14 January 2010

Housing Collapse

This is from a previous post I made back in June. The housing collapse recently came up in another discussion so I am reposting this portion:

Many people have expressed a lack of understanding on how we came to be in this economic mess in the first place. I did some reading and here is some of the factors that caused the meltdown. First there was the Community Reinvestment Act of 1977. This created an "affirmative obligation" that banks had to give more loans to poor people and minorities. In 1989 Congress changed the Home Mortgage Disclosure Act and made banks record racial and other personal data on mortgage applications.Then in 1995 the Clinton Treasury Dept. began tracking loans by neighborhoods, income groups, and races. They used this data to rate the performance of banks. These ratings were used to determine if bank mergers, acquistions, or new bank branches would be approved. So the government encouraged banks to give more loans to poor and minorities. Groups like ACORN and other community activists began extorting banks and pressured them into making more bad loans. With all of this going on banks were forced to abandon traditional underwriting standards. Otherwise the government would not allow the banks to expand. This government interference created the subprime mortgage market. Then in 1992 the Dept. of Housing and Urban Development created government corporations Fannie Mae and Freddie Mac to buy up bundles of these sub-prime loans.This diversified the risk and made more money available for banks to make more risky loans.Then Congress passed something called the Housing Enterprises Financial Safety and Soundness Act. As with most legislation the title did not match the bill. This essentially mandated that companies had to buy 45% of all loans from people of low to moderate incomes. In 1995 the treasury dept. established the Community Development Financial Institutions Fund and provided banks with tax money to encourage even more high risk subprime loans. Fannie and Freddie were not regulated or forced to adhere to standard business and oversight practices. When people called for them to open up their books and comply with ethical and financially sound regulations top congressional allies of Fannie and Freddie, including Barney Frank Chris Dodd, Chuck Schumer, and others resisted all efforts of reform. Meanwhile Fannie and Freddie executives cooked the books and awarded themselves millions in bonues. Government interference and social engineering created the derivatives market. Deriviatives are contracts. One bank would sell the risk associated with a mortgage to another company in exchange for payments based on the loan's value. It was kind of like buying insurance. People were gambling. They were betting on which mortgages would be foreclosed and which would not. This practice spread and multiplied the risk of bad mortgages to other parts of the economy. The last factor that played a huge role in the economic crisis was the Fed. From Jan. '01 to June '03 the Fed slashed interest rates from 6.5% to 1%. So the Fed imposed an easy money policy that artificially manipulated the housing market, interfered with normal market conditions, and destabilized the economy. When everything began to crash the government started spending money like crazy. First it was TARP at the end of '08. This program alone might exceed $1 Trillion. or 7% of our GDP. $350 billion of that TARP money is currently unaccounted for. The Fed also began bailing out companies like Bear Stearns and AIG, and of course Fannie and Freddie got $200 billion. The Fed all together gave out $7 trillion. Then of course there is the so called stimulus package which has also been a staggering waste of money. Thus far it has been a slush fund wrought with corruption and fraud. All of this spending has slowed economic recovery and will cause a lot of pain in the future. This thing is not over yet. So all in all there are a lot of culprits responsible for this economic meltdown. Its origins are further back than people realize. This storm has been coming for a long time and there are no clear skies in sight. So cheer up the worst is yet to come! ;-)

5 comments:

Silke said...

With all of this going on banks were forced to abandon traditional underwriting standards. Otherwise the government would not allow the banks to expand. This government interference created the subprime mortgage market.

Not true. Federal Reserve Board data show that more than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions. Only one of the top 25 subprime lenders in 2006 was directly subject to the housing law criticized by conservatives.

“Fannie and Freddie, however, didn’t pressure lenders to sell them more loans; they struggled to keep pace with their private sector competitors. In fact, their regulator, the Office of Federal Housing Enterprise Oversight, imposed new restrictions in 2006 that led to Fannie and Freddie losing even more market share in the booming subprime market. What’s more, only commercial banks and thrifts must follow CRA rules. The investment banks don’t, nor did the now-bankrupt non-bank lenders such as New Century Financial Corp. and Ameriquest that underwrote most of the subprime loans. These private non-bank lenders enjoyed a regulatory gap, allowing them to be regulated by 50 different state banking supervisors instead of the federal government. And mortgage brokers, who also weren’t subject to federal regulation or the CRA, originated most of the subprime loans.”

http://www.mcclatchydc.com/251/story/53802.html

Government interference and social engineering created the derivatives market.

Actually it was the lack of government regulation that lead to new and more complex financial instruments such as credit default swaps (CDS). The CDS market was estimated to be in excess of $50 trillion and was unregulated.

SSG_E said...

Didn't we already go over this on the other blog?

At any rate I do not think this is an 'either or situation.' This collapse was due to a complex web of policy failures, corruption, and stupidity from both the govt and large lenders. It was a complicated collapse and we were building on top of sand for a long time.

SSG_E said...

I see, I thought I replied to this on the other blog but my comment didn't post. This is what I meant to post there:

"I don’t dispute the government bears some responsibility but to place it all on the government is simply false."

I never claimed that it was entirely the govt's fault. They were a major player in it though. It is certainly not the fault or "the free market." We don't even know what a free market is in America anymore. We should give it a try some day.

“turmoil in financial markets clearly was triggered by a dramatic weakening of underwriting standards for U.S. subprime mortgages, beginning in late 2004 and extending into 2007.”

This problem is far more complex than that. It also began a long time ago. It was a convergence of terrible monetary and fiscal policy, poor management in these financial institutions affected, and corporate cronyism due to govt interference. Underwriting standards were abandoned under outside pressures and distortions in the markets created by govt policy and a failure by the govt to enforce regulations that already existed.

"Federal Reserve Board data show that more than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions."

Of course. Most mortgages were issued by private institutions. This does not really dispute my point.

"Only one of the top 25 subprime lenders in 2006 was directly subject to the housing law"

The key word there being 'directly'. This isn't a closed system. Laws have rippling effects through the markets. Lenders decided that if this is where the govt is going then they need to be in to take advantage of it. Poor decision on their part obviously. As lenders started selling the subprimes it was like a stack of dominoes. Other institutions decided they needed to by in it too in order to remain competitive. Allowing non-bank lenders into this market was a terrible mistake and it was also a chief component of this crisis.

Silke said...

With all of this going on banks were forced to abandon traditional underwriting standards. Otherwise the government would not allow the banks to expand.

They were not forced. Private lenders wanted to make a profit and the availability of unregulated complex financial instruments allowed them to pass of the risk of bad loans. Most of the subprime loans didn’t even come from traditional banks subject to government regulation.

I never claimed that it was entirely the govt's fault. They were a major player in it though.

This is what you said: “Govt interference into the housing market over the last two decades caused the housing collapse and is responsible for millions of foreclosures. They wanted to help the poor own a house, but instead they tanked the entire market and created a greater problem than what had existed before.”

It’s not true (for reasons I provided earlier). Now you’re changing your story: “At any rate I do not think this is an 'either or situation.' This collapse was due to a complex web of policy failures, corruption, and stupidity from both the govt and large lenders. It was a complicated collapse and we were building on top of sand for a long time.”

At least this version is closer to the truth.

SSG_E said...

Sorry for the long delay. We can just agree to disagree. You admit it is not an either or. I agree. I never changed my story. The post I made here was written long ago. More info has become available since then and it is clear that the situation was far more complex than any of us realize. If gov't was not so prevalent and corrupt it would not be so beholden to special interest groups that caused these problems. There were banks lobbying for de-regulation, community organizers and politicians strong arming lenders into making bad decisions, greedy people simply being stupid, and politicians trying to buy votes. It is simply more evidence that we need much smaller gov't that answers to the people rather than special interests. Right now our gov't is one of diffused burden and centralized benefits. Wall Street, unions, and certain other lobbyists are receiving all of the benefits of gov't. If you are a member of a protected class like a public service union then you are golden. If you are a regular American you get screwed. It is time these clowns answer to us.