 90 percent of their losses are coming from the third that’s nonprime, which means that only ten percent of their losses are coming from the two-thirds of its prime. . . they really increased their volume tremendously in 2005, 2006, and 2007 and so 2007, when a lot of the other players had really exited the market, they really jumped in and went all in, as they say in Texas Hold ‘Em."

So, basically the problem greatly expanded during the reign of a Republican Fannie Mae appointee, overseen for most of that time by a Republican-led committee.
posted by markkraft at 8:28 PM on February 12, 2009


No. Subprime means the borrowers have lower credit scores (around 620 or less) or lower annual income than prime borrowers. While it may mean that they have less of a credit track record (i.e., haven't taken out large loans in the past) than prime borrowers, it doesn't mean they aren't supposed to fully disclose their financial histories.

That's just one aspect of what a subprime loan is. I'm arguing that in reality what a subprime loan is is a loan that is substantially riskier than a prime loan. That could be true for a variety of reasons, including lack of documentation. It's analogous to junk bonds, which are theoretically only junk because they are issued by less credit-worthy companies, but in fact are often junk also because the companies are less diligent about the transparency of their finances. A used car is technically simply a car that's been previously owned, but in matter of fact carries in its lower price the risk of unknown defects.

The creditworthiness of a loan and the disclosure of financial data are not uncorrelated, I would think. The kinds of borrowers who are less credit-worthy are generally going to be in less of a position to fully disclose.

----

Well, I'm not sure what the profit motive has to do with government pressure.


It's a quid pro quo: the government will keep the implicit promise of bailout, and look the other way while F/F stock up on subprime loans, and in exchange F/F continue the homebuying spree that makes politicians popular.

Indeed, look the other way is probably putting it mildly. Intertwined as F/F was with various congresscritters, it doesn't seem unlikely that they strongly encouraged F/F to do more to encourage homebuying, even if that meant taking riskier bets.

They tried to increase their profits in order to better reward shareholders, and they did that, in 2005, by getting into the subprime business, which at the time was very profitable.


Actually, as I've demonstrated more than once, they entered it in force in 2002, and Wallison argues that they entered it de facto even earlier, through a subtle erosion in lending standards and hidden redefinition of what subprime meant.

"There was no government pressure to do that."

But there was. See the quota issue above.

"But why does the fact that they happened matter in terms of the mortgage meltdown. ... The problem was that the mortgages were priced wrong."

I think the argument is that the REASON they were priced wrong is largely because of artificial demand for these loans, fueled in important measure (though of course not exclusively) by the F/F cheap credit combined with the politically-mandated and profitable purchase of subprime loans, made legal through relaxed lending regulation (again for political reasons). This artificial demand made possible a fluid and liquid market in these loans and derivatives based on them. This pumped up demand even further, etc.

Why are F/F so important? Because in 2002, F/F was involved in at least 25% of the subprime market, and this held true or got worse over the intervening years. It was the background against which other transactions were made (i.e. people made subprime loans thinking there was a good chance F/F would be a buyer of last resort).

And if you think some of their PRIME loans were actually less than prime-quality (as Wallison does), then some of the rest of their $5 trillion mortgage portfolio might be implicated too.
posted by shivohum at 8:34 PM on February 12, 2009


Note that you are pointing out exposure to subprime **securities**, while I am talking about exposure to subprime loans, which Fannie Mae did not do significantly until the very end of 2004. The securities are designed to ideally reduce risk, and are rated by type of risk, from AAA down to levels that aren't investment grade.

Fair enough, but the point still stands, does it not, that F/F enabled the growth of the subprime market generally -- its massive purchases of securities undoubtedly encouraged issuance of the loans by private labels. No?

And its willingness to issue near-prime loans and loans of subtly lower-quality (though still not "technically" subprime) would have meant an overall increase in the supply of subprime or close-to-subprime loan funds... and that in turn would have meant downward pressure on the costs (financial and in terms of documentation, creditworthiness, etc.) of subprime loans. The equilibrium would shift, would it not?


So, basically the problem greatly expanded during the reign of a Republican Fannie Mae appointee, overseen for most of that time by a Republican-led committee.


Look I'm hardly a supporter of the Republicans right now. But that's not my point. My question is whether relaxation of the kinds of loans and securities F/F could purchase played a critical role in driving the growth of the subprime market and the associated housing crisis.
posted by shivohum at 8:44 PM on February 12, 2009


"on the costs...of subprime loans"

I guess I mean prices, technically. :)
posted by shivohum at 8:45 PM on February 12, 2009


The relaxed lending standards were not put in place due to political pressure, rather, the lending standards that did exist were ignored because the banks were making what they thought was a fortune, and wanted desperately to move paper.

Your right about lending standards being lowered overall, but you keep trying to tie it into the CRA, based entirely on speculation and right-wing propaganda. The CRA did not facilitate the relaxation of lending standards in 2005-2007 when things really went nuts.
posted by delmoi at 6:21 AM on February 13, 2009 [3 favorites]


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