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Who should we blame for the mortgage crisis?

16 January 2010

Here are questions asked on the FM website this week (some of these were assertions, which I’ve rephrased at questions).  Click on the question to go directly to the answer.

  1. Did FNMA and the other Government Sponsored Enterprises cause the sub-prime mortgage crisis?
  2. Did the Community Reinvestment Act cause the housing crisis?

(1) Did FNMA and the other Government Sponsored Enterprises cause the sub-prime mortgage crisis?

Stuki Moi wrote about the subprime mortgages here.  Did FNMA and the other Government Sponsored Enterprises cause the sub-prime mortgage crisis?

The primary cause of the housing bubble was a series of changes in regulation of the financial system, removing constraints imposed during and after the Depression — changes driven by banks. For a description of these changes in laws and regulations see “The Evolution of the Subprime Mortgage Market” by the St Louis Fed.

Let’s take the analysis one step further. Given the primacy of these structural changes by Congress and regulators, what was the role of the GSE’s as players in the sub-prime part of the bubble? At Calculated Risk, one of the go-to sites for reporting on the housing crisis, Tanta said:

I think we can give Fannie and Freddie their due share of responsibility for the mess we’re in, while acknowledging that they were nowhere near the biggest culprits in the recent credit bubble. They may finance most of the home loans in America, but most of the home loans in America aren’t the problem; the problem is that very substantial slice of home loans that went outside the Fannie and Freddie box.

For something more specific see:

Between 2004 and 2006, when subprime lending was exploding, Fannie and Freddie went from holding a high of 48 percent of the subprime loans that were sold into the secondary market to holding about 24 percent, according to data from Inside Mortgage Finance, a specialty publication. One reason is that Fannie and Freddie were subject to tougher standards than many of the unregulated players in the private sector who weakened lending standards, most of whom have gone bankrupt or are now in deep trouble. During those same explosive three years, private investment banks — not Fannie and Freddie — dominated the mortgage loans that were packaged and sold into the secondary mortgage market. In 2005 and 2006, the private sector securitized almost two thirds of all U.S. mortgages, supplanting Fannie and Freddie, according to a number of specialty publications that track this data. (source: McClatchy Newspapers)

A second calculation confirms this: “From 2004 to 2006, the two purchased $434 billion in securities backed by subprime loans, creating a market for more such lending.” (source: WaPo). That’s 5% of the roughly $10 trillion in outstanding mortgages, aprox 1/5 is subprime.

A third set of evidence provides definitive proof, since the housing bubble was a global event: “Safe as houses – Compare countries’ house-price data over time“, The Economist, 30 December 2009.

Two important notes about this, however.

  • The GSE’s were major factors in the overall mortgage bubble by converting mortgages into government-guaranteed securities.
  • Now owned by the government the GSE’s and FHA have become the subprime market. Conduits for massive flows of our money into subprime mortgages, attempting to save the banks and re-inflate the US economy. This is an almost certain-to-fail strategy, the cost of which probably be horrific.

(2)  Did the Community Reinvestment Act cause the housing crisis?

Or, more mildly stated, was it a major cause of the crisis?   Here we have another politically useful urban legend, confidently asserted many times in the comments.  Since facts mean nothing when seeking political power, we can expect this story to circulate for many more years despite its almost total lack of factual foundation.  There is near-zero evidence that the Community Reinvestment Act, passed in 1977 played a significant role in the mortgage crisis. This is just right-wing propaganda. Matthew Yglesias gives the nickel summary on this:

“The technical term for this argument is ‘bullshit.’ For one thing, the timeline is ludicrous. The Community Reinvestment Act was passed in 1977. Are we supposed to believe that CRA was working smoothly throughout the Carter, Reagan, Bush I, and Clinton years and then only under Bush II did overzealous anti-”redlining” enforcement come into play, perhaps a result of Dubya’s legendarily close relationship with ACORN? Or maybe overzealous enforcement back in the late 1970s is somehow responsible for a real estate blowout that only materialized 30 years later? It doesn’t even come close to making sense.”

Note that the people asserting this seldom (if ever) cite actual research, just op-eds and stray quotes. For a more detailed rebuttal see the following, a sample of the many studies on this subject:

For a summary of these studies see “Setting the Record Straight: Blame Conservatives, not CRA, for subprime mortgage mess“, Tim Westrich (bio), Center for American Progress, 30 September 2008:

Studies done by respected institutions—not just CRA’s cheerleaders—show that CRA works at what it was intended to do: overcoming market failures in low-income communities. Case in point: CRA-regulated lenders operating in their so-called assessment areas (census tracts where they maintain deposit-taking operations) have shares of conventional, prime home purchase loans that exceed the equivalent shares for out-of-area lenders or non-covered organizations, said a study by Harvard’s Joint Center for Housing Studies in 2002. And as late as 2005, when Bush-appointed bank regulators were trying to water down CRA, an evaluation by the Brookings Institution concluded that by fostering competition among banks in serving low-income areas, CRA generates larger volumes of lending from diverse sources and adds liquidity to the market, decreasing the risk of each bank’s loan.

Afterword

Please share your comments by posting below. Per the FM site’s Comment Policy, please make them brief (250 word max), civil and relevant to this post. Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).  Reference pages about other topics appear on the right side menu bar, including About the FM website page.

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4 Comments leave one →
  1. Greg permalink
    16 January 2010 5:42 am

    Did FNMA and the other Government Sponsored Enterprises cause the sub-prime morgage crisis?
    Did the Community Reinvestment Act cause the housing crisis?

    “CAUSE”??? No Nope No way. …merely one of the vehicles that facilitated the promulgation of fraud.

    The main “culprit” from an operational point was (and still is) the creation of a parallel, formal “shadow system” of banking and finance that was allowed leverage at unheard of multiples and essentially now to be seen as State sponsored (The Treasury did in fact and continues to backstop this) fraud and looting. Couple that reality with the metaphysical error of allowing these entities to decouple debt from the debtor and assign such debt the status of “asset” and POOF! The USA FINANCIAL SYSTEM reaches collapse.

    It is that simple.
    .
    .
    FM reply: No, it’s not that simple. Nor is the prime role of the “shadow financial system” anything more than pleasant story. It serves to deflect blame from the major actors. In fact most of this was done in the daylight. The finance industry and its regulators just didn’t want to see — there was too much money to be made.
    * The 1999 repeal of Glass-Steagall, with the predictable consequences (the things it prevented for 65 years)
    * The 2004 change in the net capital rules
    * The failure of bank regulators to respond to the obvious breakdown of the lending process. This was obvious by early 2005, when the Calculated Risk website was started to track the mortgage follies. The regulatory agencies spotted these problems earlier, but due to regulatory capture did nothing despite their vast powers.

    Like

  2. Greg permalink
    16 January 2010 3:39 pm

    No you are cognitively confused. And it is very simple. You are confusing and deflecting blame with your abstraction. “RULES”, “Regulations” are not actors. Actors produce actions/results. The repeal of GS was a vehicle not a cause. Net Cap Rules were a reflection of a Shadow System fully functioning and already teetering on dissolution.

    AIG was not a ‘bank’ and was not affected by either of these ‘regulations’. And former Drexel B L People had come along way earlier than any of your examples and formulated a system that was designed to befuddle and confuse and skirt any and all regulations. Mr Greenberg loved these boys and the copy cats saw the beauty and away they went.

    To assign cause to a rule or reulation allows the actors to drift into the background. In essence such ideas as yours function as an abstraction (and deflection from blame and responsibility) that not only confuses the issues and consequences of human actors but allows the crimes to go unpunished. Your dismissive notion of a “pleasant story” is simply an effort by youn to avoid dealing with the frauulent nature of ALL that transpired and worse moires us in a room where solutions cannot arise. Defining the problem or cause is the most important part of rectification and future prevention.

    Obviously and unfortunately for the readers you simply do not understand the functioning of the shadow system that you assign to fairy tale status and worse do not comprehend how a few bad lending patterns resulted in the failure of the Financial System/. And “leverage” is truly foreign to you. Witness Blankfein and Dimons distortions this week in front of Congress. Your ideas are as dangerous as they allow the actors to lie and pretend that it just happened! Like a Hurricane Like an earth quake. Like a few reulations. RUBBISH! Not just a few apples were bad, sir. And a few strokes of the regulatory pen would extract them….no. The BARREL is ROTTEN! And a very clever Barrel it is
    .
    .
    FM reply: Your comment grossly misrepresents what I said. While I share your anger, this is an empty polemic and IMO helps not at all.

    “‘Regulations’ are not actors.”
    I said “The finance industry and its regulators just didn’t want to see — there was too much money to be made.” Those are the actors, the rule changes were the actions.

    “To assign cause to a rule or reulation allows the actors to drift into the background.”
    Nonsense. Understanding the regulatory changes that created the problem not only allows us to assign blame (to those who drove the changes), but also illuminates the reforms that need to be made.

    “AIG was not a ‘bank’ and was not affected by either of these ‘regulations’.”
    First, why do you put regulations in quotes? Those were in fact regulatory changes. (BTW my list was obviosly a sample to illustrate how regulatory changes drove the bubble, not a comprehensive list).Second, AIG is a remarkably poor example of the “shadow banking system.”
    (a) As one of the world’s largest insurance companies, it was hardly in the shadows.
    (b) Insurance companies are regulated tightly — just like banks.
    (c) The over the counter derivatives that sank AIG were largely marketed and run by banks. The US banks in this biz were JP Morgan and (tied in distant 2nd place) BofA and Citicorp (from memory).

    “The BARREL is ROTTEN!”
    I don’t know what this means, if it means anything. The US financial system is grossly flawed, in ways that have been clear for many years. No reforms have been made due to the political power of those in the finanical sector. Only a widespread call for action will produce change, from the business community (main street, on which wall street has become parasitic) and the general public.

    “you simply do not understand the functioning of the shadow system”
    I suspect its clear to readers who better understands the situation. I cite specific facts and events, while you rant and rave. Plus there are my many accurate predictions about the economy over the past 2 years or so (can you show anything similar?).
    * End of the post-WWII geopolitical regime
    * Financial crisis – what’s happening? how will this end?

    For a analysis easily understood by the general public I recommend these as good starting points:

    (1) “The Quiet Coup“, Simon Johnson, The Atlantic, May 2009 — Johnson was IMF chief economist, now MIT professor). Excerpt:

    The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time.

    (2) “The Great American Bubble Machine“, Matt Taibbi, Rolling Stone, 9-23 July 2009 — “how Goldman Sachs has engineered every major market manipulation since the Great Depression ” Taibbi examines the role of one institution, to put a face on the crisis.

    Like

  3. Nisha chauhan permalink
    26 January 2012 7:43 am

    is financial crisis man made??

    Like

    • 26 January 2012 1:20 pm

      “is financial crisis man made??”

      As oppoesed to what? Acts of God? Yes, man-made.

      Perhaps you mean “was the crisis deliberately created?” No, it was not.

      Like

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