The Subprime Meltdown
As anyone who’s looked at this issue with even a shred of intellectual honesty knows, Fannie and Freddie and especially the CRA had almost nothing to do with it:
Commentators say that’s what triggered the stock market meltdown and the freeze on credit. They’ve specifically targeted the mortgage finance giants Fannie Mae and Freddie Mac, which the federal government seized on Sept. 6, contending that lending to poor and minority Americans caused Fannie’s and Freddie’s financial problems.
Federal housing data reveal that the charges aren’t true, and that the private sector, not the government or government-backed companies, was behind the soaring subprime lending at the core of the crisis.
Subprime lending offered high-cost loans to the weakest borrowers during the housing boom that lasted from 2001 to 2007. Subprime lending was at its height from 2004 to 2006.
Federal Reserve Board data show that:
* More than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions.
* Private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year.
* Only one of the top 25 subprime lenders in 2006 was directly subject to the housing law that’s being lambasted by conservative critics.
…snip…
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.
In 1999, the year many critics charge that the Clinton administration pressured Fannie and Freddie, the private sector sold into the secondary market just 18 percent of all mortgages.
Fueled by low interest rates and cheap credit, home prices between 2001 and 2007 galloped beyond anything ever seen, and that fueled demand for mortgage-backed securities, the technical term for mortgages that are sold to a company, usually an investment bank, which then pools and sells them into the secondary mortgage market.
About 70 percent of all U.S. mortgages are in this secondary mortgage market, according to the Federal Reserve.
See also here:
Notice that the delinquency rate is highest in the years after Fannie and Freddie are constrained in terms of their subprime holdings.
You got that? The overwhelming majority of bad loans — over 84% — were not made or backed by Fannie and Freddie. Twenty-four of the top twenty-five subprime lenders (96% of them) were not covered or regulated in any way by the Community Reinvestment Act. Of course, silly “facts” won’t stop the True Believers (like John Sununu) from parroting their Fox News talking points.
UPDATE: The best overall summary I’ve seen of what happened can be found here (PDF). H/T: Econbrowser.
[...] [I originally had the full post mirrored to this site, but rather than monopolize Uncle's front page, I figured I'd just redirect you to Lean Left.] [...]
And 16% of the bad loans fall squarely on two companies — Fannie and Freddie. Out of over 200 lenders, two companies account for over 1 in 6 came from two government backed (and therefore risk-immune) companies.
No company is an island, and all the other lenders were forced to compete with these risk-immune powerhouses. They had to make riskier loans simply to compete, and FM/FM had little reason to moderate their behavior.
You can’t remove Fannie and Freddie from the analysis. They put pressure on every loan, whether they back it or not.
Let’s not forget the following:
a) Some of those major private banks were sued and threatened by the government to provision more urban loans or lose access to monies.
b) That those private banks were forced to compete in against a socialized mega bank for mortgages.
Factor those two things in, and I still lean toward government meddling created this problem.
Phelps:
The number of lenders is irrelevant. The number of loans they held, and the percentage of those loans that went bad, is. 16% of the loans that went bad were held by Fannie and Freddie at a time when Fannie and Freddie controlled 26% of all the loans. Basic math tells us, then, that the loans held by Fannie and Freddie were substantially less likely to go into default than those made by their private sector counterparts. Seems to me like that reflects well on Fannie and Freddie, not poorly.
I don’t argue that Fannie and Freddie should be removed from the analysis. I don’t even argue that they were in no way involved. All I argue is that I’ve seen zero credible evidence that Fannie and Freddie (and especially the CRA) were anything like the cause of the problem.
N.U.G.U.N.:
As I stated at Uncle, I’d like to see evidence demonstrating that those two things were significant factors. I’d especially like to see evidence of “a” being a common occurrence. Because all the hard numbers I can find say quite the opposite. See the newly-linked PDF above.
A bit more on point b, while we’re at it. The private banks weren’t competing with Fannie and Freddie. They were selling their loans to Fannie and Freddie. It was only when they stopped being able to rely on F&F that those banks really started making irresponsible loans in large numbers.
Sure.
But with FM/FM doing it at Uncle Sam’s command, and the implicit backing of private banks, a moral hazard was created which encouraged bad actors in the private sector to play along. Not to mention artificially tilting the market so that such practices seemed even remotely feasible.
Was it stupid and greedy for the private firms to jump on the bandwagon? Absolutely. But getting mad now is a bit like slapping a child for repeating the naughty word you just said which they assumed must be okay because you did it.
But, then, I suppose it’s not much fun admitting that everybody screwed up when there’s fingers to be pointed. :p
tgirsch, what exactly are you trying to prove? Business cycles are a natural part of the economy–things are profitable in one area, so everyone pumps more capital into it, and they overshoot the opportunity. It happens all the time, in lots of industries.
You seem to think that we can somehow “regulate” these business cycles, so that the economy grows at a steady 2%/year forever, or at least steadier than what we’ve got now. But remember–just because you’ve “proved” that businessmen want to make money (duh!) and the masses will sign anything (duh!) doesn’t mean that bureaucrats are intelligent, disinterested, incorruptible, and prescient. I’ll take capitalism (with laws against crimes, not stupidity) over collectivism/socialism/”regulation” any day–because businessmen get punished by the market for their stupidity (well, they did before the bailouts) and bureaucrats get away with whatever they heck they want. Planned economies don’t have a record of steady growth, but by all means, demonstrate that Hayek and Friedman were wrong, show us all how a planned economy can survive long-term, and then we’ll have something to debate.
Face it, T., you said it yourself: Facts do not impress some people, most especially people whose single-minded desire is to find a way to blame government (and particularly government assistance to the poor) for all economic, and most social, ills – and that will involve a willingness to blame either too much or too little regulation, whichever is required to that end.
Greed is part of human nature. People, especially if they are protected by a corporation, wil do whatever they can possibly get away with.
Who started making sub-prime loans? Who started forcing sub-prime loans? Who started securitizing mortgages?
That’s where the blame lies.
LarryE and tgirsch,
NUGUN is right, I’m in this business and have been for 13yrs. now. If you go back and look at some of the footage of Barney Frank and Nancy Pelosi you will see it, saw it on YouTube….they thought lenders weren’t doing enough and were possibly discriminating against lower income borrowers. They are also the folks who rebuffed the Bush administration’s request for Fannie and Freddie to re-capitalize or increase their cash reserves, stating that current home equity levels were sufficient to avoid cooling off of the housing market……whoops
Scen:
Except that, relatively speaking, the lower-income borrowers through Fannie/Freddie loans weren’t the ones at the highest risk of default — that fell to aspirational middle-class buyers, many of them outside of Fannie/Freddie’s purview. Whoops.
I think it is important to separate the Fannie and Freddie question from the CRA question.
The CRA argument is absolute conservative bullshit designed to blame Clinton for the problem. Basic logic tells us that any bank that is forced to make unprofitable loans in order to satisfy some regulatory requirement is going to make the absolute minimum quantity. The overwhelming majority of loans were made by entities that were not subject to the CRA, were securitized by entities that were not subject to the CRA, and were sold to investors who were not subject to the CRA. They were made because it was believed that a rising housing market would cover all sins.
Fannie and Freddie were over-leveraged badly run institutions that contributed to the housing bubble. However, the default rate on their loans is much lower than average and according to a recent article in Vanity Fare, they have in fact only required a tiny fraction of the bailout funds that the rest of the finance industry has required.
One of the points of discussion that is missing is the derivatives that were able to be written on FM/FM loans. Being in the banking business, I wrote code that managed these derivatives. They were sold as US Govt. backed securities. I sat down and did the math and realized that the value of all of the derivatives on $1 backed by the US was about $4. That was just in the bank I worked for.
It is not just the value of loans or the % of the market that FM/FM had, you also need to look how FM/FM used those loans as assets for other deals.
By the way, the last I heard was that if you valued all of the derivatives they are about 4 time the WORLD GDP.
Trost Osler -
Sitting in a culture that values “more” as a basic concept, I don’t feel in a position to argue if greed is “part of human nature” or not. But even if it is, that is no more an excuse than the claim that violence is part of human nature is an excuse for murder.
Scen -
they thought lenders weren’t doing enough
And they were right.
possibly discriminating against lower income borrowers
Not quite. The charge was discriminating against lower-income neighborhoods through the well-known and justifiably infamous practice called red-lining, of simply refusing to extend credit to anyone who lived in certain neighborhoods regardless of their individual circumstances. There were cases uncovered where whether or not you got a loan came down to on which side of a particular street you lived.
Vinny -
it is important to separate the Fannie and Freddie question from the CRA question
Agreed.
any bank that is forced to make unprofitable loans in order to satisfy some regulatory requirement
Except that they weren’t. In fact, the CRA required in so many words that banks follow sound business practices. The point was that, as our self-announced industry people here surely know, every lending institution carries a certain amount of risk on its books. One of the ideas of the CRA is that banks could not properly simply suck money out of a neighborhood (by accepting deposits from there but extending no credit there) – that some portion of that risk had to be related to investments in those communities. (Thus the name of the act.)
The overwhelming majority of loans, etc.
Precisely.
it was believed that a rising housing market would cover all sins
And that distributing the risk via derivatives would spread it around to the point where there really wasn’t any risk at all, not worth noticing, anyway.
over-leveraged badly run institutions that contributed to the housing bubble
Yup. But the key phrase there, as I expect you realize, is “contributed to” as opposed to what the right wing would have it be, which is “caused.” And in that difference lies the core of the dispute: the desire of some to exonerate private industry and excoriate public (or quasi-public) institutions.
http://www.youtube.com/watch?v=hxMInSfanqg
bob:
The premise of that video is that Fannie and Freddie caused the crisis. If they didn’t, then whatever you think of Pelosi and Frank’s handling of things isn’t terribly relevant. In case you haven’t been paying attention, we’ve presented quite a bit of evidence that Fannie and Freddie didn’t cause anything.
I’m still trying to figure things out but here is my best guess so far.
Alan Greenspan cutting interest rates to 1% and keeping them there for a long time was a huge part of the problem. This brought mortgage rates down and inflated the housing bubble. It also made mortgage-backed derivative securities (with their fantasy AAA ratings) extremely attractive to yield starved investors who were desperate for a better return on their money.
The culture of Wall Street and the finance industry ties everyone’s earnings to the short-term production of transactions regardless of risk rather than the long-term stability in returns of either assets or company. This is a situation that has been building since the Reagan years with plenty of blame to go around.
Deregulation itself really wasn’t the problem because much of this was brand new crap that really had never been that heavily regulated in the first place. However, the philosophy that underlies deregulation—i.e., that the free market should be trusted to make the optimum risk allocation decisions—was a huge part of the problem. This was a philosophy that Greenspan and the Republicans unquestioningly defended.
From what I have read, Fannie and Freddie stayed in the very safest part of the mortgage market, i.e., fully documented non-jumbo conforming loans, until pretty late in the game and only then ventured into slightly riskier areas. However, given their size and the fact that they got involved when the bubble was already stretched to the limits, it would not surprise me if they made the popping of the bubble that much messier. However, I am still developing my understanding of this.
I have CNBC on in my office and I cannot count the number of times during the years before the housing bubble burst that I heard officials from the administration tout record levels of home ownership as proof that Bush’s economic policies were good for everybody. On top of this, consumer spending driven by home equity loans and mortgage refinancings was what kept the economy humming from 2002 onward. This makes me highly skeptical that Republicans ever had any will to reign in the housing market. My instinct is that Republican attacks on Freddie and Fannie were driven primarily (if not overwhelmingly) by partisanship and ideology although I definitely have more to learn on this.
At present, I have not run across much to convince me that the conduct of the Democrats was particularly praiseworthy in any general way. Their only redeeming virtue seems to be that the Republicans controlled the House, the Senate, and the Oval Office from 2002-2006. I suspect that there may be a few cases that I don’t know about yet where Democrats acted on principle, but I would not be surprised to find a Republican or two who did so as well.
As I noted above and LarryE corroborates, the CRA didn’t have diddly squat to do with anything. The argument is a bullshit red herring.
Lots of great cognitive dissonance here.
However, I wanna single out one very special example of cognitive dissonance – not to admonish the commenter, but to present the comment itself with a Cognitive Dissonance Lifetime Achievement Award.
Ladies, and gentlemen, I present the greatest of all self-deluding, self-serving, flawed value-protective scapegoats – (Drum roll) HUMAN NATURE!
Of course, the notion of describing human nature is a paradox in and of itself. For human nature does not exist, at least not in a manner that can be described in terms of value judgment. First, mere observation renders the “nature” part false – once the subject is aware it is being observed, it no longer acts “naturally.” Second, any attempt to quantify such behavior is refracted through the value system of the observer. Humans are not greedy by nature – sorry. Or, at least they are no more greedy by nature than they are selfless and charitable. True human nature merely casts a wide range of behaviors, emotions, etc. that man will employ when presented with a particular environment. It’s not as exciting that way, but intellectual honesty is often a killjoy.
Using “human nature” as a scapegoat is not only naive, but reflective of a cultural myopia. We see behavior that is valued by our society as being “human nature,” which in turn helps us dehumanize those with alternate value systems. We equate our own values (falsely labeled “nature”) as related to being civilized. Put the whole thing together, and you get people thinking things like anti-American acts of terror are rooted in jealousy over not having Playstations and shit…
Anyway, in case I haven’t been condescendingly insulting enough for some of you yet, I’d just to relay a little anecdote. I have a few friends who work in the financial sector. Every year, I make sure to leverage myself into some of their nice-stakes office fantasy baseball leagues – and this is all the experience you really need to do to get a feel for the values and mathematical/statistical competencies of those in the industry. (Most of these guys who I play with are self-professed baseball nuts, so I’m presuming they care).
The willingness to trade a slumping stud for a flash-in-the-pan. The hubris to think they can turn every flash in the pan into a proven stud. Wanna talk treating risky investments as AAA-backed securities? In 2006, some random red-headed dude by the name of Chris Shelton came outta nowhere to hit about 10 homers in April for the Detroit Tigers. Well, these dudes were incredulous – how could I not give up a slumping Bobby Abreu for this guy? By the All Star Break, Shelton was a reserve, by the way.
Further, the utter reluctance to embrace stats like BABIP that indicate the reliability of the cosmetic, every-man stats like batting average tell me a lot about how much research they do (or how much they care) about the underlying stability of the numbers that speed across their tickers everyday. So kudos to the prevailing culture of the financial industry – no matter what anybody says about y’all, you guys help pay my rent (soon to be mortgage)!