Wednesday, March 23, 2011
The Future of Fannie Mae and Freddie Mac
Last summer President Obama signed a sweeping financial reform law, which he said it would provide “the strongest financial protection for consumers in the nation's history.” But the 2,300-page law did not apply to Fannie or Freddie, which were at the heart of the housing/mortgage crisis and last year accounted for 90 percent of new mortgages. Now the administration has released its proposals—nearly two years in the making— in a “white paper” on the future of Fannie and Freddie. It is 31 pages.
When he signed the 2,300-page bill, Obama said consumers would “never again have to foot the bill for Wall Street's mistakes[!]” It was all due to Wall Street. The big banks. Those were the greedy villains responsible for selling mortgages to poor people who couldn't afford them. Or so we were told. Nothing was said about the fact Congress had established Fannie and Freddie and authorized them to securitize mortgages long before the Wall Street banks ever got into the act. Nothing was said about Fannie and Freddie being twice as leveraged as Bear Stearns, a global investment bank that was an early casualty of the financial crisis. Nor was anything said about the government's role in using the Community Reinvestment Act to force banks to lower their underwriting standards in order to qualify low-come people, principally minorities, for mortgages. Nor was anything said about the role of special interest groups such as ACORN—in which Obama had been active for years—in using the CRA to force banks to accept mortgage applications with low down payments, no verification of income, and weak credit history.
The Community Reinvestment Act of 1977 was passed when St. Jimmy the Simple was president. It purported to remedy “redlining”—racial discrimination by banks denying mortgages in black neighborhoods. The charge was false, as shown by a 1992 study from the Federal Reserve Bank of Boston, which showed 97 percent of mortgage applications by minorities were approved regardless of race. Most of the remaining 3 percent could be attributed to poor credit history. The charge of racial discrimination was made laughably false by the fact the loan denial rate for blacks and hispanics was also significantly higher than for whites and Asians at minority-owned banks! But the truth never caught up with the widely publicized charges of discrimination. Instead, the banks were now required to open new branches in low-income areas and to have a certain percentage of their small-business loans and home mortgages located there. They were also prevented from opening new branches in other—untroubled—areas if they failed to maintain this ratio.
According to Edward Pinto, former chief credit officer at Fannie Mae:
ACORN and other community groups were informally deputized by then House Banking Chairman Henry Gonzalez to draft statutory language setting the law's affordable-housing mandates....The goal of the community groups was to force Fannie and Freddie to loosen their underwriting standards, in order to facilitate the purchase of loans made under CRA....Thus a provision was inserted into the law whereby Congress signaled to the GSEs [government sponsored enterprises, Fannie Mae and Freddie Mac] that they should accept down payments of 5% or less, ignore impaired credit if the blot was over one year old, and otherwise loosen their lending guidelines.
In his biography of Obama, Stanley Kurtz, senior fellow with the Ethics and Public Policy Center, writes, “ACORN [Association of Community Organizations for Reform Now] won this showdown....[It] succeeded in dragging Fannie Mae and Freddie Mac—kicking and screaming—into the subprime mortgage business.”
He also writes: “By the mid-nineties, the CRA applied to only about a quarter of the banking system. Yet Achtenberg [Assistant Secretary for Fair Housing] made key regulatory changes that had the effect of pressuring the other three-quarters of America's mortgage industry into greater subprime lending....Achtenberg's new definition of discrimination helped push even institutions not covered by CRA into the business of subprime lending. ACORN pressed Achtenberg hard on this and other issues, at times with help from [President Clinton's] Housing Secretary Cisneros....Without being asked, Cisneros also requested ideas on ways HUD could channel money to ACORN and other community organizations.”
Initially, the affordable-housing mandate was set at 30 percent of single-family mortgages purchased by Fannie and Freddie. In 1995, Henry Cisneros directed Fannie and Freddie to buy the mortgages of low- and moderate-income borrowers amounting to 42 percent of their annual business volume. His successor Andrew Cuomo upped that to 50 percent and directed the GSEs to buy mortgages from borrowers with “very low income.” Banks ended up having to make more and more “subprime” loans and agreeing to dangerously lax underwriting standards—no down payment, no verification of income, interest-only payment plans, and weak credit history. By 2007, HUD's affordable housing regulations required 55 percent of all the GSE loans to be made to borrowers at or below the median income, with almost half of these required to be low-income borrowers. By the late 2000s, more than one-third of all new mortgages had down payments of 3 percent or less.
The credit bubble was now inflated to the bursting point. But when it burst, it was not government but the banks that took the blame. The virulently anti-business and anti-capitalist Obama was quick to decry the “fat-cat bankers on Wall Street,” the “greedy” and “irresponsible” lenders who pushed subprime mortgages on the poor and vulnerable who couldn't afford them and now were losing their homes. The Obama-adoring news media, still in love with him since the early days of the presidential campaign, flooded the public with stories about how the economic misery was due to businesses run amuck in the reckless pursuit of profit and the lack of regulation. What was needed, according to the politicians, commentators and opinion makers who dominated the media coverage was greater regulation “to prevent this from ever happening again.” The question of whether the problems had been caused by regulation in the first place never seemed to come up.
Obama's Treasury Department's “white paper” for housing finance reform is short on details but proposes reducing government investment in housing—while increasing government oversight of the mortgage market. This would include, among others, making underwriting standards stronger. Of course, it was government “oversight” that weakened them in the first place. The three proposals in the “white paper” offer varying degrees of government involvement and may include phasing out Fannie and Freddie. But the administration has said it is committed to ensuring that those two “have sufficient capital to perform under any guarantees now or in the future.” It also said it will still provide “targeted assistance” to low- and moderate-income home buyers and renters. Just like before.
If the government wanted real reform, it should repeal the CRA. Leaving that statute stand merely leaves the door open for future administrations to repeat abuses and again allocate credit for political purposes. Three statutes closely related to the CRA should also be repealed. These are the Equal Credit Opportunity Act (ECOA), the Home Mortgage Disclosure Act (HMDA), and the Fair Housing Act (FHA), all aimed towards eliminating “discrimination” in the lending process. The close relationship arises from the near-automatic determination that if ECOA or FHA are violated, the institution is not serving its community. The Department of Housing and Urban Development (HUD) and the Justice Department complement the efforts of the bank and thrift agencies in enforcing the FHA and ECOA. The CRA was enacted as a follow-up to the HMDA.
In the 1990s, Attorney General Janet Reno, along with her assistant Eric Holder, bludgeoned the banks with faulty statistical methods, quotas, market share, “disparate impact analysis” and other factors to extort millions of dollars from them with charges of racial discrimination. Many banks were intimidated and willing to acquiesce to cash settlements to avoid trials and bad publicity.
Vern McKinley, who worked for the FDIC and the Federal Reserve Board, wrote, “Lending commitments have also been extracted by community groups in connection with merger applications, when banks are most vulnerable to CRA protests, a phenomenon described as 'megamerger CRA megapledges.' These commitments range from a few hundred thousand dollars up to the largest CRA megapledge of $12 billion by Bank of America.... There is even a rule of thumb for calculating such CRA commitments of around one half of 1 percent of assets per year.” In the New York Post September 29, 2008, Kurtz wrote: “Intimidation tactics, public charges of racism and threats to use CRA to block business expansion have enabled ACORN to extract hundreds of millions of dollars in loans and contributions from America's financial institutions.”
Such commitments are often “set forth as proof of the positive economic impact resulting from active CRA enforcement,” says McKinley. “A more accurate characterization would be codified extortion. In fact, comments by those who utilize such agreements to extract negotiated settlements often resemble utterances of organized crime figures. Typical is a statement by Bruce Marks, executive director of Union Neighborhood Assistance Corporation and self-styled 'urban terrorist,' who threatened that, if banks aren’t willing to meet the new standards of community investment, then, 'we’ll have to start making it in their interest [to do so].'”
The idea that home ownership was a socially desirable goal that should be promoted by the government led to a vast, incredibly expensive, decades-long effort, but how effective was it? Home ownership in the U.S. peaked at 69 % at the top of the housing bubble and is now 67%. But there are at least 14 countries that have higher ownership rates than the U.S., including Hungary, Iceland, and Poland. In the European Union, where most countries don't offer tax breaks and subsidies like the U.S., home ownership was just shy of 75% in 2006, according to Eurostat. Home ownership in the U.S. increased by only 3.4 percentage points over the last 20 years, the period of the the U.S. government's greatest efforts to promote it. In the Netherlands and Italy, it increased by 12 percentage points between 1991 and 2008.
Canadian banks weathered the international financial crisis much better than U.S. banks. Canada has nothing comparable to Fannie or Freddie or our Community Reinvestment Act. It does not have 30-year fixed-rate mortgages, and interest on mortgages is not tax deductible. Down payments of less than 20 percent require the mortgage holder to buy mortgage insurance. Canada's regulatory agency concerns itself with risk management and abstains from social and political objectives, such as affordable housing and diversity. Yet it has a home ownership rate of 68%, and the percentage of mortgage loans delinquent for more than 90 days is approximately one-tenth of the U.S. level. A comparison to the U.S. shows two very different housing finance systems, one much more political and riskier than the other, with no advantage to the U.S. system. By the end of 2010, the financial meltdown and rising foreclosures wiped out more U.S. homeowners than were created in the 2000-2007 housing boom.
Employing government to achieve a socially desirable goal, home ownership, has led to the greatest economic contraction since the Great Depression. There is a glut on the housing market that is not going to go away any time soon. Nor will Fannie and Freddie disappear soon. If they do, their functions will likely be replaced in large measure by a similar agency with a new name. Already we hear claims that government still has to provide 30-year mortgages or people aren't going to be able to achieve the American Dream of owning their own home. But how have people in those other countries which do not have 30-year mortgages managed to achieve higher home ownership rates than the U.S.? Other reasons, too, will no doubt be offered for stretching out the existence of Fannie and Freddie. But if that occurs, particularly if the CRA and related laws are retained, it will stretch into the future the potential for politicians to again employ them for social goals and vote-buying schemes. And there is no reason to believe the results next time will be any better than what we have just witnessed.