Tag Archives: Housing Bubble

Housing Bubble – Who Created It

Housing Bubble

Last year I posted on who I thought created the housing bubble:

There is no doubt that the housing crisis was caused by government policy.  Bad actors everywhere?  Sure.  But at the root of it all the was the government’s desire – by both parties – to increase home ownership in America.  And specifically for the poor and minorities.

There has yet to be evidence produced that would cause me to change my mind.  There is absolutely no question whatsoever that the administrations of Presidents going back to Jimmy Carter pursued the goal of home ownership in America – most specifically in the poor and minority populations.

The flip side to the “government created the bubble” is the “Wall Street’s greed created the bubble.”  The most vocal in my circle has been Scott Erb over at World inn Motion here and here:

The housing bubble and subsequent crisis was created by the big banks who were able to pull off the equivalent of a high stakes ponzi scheme and get away with it.

I’ve been going back and forth with Scott, and other wrong minded individuals about this as if it were a binary proposition.  Meaning that the answer was either I was right or “they” were right.

I’ve come to a different conclusion.  Namely, that while the government certainly was the trigger of the events that led to the crash, the whole thing still had to be set in motion with the people who would make and then sell the loans.

Consider – the government requires banks increase lending to people who have no hope of repaying those loans.  It stands to reason that the banks then go and meet the requirements.  This doesn’t change the fact that they were incented to make those loans and create the vehicles which facilitated those activities.

What might it take to create the case that this is the case?

  1. A bubble existed
  2. That government policy favored or desired homeowner ship among the poor and minority populations.
  3. That the government created conditions that either incented or required banks to increase these risky loans.
  4. That government assisted in this practice

If government passes a law that creates a disincentive to hire or retain employees, and then business reacts by firing or not hiring people it is BOTH true that government created the conditions that led to reduced employment AND that business acted out those policies – both Scott and I might be correct.

Wall Street may have enacted the policies but did so only due to government involvement.

Housing Bubble – Government Creation Part III

Housing Bubble

Setting the stage.

My argument is that government policies created an environment that encouraged loans to individuals that had an elevated risk of defaulting on those loans.  In many cases the government sponsored enterprise directly encouraged the loans and in others, the actions of those GSEs encouraged others in the market to make riskier and riskier loans themselves.

First, how did Fannie and Freddie define loans:

To better understand how this accumulation of weak mortgages came about, a description of the loan classification system used by Fannie and Freddie (the GSEs) and followed by others is in order. Fannie and Freddie did not classify subprime and Alt-A loans based on objective risk characteristics but on the basis of how the lender or securities issuer classified a loan. Thus a loan was only subprime or Alt-A if a lender or issuer denominated it as such.

Fannie and Freddie didn’t perform any due diligence on their own.  When did Fannie and Freddie acknowledge this?

“We have classified mortgage loans as Alt-A if the lender that delivered the mortgage loans to us had classified the loans as Alt-A based on documentation or other features. We have classified mortgage loans as subprime if the mortgage loan was originated by a lender specializing in the subprime business or by subprime divisions of large lenders. We apply these classification criteria in order to determine our Alt-A and subprime loan exposures; however, we have other loans with some features that are similar to Alt-A and subprime loans that we have not classified as Alt-A or subprime because they do not meet our classification criteria.” P. 182 of Fannie’s Q.3:2008 10-Q

What does this mean?

…one of the key triggers of the Financial Crisis was a policy decision to promote the widespread use of high LTV (highly leveraged) lending in the early 1990s. The risk inherent in high LTV lending was well known.  When Fannie decided to proceed with a 97% LTV program in 1994, objections were made – pointing out the poor experience on 95% LTV lending just a dozen years before…

And that risk?


The risk in proceeding with a 95% LTV loan is about 4 times the risk compared to a conventional 20% down loan.  The table above demonstrates.

Consider an individual taking out a loan; credit score between 680 and 720.  Further, they are putting down between 20 and 30%.  Their risk is assigned a value of “1”.  The same individual taking out a loan but only putting down between 5 and 9%?  The risk moves to a rating of 4.1.  Four times the previous rate.

These were the types of loans that Fannie and Freddie, indeed, other government agencies, would be encouraging.

The beginning.

Housing Bubble – Government Creation Part II

Housing Bubble

A teaser:

First, Clinton:

Former president Bill Clinton said it best in 2008. “I think the responsibility the Democrats have may rest more in resisting any efforts by Republicans in the Congress or by me when I was president to put some standards and tighten up a little on Fannie Mae and Freddie Mac.”

And then Artur Davis:

“Like a lot of my Democratic colleagues I was too slow to appreciate the recklessness of Fannie and Freddie. I defended their efforts to encourage affordable homeownership when in retrospect I should have heeded the concerns raised by their regulator in 2004. Frankly, I wish my Democratic colleagues would admit when it comes to Fannie and Freddie, we were wrong.

It’s not even close.

Housing Bubble – Government Creation?

Housing Bubble

With Obama’s announcement that he is interested in creating conditions that will lead to another housing bubble, it’s interesting to go back and revisit the conditions that led to the most recent bubble.

It has long been my position that it was the government that was responsible for the conditions that created the housing bubble that burst in 2007.  That it was the government’s role in pushing home ownership levels to higher and higher values that eventually led to the condition where people who couldn’t afford homes finally began to default resulting in the crisis.  A crisis that we haven’t truly recovered from.

To be sure, there were private industry players that contributed to the crisis.  There were vehicles that were created that also led to that crisis.  But, in the end, it was the government’s desire to increase home ownership among lower income and “at-risk” households that drove the poor behavior of those private individuals and the creation of those vehicles.

Not everyone agrees with me.  In fact, blog favorite Scott Erb often takes me to task, most recently in the comments of the above post.  More specifically, he’s pointed me to a book that he claims supports his position: “All The Devils Are Here”.

As part of my attempt to make MY case, I’ll be quoting from this book in an effort to show that it was government goals that was the genesis of the whole meltdown.

Here’s the first such example:

Here’s a surprising fact: it was the government, not Wall Street, that first securitized modern mortgages.  Ginnie Mae came first, selling securities beginning in 1970 that consisted of FHA and VA loans, and guaranteeing the payment of principal and interest.  A year later, Freddie Mac issued the first mortgage-backed securities using conventional mortgages, also with principal and interest guaranteed.    In doing so, it was taking on the risk that the borrower might default , while transferring the interest rate risk from the S&L to a third party party: investors.  Soon, Freddie was using Wall Street to market its securities.  Volume grew slowly.  It was not a huge success.

In the example above, it would be my position that the government created the conditions that eventually led to Wall Street marketing those loans in the early 70’s.  Did Wall Street actors engage and participate in the process?  Sure, it’s clear they did.  Were they all above board?  Perhaps but likely not.  However, the initial push, the lighting that struck primordial mud and created carbon life was government.

And it’s my case that the same thing happened long ago that resulted in the crash of 2006-2007.

Another Government Creation, Another Bailout?

In the same way that government created the housing bubble, the government has created the college-loan bubble.

Once upon a time, government officials decided it would help them keep their jobs if they could claim they had expanded the middle class.  Unfortunately, none of them really understood economics or even the historical factors that led to the emergence of the middle class in the first place.  But they did know two things:  Middle class people tended to own their own homes, and they sent their kids to college.

So in true cargo cult fashion, they decided to increase the middle class by promoting these markers of being middle class.  They threw the Federal government strongly behind promoting home ownership and college education.  A large part of this effort entailed offering easy debt financing for housing and education.  Because the whole point was to add poorer people to the middle class, their was a strong push to strip away traditional underwriting criteria for these loans (e.g. down payments, credit history, actual income to pay debt, etc.)

We know what happened in the housing market.  The government promoted home ownership with easy loans, and made these loans a favorite investment by giving them a preferential treatment in the capital requirements for banks.  And then the bubble burst, with the government taking the blame for the bubble.  Just kidding, the government blamed private lenders for their lax underwriting standards, conviniently forgetting that every President since Reagan had encouraged such laxity (they called it something else, like “giving access to the poor”, but it means the same thing).

What are the chances that we bail out all those kids who’ve majored in such “in demand” course work as Art History, Religious Studies, Women’s Studies and others?

I’d say pretty high.