Another opportunity lost

The Washington Post reports that we are on our way to the largest financial bailout in American history.  The Post has pictures, too.  Barney Frank stands at the podium with Nancy Pelosi, Harry Reid, and Chris Dodd in the background with grave expressions.  They pose as the rescuers.

The proposed legislation, which is scheduled for a vote today in the House, would authorize Treasury Secretary Henry M. Paulson Jr. to initiate what is likely to become the biggest government bailout in U.S. history, allowing him to spend up to $700 billion to relieve faltering banks and other firms of bad assets backed by home mortgages, which are falling into foreclosure at record rates.

Therein lies the problem.  The roots of financial mess are those home mortgages that are falling into foreclosure at record rates.  At the first presidential debate in Oxford, Mississippi Friday night, Barack Obama charged that the need for this financial bailout was caused by lax regulatory oversight of Wall Street.  He said Republicans were to blame since they are the ones who most often oppose government regulation.  John McCain missed an opportunity when he didn't challenge Obama on it.

Foreclosures are coming at a fast and furious rate because mortgage lenders were handing out mortgage money to people who were at high risk of being unable to pay it back.  These folks were able to qualify for the money based on a schedule in which mortgage payments were very low in the first years of the mortgage, but would increase as years went by.  It's a gimmick that works for people when housing prices are on the rise.  In a rising market, home values grow to the point where homeowners can convert to a conventional mortgage before the killer payments kick in.  Unfortunately home prices have been falling for the last couple of years, so at risk homeowners couldn't sell and they didn't have the equity in their homes to refinance.

So how did so many of these at risk homeowners get so much mortgage money?  Where was the regulatory oversight that would prevent it?  A New York Times article from September 11, 2003 provides helpful clues.

The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago.

Under the plan, disclosed at a Congressional hearing today, a new agency would be created within the Treasury Department to assume supervision of Fannie Mae and Freddie Mac, the government-sponsored companies that are the two largest players in the mortgage lending industry.

The new agency would have the authority, which now rests with Congress, to set one of the two capital-reserve requirements for the companies. It would exercise authority over any new lines of business. And it would determine whether the two are adequately managing the risks of their ballooning portfolios.

George Bush, john McCain and others saw this coming back in 2003 and called for tighter regulations and stricter oversight of Fannie Mae and Freddie Mac.  So what happened?  It was opposed by Democrats.

''These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis,'' said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ''The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.''

Representative Melvin L. Watt, Democrat of North Carolina, agreed.

''I don't see much other than a shell game going on here, moving something from one agency to another and in the process weakening the bargaining power of poorer families and their ability to get affordable housing,'' Mr. Watt said.

Democrats and some Republicans had other incentives to overlook rather than oversee.

Fannie Mae, which was previously known as the Federal National Mortgage Association, and Freddie Mac, which was the Federal Home Loan Mortgage Corporation, have been criticized by rivals for exerting too much influence over their regulators.

''The regulator has not only been outmanned, it has been outlobbied,'' said Representative Richard H. Baker, the Louisiana Republican who has proposed legislation similar to the administration proposal and who leads a subcommittee that oversees the companies. ''Being underfunded does not explain how a glowing report of Freddie's operations was released only hours before the managerial upheaval that followed. This is not world-class regulatory work.''

Over the years both Fannie Mae and Freddie Mac poured money into receptive political campaigns, with the most money going to Democrats.  Between 1989 and 2008 the top four money winners in the Senate were all Democrats:  Chris Dodd: $133,900, John Kerry: $111,000, Barack Obama: $105,849, and Hillary Clinton: $75,550.  In return Democrats have blocked every effort to reign in the mortgage giants.

Barack Obama's attempt to lay the current crisis at Republican feet was McCain's best opportunity to set the record straight in front of a national audience.  It was a huge mistake to let it go.

Comments

[Kris, in New England]

Nice, very nice. A good and proper fisking placing the blame where it belongs - at the feet of the do-nothing-and-blame-everyone-else Democrats, especially The One.

[Smithington]

"So how did so many of these at risk homeowners get so much mortgage money?"

Therein lies the rub.

Suprime loans exploded from 2% of all loans in 2002 to 30% of all loans in 2006.

They exploded because mortgage lenders came up with techniques for avoiding any risk if the loans defaulted. There was a complete lack of oversight of the mortgage lenders. Fannie and Freddie are not mortgage lenders. The legislation you are talking about did not have anything to do with subprime loans at all.

[Tom Bowler]

Mortgage Lenders avoid risk by selling the mortgages. Fannie Mae and Freddie Mac bought them in the form of mortgage backed securities.

In 2004, as regulators warned that subprime lenders were saddling borrowers with mortgages they could not afford, the U.S. Department of Housing and Urban Development helped fuel more of that risky lending.

Eager to put more low-income and minority families into their own homes, the agency required that two government-chartered mortgage finance firms purchase far more "affordable" loans made to these borrowers. HUD stuck with an outdated policy that allowed Freddie Mac and Fannie Mae to count billions of dollars they invested in subprime loans as a public good that would foster affordable housing.

Housing experts and some congressional leaders now view those decisions as mistakes that contributed to an escalation of subprime lending that is roiling the U.S. economy.

The agency neglected to examine whether borrowers could make the payments on the loans that Freddie and Fannie classified as affordable. From 2004 to 2006, the two purchased $434 billion in securities backed by subprime loans, creating a market for more such lending.

Chris Dodd and Barney Frank were instrumental in blocking Bush's efforts to put Fannie Mae and Freddie Mac under the regulatory control of the Treasury Department in 2003.

The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago.

Under the plan, disclosed at a Congressional hearing today, a new agency would be created within the Treasury Department to assume supervision of Fannie Mae and Freddie Mac, the government-sponsored companies that are the two largest players in the mortgage lending industry.

The new agency would have the authority, which now rests with Congress, to set one of the two capital-reserve requirements for the companies. It would exercise authority over any new lines of business. And it would determine whether the two are adequately managing the risks of their ballooning portfolios.

My emphasis above.

[Smithington]

"Eager to put more low-income and minority families into their own homes, the agency required that two government-chartered mortgage finance firms purchase far more "affordable" loans made to these borrowers."

I saw this article and noted the particular paragraph I put in quotations above.

Subprime mortgages were made by mortgage brokers and lenders and securitized by investment banks. They were hidden in convoluted paper known as mortgage backed securities.

The “affordable” loans mentioned by the writer in that particular paragraph were not subprime loans bundled into MBSs. They were conforming loans bought directly by Fannie and Freddie under different rules and standards.

Fannie and Freddie, for the most part, are not allowed to purchase and sell subprime loans.

And they are not allowed to securitize subprime loans.

They can purchase MBSs, but the demand for mortgage backed securities was insatiable, and Fannie and Freddie were late to the party and limited compared to other institutions on what they could purchase. MBSs would have been created and sold whether Fannie and Freddie existed or not.

Legislation pertaining to Fannie and Freddie could not have affected subprime loans packaged into MBSs because Fannie and Freddie could not securitize subprime loans.

In order to control subprime loans, legislative oversight of private mortgage lenders was needed. And there wasn't any.

http://www.businessweek.com/investing/insights/blog/archives/2008/09/community_reinv.html

[Smithington]

http://www.businessweek.com/investing/insights/blog/archives/2008/09/
fannie_mae_and.html

[Smithington]

http://www.businessweek.com/investing/insights/blog/archives/2008/09/fannie_mae_and.html

[Tom Bowler]

"Fannie and Freddie, for the most part, are not allowed to purchase and sell subprime loans."

As of July 30th of last year Fannie Mae and Freddie Mac combined held $168 billion in bonds backed by subprime loans.

NEW YORK: Fannie Mae, the largest provider of money for U.S. home loans, said it held $47.2 billion of securities backed by subprime mortgages at the end of June. Freddie Mac, the second-largest, held $120.8 billion of such debt as of May 31.

The subprime mortgage bonds that Fannie Mae and Freddie Mac hold may have lost $4.7 billion in value, two Citigroup analysts, Brett Rose and Scott Peng, estimated in a report last week. The figures were based on reported holdings of $58 billion for Fannie Mae and $124 billion for Freddie Mac in December.

It's really quite an interesting to watch the story evolve. In 2003 the New York Times was making Bush out to be the bad guy for wanting to rein in Fannie and Freddie. That would make it harder for low income borrowers to qualify for mortgages. The all those mortgages started to go bad. By June of 2008 the Washington Post was making Bush out to be the bad guy because for HUD's lax oversight of Fannie and Freddie.

But by 2004, when HUD next revised the goals, Freddie and Fannie's purchases of subprime-backed securities had risen tenfold. Foreclosure rates also were rising.

That year, President Bush's HUD ratcheted up the main affordable-housing goal over the next four years, from 50 percent to 56 percent. John C. Weicher, then an assistant HUD secretary, said the institutions lagged behind even the private market and "must do more." (my emphasis)

Oops. They forgot Bush was had tried to put Fannie and Freddie under stricter supervision of the Treasury Deptartment but he was blocked by Democrats in congress. So now we get the new and improved story line: Fannie and Freddie had nothing to do with the subprime crisis. Why they hardly even know what subprime is.

[Smithington]

"As of July 30th of last year Fannie Mae and Freddie Mac combined held $168 billion in bonds backed by subprime loans."

Bonds backed by subprime loans are not subprime loans. They are bonds.

To prohibit private mortgage lenders from putting subprime loans into bonds, oversight of private mortgage lenders was needed. And there wansn't any.

[Tom Bowler]

The problem was not that subprime mortgages were securitized. The problem was that there was such a flood of subprime mortgages to begin with. Fannie Mae and Freddie Mac pumped huge amounts of money into shakey loans. The Community Reinvestment Act required banks to meet higher and higher lending targets for low income borrowers (definition = subprime). Just like a stimulus package for the housing industry, that was your classic boost in aggregate demand which drove up housing prices. When the market was finally saturated and housing prices simply could not go higher, all those borrowers who were depending on continued rising prices were suddenly stuck with mortgages they could neither afford nor refinance on houses they could not sell. Result - foreclosure.

The root of the problem was pressure from CRA, Fannie Mae, and Freddie Mac on mortgage lenders to make subprime loans.

Banks that got poor reviews were punished; some saw their merger plans frustrated; others faced direct legal challenges by the Justice Department.

Flexible lending programs expanded even though they had higher default rates than loans with traditional standards. On the Web, you can still find CRA loans available via ACORN with "100 percent financing . . . no credit scores . . . undocumented income . . . even if you don't report it on your tax returns." Credit counseling is required, of course.

Ironically, an enthusiastic Fannie Mae Foundation report singled out one paragon of nondiscriminatory lending, which worked with community activists and followed "the most flexible underwriting criteria permitted." That lender's $1 billion commitment to low-income loans in 1992 had grown to $80 billion by 1999 and $600 billion by early 2003.

Who was that virtuous lender? Why - Countrywide, the nation's largest mortgage lender, recently in the headlines as it hurtled toward bankruptcy.

In an earlier newspaper story extolling the virtues of relaxed underwriting standards, Countrywide's chief executive bragged that, to approve minority applications that would otherwise be rejected "lenders have had to stretch the rules a bit." He's not bragging now.

For years, rising house prices hid the default problems since quick refinances were possible. But now that house prices have stopped rising, we can clearly see the damage caused by relaxed lending standards.

[DaveNYC]

These arguments makes no sense -

1st GSE's WERE regulated by two agencies HUD and OFHEO, BOTH of which are administered by the EXECUTIVE BRANCH - i.e. President Bush. HUD deals with regulatory oversight concerning the GSE mandate to provide affordable housing assistance and other non-discrimination rules and OFHEO was charged with overseeing the capital requirements and other financial aspects of the GSEs.

2nd if the Bush Administration was so concerned about the GSEs oversight as it related to its financial condition then WHY would the administration change the mandates to require the GSEs to take on MORE affordable housing loans in 2004.

It is simple - sure Dems in Congress wanted the GSEs to promote more loans for poorer people - BUT it was the PRESIDENT as the EXECUTIVE who had nearly all the power in terms of regulating all aspects of the GSEs; and even the easiest Google search will demonstrate that, President Bush was just as complicit in this mess as anyone (and more so if you consider the ability to back up policy with regulatory authority)
banking.senate.gov/public/_files/weicher.pdf