Wall Street undoubtedly should bear most of the blame for fostering the credit meltdown--which is only partially based on the problem of sub-prime mortgages. In the end, there is nothing rational about leveraging a debt at a ratio of 30 to 1, even if you believe the debt is somehow backed by the US government. This was a new practice, mostly based on complex calculus formulas that money managers falsely believed were infallible. As some GMU economists have pointed out, a portion of this was an Expert induced bubble
that was largely based on the belief that home values wouldn't go down and that local home values were accurate representations, a belief supported by experts in investment. More on this in a moment...
Spinning it back so it is ONLY the fault of HUD institutions is little more than a political rant. There is very little to this and the only reason it seems to stick in the conservative pundit's net is that it has three attractive attributes.
1) For the free market proponent it is excellent because it provides an elegant way of explaining how, far from this being the result of deregulation, it is really the result of too much regulation: i.e. the government involvement in making mortgage policies.
2) For the doctrinaire republican it provides the added bonus of being a regulation that was more likely to be pushed by democratic politicians and legislators--Freddie Mac and Frannie Mae are meant to benefit "the poor" and thus it shows how those bleeding heart liberals have, again, caused all the problems. (NOTE: depending on the commentator, the culprit here is either Barnie Frank, Bill Clinton, or a more recent democrat [sometimes Obama] for passing legislation buffering Freddie Mac and Fannie May sometime in the last 15 years; for the really old school folks, the blame rests on Jimmie Carter for passing the Comminity Reinvestment Act in 1977.)
and, in its most unfortunate iteration,
3) it contains a racist and even xenophobic component. Minorities, it is said, were the ones who most clearly benefited from these mortgages--i.e. African Americans and those of Latin American descent. In the most breathless screeds--such as those of Michelle Malkin on Hot Air--this especially includes "illegal immigrants," who are supposed to have received a boatload of mortgages to help them remain in the country illegally.
I'll start with this first one since it is both the clearest to refute and the most disgusting in it's racist implications.
As these articles point out- 1, 2, and 3 -the actual CRA (community reinvestment act) has had some of the best results of all mortgages in the past few years. This study by a NY law firm of all the CRA banks showed that they were actually less likely than other institutions to have these kinds of bad mortgages.
On the other hand, the model of offering sub-prime mortgages to people who actually qualified for a regular Mortgage is little talked about in these debates. It was a fairly widespread practice as some of the incentives were set up to encourage giving out these loans instead of a normal 30-year fixed because the brokers got better fees for the sub-prime ARMs. They got better fees because the companies offering these mortgages were expecting that people wouldn't refinance, that--like people who get credit cards at the teaser rates and don't move their money before it resets to a higher rate--the people holding the mortgages would have a boatload of cash coming in when all these higher interest payments started flowing in. They concocted all sorts of policies that made it very difficult for people to get out from under them unless they were able to refinance.
More importantly, there was, in fact, a racial component to the lending, but it wasn't in the way that these people would like to spin it. Instead of it being that blacks and hispanics were given mortages they couldn't afford because of some government sponsored program, they ended up with them because of straight up racial profiling, also discussed as "predatory lending." ACORN and all the community organizations that are getting blamed for tilting government policy in favor of minorities were actually at the forefront of the protest against the use of these subprime mortgages. The Nation had a story about this over the summer. And I wrote a blog post about this last year when the initial protests were finally making waves in the media
It notes, among other things, that the GAO (General Accounting Office) knew that this was a problem, but basically blamed the mortgage borrowers for not understanding complex mortgages they were being offered--instead of the lenders who were basically running a shell game--sometimes with very deep corruption. Mother Jones wrote about some of the worst of this back in 2006. The article notes, among other things,
Subprime lending is now an established presence on the banking scene. What began as a way for borrowers with poor credit to get loans, albeit at higher interest rates and with extra fees, has become a booming business that often targets customers who could qualify for less expensive "prime" mortgages but don't know it.
In the Cleveland area, one out of every five mortgages is subprime, and in Slavic Village subprimes account for more than half of all loans. Subprimes are much likelier than other mortgages to end up in foreclosure, even taking into account the usually shaky finances of their borrowers. Many of the loans are burdened with penalties for early repayment (which makes it tough to refinance at lower rates) and expensive mortgage insurance that is charged to buyers who make small down payments.
On Wall Street, though, high risk means high returns. Investment banks buy up thousands of loans at a time from mortgage companies, pool the loans into trusts, and then resell shares in these funds to investors. In 2004, the U.S. market in these mortgage-backed securities approached a record $4.7 trillion. Mortgage-backed securities that include large numbers of subprime loans are the most lucrative, bringing returns of up to 15 percent. Ohio isn't on Wall Street's radar: Its foreclosure disaster is just a dent in a shiny moneymaking machine. "Cleveland is the sacrificial lamb so the lenders can make more money everywhere else," says Mark Wiseman, who runs a foreclosure prevention program at the Cuyahoga County Treasurer's Office.
The worst part of this story is where they document the practice of getting a home appraisal business into the action, so that the mortgage broker is able to sell an inflated, sub-prime mortgage to an unknowing individual after having arranged for the home appraiser to inflate the supposed value. Since they were simply sending these loans out the back door in the form of securities, it didn't matter if they were backed by any value in the home. I doubt this depth of corruption existed on a national level, but it is the kind of crap that blaming Freddie and Fannie doesn't get close to.
Eliot Spitzer, then Attorney general of New York, said last February that not only did the GAO and the Bush administration not do anything about the predatory lending practices, but they prevented states from doing anything about it.
In other words, in so far as minorities are being adversely effected, it is,
1) not the result of HUD, Fannie Mae, or Freddie Mac
2) was the result of private mortgage corporations which targeted minority communities specifically to take advantage of them since they weren't experienced in the process;
3) was seen as a problem several years ago by the very activists now blamed for the crisis--and ignored by the current administration
As for whether this is the result of democratic or republican policies (Large point two above), I would contend, that, except for at the margins, there isn't much difference between these two groups. Fannie and Freddie are basic, post-war institutions that are supposed to help expand home ownership, a cornerstone of the "American dream." The most compelling article I've read tracing any of this back to any particular politician involved with Freddie and Fannie is this Village Voice piece which places the blame on Andrew Cuomo, who was director of HUD for several years.
But even this, when it comes down to it, is really just a case of the government caving to the mortgage industry. The other, more sinister version puts it at Karl Rove's feet, making it seem that the extension of mortgage credit to unworthy minorities (their characterization, not mine) was all part of an electoral ploy.
As pointed out above, these are both reductive takes on it and none of them get at the larger issue. For one thing, they are way too focused on national policies. The same thing could be said for the repeal of the Glass-Steagall act, which McCain advisor Phil Graham authored but Bill Clinton signed into law. Clinton has recently claimed that this bill actually helped lessen the current crisis. But Phil Graham, as the piece you read in Mother Jones last summer pointed out, also authored the Commodity Futures Modernization Act which helped open the door for more of the credit-default-swaps and other complex instruments that would be difficult to regulate or depend upon even if they weren't based on faulty mortgages. This created what many are now referring to as a shadow banking system. As the article points out:
In essence, Wall Street's biggest players (which, thanks to Gramm's earlier banking deregulation efforts, now incorporated everything from your checking account to your pension fund) ran a secret casino. "Tens of trillions of dollars of transactions were done in the dark," says University of San Diego law professor Frank Partnoy, an expert on financial markets and derivatives. "No one had a picture of where the risks were flowing." Betting on the risk of any given transaction became more important—and more lucrative—than the transactions themselves, Partnoy notes: "So there was more betting on the riskiest subprime mortgages than there were actual mortgages." Banks and hedge funds, notes Michael Greenberger, who directed the cftc's division of trading and markets in the late 1990s, "were betting the subprimes would pay off and they would not need the capital to support their bets."
These unregulated swaps have been at "the heart of the subprime meltdown," says Greenberger. "I happen to think Gramm did not know what he was doing. I don't think a member in Congress had read the 262-page bill or had thought of the cataclysm it would cause." In 1998, Greenberger's division at the cftc proposed applying regulations to the burgeoning derivatives market. But, he says, "all hell broke loose. The lobbyists for major commercial banks and investment banks and hedge funds went wild. They all wanted to be trading without the government looking over their shoulder."
Now, belatedly, the feds are swooping in—but not to regulate the industry, only to bail it out, as they did in engineering the March takeover of investment banking giant Bear Stearns by JPMorgan Chase, fearing the firm's collapse could trigger a dominoes-like crash of the entire credit derivatives market.
This brings be back to the first point--the one about how none of this can be blamed on the Free Market, that it is really, at it's heart, the problem of government regulation. This is the meme that has been troubling the editors at the Wall Street Journal, The Weekly Standard and other fiscally conservative (i.e. neo-liberal) publications; and it is driving the most doctrinaire economists (like those at GMU) completely bonkers--so much so that they have begun leaning on precisely the faulty meme about the CRA or Fannie/Freddie or whatever narrative they can use to control the fallout.
In doing so they actually avoid speaking at all about the market itself or any of what was going down in finance over the past few years. Finally, they fail to note what people on the ground saw long ago and that my go to source for economic news had been pointing out for years: namely that the housing bubble, was largely the follow up to the dot.com bubble; that most of the rising home values of the past few years (before the collapse) can be attributed to a combination of things:
1) Once stocks were seen as unreliable sources of value, international (i.e. not just NATIONAL) investors began sinking money into real estate in the US. In the largest forms it was in commercial real estate: this was up 60% in 2005 and 37% in 2007, to give you two indexes. But despite the current concern of sovereign wealth funds buying up foreclosed homes even that trend was present before, if only on a smaller, more individuated level.
The rising home values in Arlington, where we used to live, weren't driven by some enormous influx of population or a sudden loss of housing stock: instead there were building booms and housing values were skyrocketing because investors came in to plop down their funds into these new buildings (or old ones that might have increased value soon) with the possibility of flipping the property when it got a little bit hotter. This was seen as a more promising investment for some than stocks. But these rising home values created two effects that subprime mortgages were able to profit from--precisely because there was no government program or large scale intervention in the market.
2) on the one hand, as Doug Henwood pointed out long ago, "About 13% of the growth in GDP from 2002 through 2005 can be traced to housebuilding. About a third of the growth in consumption over the same period came from money borrowed against home equity and spent. Almost all the home improvement expenditures came from such equity withdrawals."
In other words, much of the GDP growth came from the above dynamic and a good portion of the rest came not from people getting better wages or finding new ways to use their money more productively. Instead it was largely by withdrawing the equity that they had in their homes. As others have mentioned, this is also related to the credit card debt boom (some of which was also sold off as securities and will likely be the next collapsed market) in that home equity, like credit card debt, was a way for people to pay for other large expenses--like long term care, short term emergency health care, and college education, all of which, in European countries, would be provided by society in a more general way. Some of this equity was real, but a good portion of it came from the split between what the house was worth before the housing boom and what it was worth at its peak. In other words, the abstract increase in your home's value because of rising housing costs was able to make up for the fact that "comparing house prices to household incomes shows that shelter is getting much more expensive, as the nearby chart shows."
For people who owned a house, they were able to take out home equity to make up for the fact that they no longer had an increase in wages to depend on. For people who didn't own their own home, they faced rising rents with no way of making up for the fact that they had less ability to pay them. That's what we and many other people faced in Northern Virginia. It is also eventually what led us to look into buying a house. This leads back to...
3) The way the subprime mortgage boom made it possible for us and others to buy a house in an inflated market. When one would expect the purchase of a one-bedroom condo to be within the purchasing power of the average school teacher in most markets, the only way we could afford it--and the only way most people making an average, i.e. depressed, wage could afford it--in the inflated market (again, a market inflated by investors who were hoping to cash in on real estate instead of stocks--with no intention of living in the homes they purchased and no concern about what their purchase of inflated real estate would have on average home prices) was by getting one of these subprime mortgages. On the other hand, even if there were other mortgages for which we could qualify, we might not have been offered them, though, as pointed out above, that is more likely if we were a minority.
These social trends were not related directly to Freddie and Fannie--home equity loans, which it seems made up a good portion of them, wouldn't fall under those agencies at all so far as I know. And the international financial markets--of which I've only barely touched on--were instrumental in not only instigating the rise in home values, but in supercharging the profitability of the loans which made it possible for people who lived in those local markets to be able to, briefly, afford the homes they might have been able to buy a few years ago; and which made it possible for people who didn't have increased wages, good health care, or subsidized college education to participate in those activities as well. As Doug Henwood and others pointed out for many years, the reason that the Chinese government was continuing to buy US treasury securities, thereby propping up both the value of the US dollar and the long term lending rate (much to the chagrin of the US federal reserve, which tries to manage the latter by manipulating the short term interest rate and found its mechanations useless in the face of the Chinese central bank's activities) was that it wanted US consumers to continue to buy Chinese crap even though this often meant living beyond their means. I'm a bit too tired to try to talk about this--especially because I don't understand it all that well--but needless to say, there is a much bigger reason for the bailout than just Wall Street: the Chinese government and other foreign investors, many of which poured money into both US treasury bonds and the stocks of Freddie and Fannie, are very concerned not just about these investments, but about the continued strength and existence of the US dollar. the latter has, since the 1970s, been the benchmark currency of the world economy and has been the most common denomination for foreign currency reserves, in no small part because OPEC prices and sells its oil in dollars.
The possibility of this faltering has dire consequences not only for the future of the US economy, but also for the future of US power around the world. That is why, until the naysayers are able to admit what has just happened, they won't be able to begin to repair the enormous damage that has been done. A good final word in that direction comes from Francis Fukuyama, who a little over a decade ago predicted that we had reached the "end of history" and that all countries from then on out--following the collapse of the USSR--would immediately adopt the US model of liberal democracy and free market capitalism. Whatever the flaws of this prediction, he is smart enough to know that there is now devastating evidence that it isn't coming true anytime soon and that, in general, the US brand has just been undermined, possibly for good if we can't learn from this tragedy.
His concern, to be clear, is for how to restore it. In large part, for him this means giving up some of the canards that Palin seemed bent on repeating over and over, especially the now laughable terms of the Laffer curve, which claims that tax cuts increase jobs and eventually pay for themselves. The good thing, it seems, is that neither party is claiming deregulation is always a good thing at this point.
The United States has come back from serious setbacks during the 1930s and 1970s, due to the adaptability of our system and the resilience of our people. Still, another comeback rests on our ability to make some fundamental changes. First, we must break out of the Reagan-era straitjacket concerning taxes and regulation. Tax cuts feel good but do not necessarily stimulate growth or pay for themselves; given our long-term fiscal situation Americans are going to have to be told honestly that they will have to pay their own way in the future. Deregulation, or the failure of regulators to keep up with fast-moving markets, can become unbelievably costly, as we have seen. The entire American public sector—underfunded, deprofessionalized and demoralized—needs to be rebuilt and be given a new sense of pride. There are certain jobs that only the government can fulfill.The meme about Freddie and Fannie is, in part, an attempt to stifle the actual lesson of this disaster. Whatever truth there is to it, it pales in comparison to the larger truth it simply cannot refute: namely, this is a disaster that is ultimately the result of the larger political-economic framework of the past thirty years. If we remain unwilling to adjust it--or if, as House Republicans did last week--we insist on imposing that framework in an even starker degree of ideological purity, we will be in for a lot of trouble. More accurately, there will likely be an enormous amount of resistance from the average American. After thirty years of protecting investors, at the expense of the American citizen, it really doesn't seem all that much to ask for the scales to be shifted in the opposite direction for a while.
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