Quick primer: Origins of the housing crisis

Fannie and Freddie’s affordable housing goals (authorized by the ironically named Federal Housing Enterprises Financial Safety and Soundness Act—the GSE Act—and enforced by HUD) were responsible for many distortions of the housing finance market. One of the most significant was that Fannie and Freddie (the GSEs) were required to compete with FHA and subprime lenders for loans that qualified under one or more of the affordable housing goals. The GSEs’ competition with FHA started in 1993 and by the mid-1990s had expanded to subprime. This competition combined with the National Homeownership Strategy required the GSEs (and the market generally) to progressively reduce down-payment requirements. By the early 2000s zero down loans had become commonplace across all market segments including subprime and Alt-A.

The GSE Acts also set low capital standards for Fannie and Freddie. These allowed them to operate at extraordinary leverage levels (for example: 220:1 on their MBS guarantee business).

The resulting high levels of leverage greased the slippery slope of declining standards and fueled the housing boom. It is now five years after home prices started declining and we have yet to deal with excessive leverage.

Michael Cembalest, Chief Investment Officer of JPMorgan, wrote an article that makes use of research from my Government Housing Policies in the Lead-up to the Financial Crisis: A Forensic Study relating to diminishing down payments and Fannie’s competition with FHA.

5 thoughts on “Quick primer: Origins of the housing crisis

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  3. Mr. Pinto this comment is in no way to be construed as disagreeing with you. However, we all only have parts of a big picture of truth of what happened with the financial crisis.

    Jeffrey Friedman in his new book Engineering the Financial Crisis convincingly shows that a “cascade” of trillions of dollars poured into the U.S. from 2000 to 2007 in the hope of bailing out the European welfare state with double digit investment returns. He fingers the Basel II Accords as liberalizing global finance to allow money to flow to the U.S. He also points out that Congress approved the Basel II Accords which replaced the bond rating standards of Moody’s and Standard and Poors with the Basel II Accords. Commercial banks under Basel II were given quotas of how much in mortgages they were to hold in their portfolios.

    The housing crisis started in Europe, flowed to the U.S. and found fertile ground with the unfunded liabilities of large government pension funds that also needed double digit returns to bail them out of a future disaster. So by “elective affinity” (Max Weber’s term) the Community Reinvestment Act and the liberalized policies of Fannie and Freddie coincidentally served the larger policy interests of trying to bail out the European welfare state to avert a repeat of rise pre-WWII totalitarianism and fascism.

    Ironically, Wall Street tried to bail out not only the welfare state but pensions. So it was trying to prop up both “Occupy Wall Street” (welfare state programs) as well as Tea Party interests (pensions). There was greed at the micro level by flippers and house speculators. But at the macro institutional level the commercial banks invested in the most conservative form of investments – mortgages – thus no greed. As fate would have it the only way to bail out the welfare state and pension systems was to expand the pool of home borrowers to the rentier class – thus subprime mortgages and securitized mortgage bonds.

    There are many layers of meanings and causes to the crisis. At the base is the lack of babies and intact family formations in Europe and the U.S. to support the welfare state and pensions. Fannie and Freddie were just bastard children that should have been aborted.

  4. Sorry to disagree but rather than blame the housing crisis on FNMA and FHLMC who merely faciliated the problems, let’s assign the blame where it should rest – on the gred of everyone involved:

    1. the purchasers who thought that housing was a speculative investment rather than a home in which to live and raise their families;

    2. the homebuilders who overbuilt and, when the market was sated, attempted to artificially create a new market with zero downpayment financing;

    3. the banks and other financial institutions who failed to properly underwrite mortgages and lent money to unqualified purchasers;

    4. Wall Street who created a new investment, mortgage-backed securities, and , with an apparent lack of proper due dilligence, sold them without concern for their actual value;

    5. Congress who created the Federal Housing Enterprises Financial Safety and Soundness Act (the GSE Act).

  5. This mess is far from over, it has only gotten worse. Fannie and Freddie just lost another $45 billion and the exec’s running it collected $12.5 million in bonuses. As usual, The Peter Principle at work, the perpetrators of corruption and incompetence are rewarded. More taxes, more spending, more big government solutions. Meanwhile, you conveniently neglect to mention the repeal of the Glass Steagall Act that was enacted specifically to prevent what happened in the Depression by allowing banks to sell securities and insurance, which resulted in the securitization of bad mortgage loans for bank profits. Banks too big to fail? That’s not capitalism, that’s crony capitalism. Bankruptcy is the market correction for banks that make bad loans, not taxpayer bailouts. And prison is the answer for corrupt politicians who profit from breaking the laws they swore to uphold and protect. As to your comment about TEA Party interests being pensions, I beg to differ. While pensions are certainly a concern to all who are relying on them for retirement, it is the corruption both of our politicians and crony capitalist corporations that is bankrupting our country and destroying the future of freedom for our children and grandchildren, paid for by the blood of our fathers and grandfathers, that is what drives the TEA (Taxed Enough Already) Party. The way you paint it with your comment about pensions makes it sound as though the TEA Party were a self-serving interest group only looking out for their own financial interests and I couldn’t disagree more.

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