Government Role in Housing Collapse

Government Role in the Financial Collapse by Ofuoma Odje

There are at least 2 facets of Government responsibility in the current financial collapse.

The first is was the aggressive promotion of home ownership by the Bush and Clinton Administrations. The New York Times front-page story on Sunday, December 21, 2008 reported that former President Bush excessively promoted growth in home ownership without adequately enforcing oversight over banks and other mortgage lenders that made the bad loans. This is now what has resulted in a banking system flooded with bad mortgages whose losses continue to drag down the banks and the economy.

The second was government policy over the last 2 decades. The Community Reinvestment Act (CRA) and the government-sponsored enterprises (GSEs) of Fannie Mae and Freddie Mac are both Governmental vehicles that were used to distort the housing credit system, crash the housing market and ultimately the broader economy.

The New York Times edition of December 21, 2008 reported on home ownership in the United States since 1990. In 1993 home ownership was at 63 percent, and by the end of the Clinton administration it was 68 percent. Under the Bush administration, it grew by about1 percent to 69 percent.

The Times also reported that in 1999 the Clinton administration put pressure on Fannie Mae and Freddie Mac to increase lending to minorities and low-income home buyers.

This was of course a high risk policy that is partly responsible for today’s financial crisis because it opened the door to subprime predatory lending and other irresponsible borrowing and lending practices that abused the mortgage markets.
The Clinton and Bush administrations’ aggressive promotion of home ownership by reduced lending standards led to the housing bubble and burst.

The CRA was originally enacted in 1977 under President Carter. It mandated regulators to consider whether an insured bank was serving the needs of the entire community. The Act was set in place to encourage banks to halt the practice of lending discrimination.

The Clinton Treasury Department changed the Community Reinvestment Act in 1995. The change required banks that wanted outstanding CRA ratings to demonstrate statistically that they were lending in poor neighborhoods and to lower-income households.

Some economists say this amendment to the CRA raised the amount of home loans to unqualified low-income borrowers and also allowed for the first time the securitization of CRA-regulated loans containing subprime mortgages.

Throughout the early 90’s the Department of Housing and Urban Development pushed Fannie Mae and Freddie Mac to purchase loans based on criteria other than creditworthiness. And by 2005, these affordable housing goals mandated that Fannie Mac and Freddie Mae buy 45 percent of all loans from those of low and moderate income neighborhoods. A majority of these loans, especially the subprime ones, significantly account for today’s housing collapse.

The Federal Government housing initiatives are not the only “Government” causes of the current mortgage crisis. State Laws also gave homeowners free options that added substantially to the mortgage crisis.

As house prices increased between 2000 and 2006, State Laws allowed homeowners to refinance their mortgages at lower interest rates, and in addition cash-out equity based on increase in home prices without penalties.

The above practice was also supported by the deductibility of the interest paid on home equity loans from individual tax returns. This of course encouraged homeowners to go for a home equity loan, instead of credit cards or traditional loans when making major household purchases.

Instead of seeing their homes as a place to live, homeowners saw their abode as accounts to withdraw from or borrow against to make purchases. Unfortunately, this meant that when house prices collapsed homeowners found themselves in a negative equity situation with their homes. Simply put they owed more than their houses were worth.

This made it easy for homeowners to walk away from their mortgages. Further exacerbating this willingness to walk away from their bad mortgages was the leeway provided by State Laws in most States. Most States allowed the so called “without recourse mortgages” that allowed defaulting owners to escape the personal responsibility of paying the difference between their home’s value and the amount they originally borrowed from the Banks.

If we’ve learned anything from the Housing burst, it’s that Government policies were a catalyst that encouraged other players to run the system aground. Certainly predatory lenders, greedy brokers and irresponsible borrowers and lenders all played their parts in the housing collapse. However, government policies like the CRA and the government-sponsored enterprises (GSEs) of Fannie Mae and Freddie Mac, which buy loans from the banks in order to provide liquidity setup the fertile ground for this abuse.

What can the government do to prevent a reoccurrence of this kind of crisis in the future?

If there is anything for the government to learn from this;-- it should allow market mechanisms to operate rather than enacting regulatory mandates like the CRA that pose political risks to financial markets.

Tools for fair, antidiscrimination, and effective housing policy should do NO MORE than to ensure that borrowers are not turned away for non-financial reasons.
Government policies that distort mortgage lending should be terminated in order for the markets to function efficiently whilst measuring risks and maintaining profitability.

Continued government intervention in the financial system will do nothing but continue this subversion of capitalism.

Ofuoma Odje