Sometimes the culprit is not the one you think

Since the start of the financial crisis of 2008, many people had said many things about the reasons why there was a financial crisis.

As always, some had said that it was the fault of the « lack » of regulation (when the financial sector is probably one of the sectors which had the most complex government regulation), the fault of the bankers, the « rich ». These are the easy answers given by those who are keen to find a scarecrow at first glance and then burn it.

But again, if we look at the problem in a sort of reverse engineering point of view, we tend to look at why this behavior happened.  Why do people were having mortgages that they could not support?

A good starting point will be to go back to September 1999 and this article from the New York Times who did not make any waves at the time:

Fannie Mae Eases Credit To Aid Mortgage Lending

By STEVEN A. HOLMES
Published: September 30, 1999

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets — including the New York metropolitan region — will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates — anywhere from three to four percentage points higher than conventional loans.


« Fannie Mae has expanded home ownership for millions of families in the 1990’s by reducing down payment requirements, » said Franklin D. Raines, Fannie Mae’s chairman and chief executive officer. « Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market. »

Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.

« From the perspective of many people, including me, this is another thrift industry growing up around us, » said Peter Wallison a resident fellow at the American Enterprise Institute. « If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry. » […]

Fannie Mae, the nation’s biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary market. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings.

In July, the Department of Housing and Urban Development proposed that by the year 2001, 50 percent of Fannie Mae’s and Freddie Mac’s portfolio be made up of loans to low and moderate-income borrowers. Last year, 44 percent of the loans Fannie Mae purchased were from these groups.

 

So, if you look closely you see that the problem comes with regulation instead as Fannie Mae and Freddie Mac are state-sponsored institutions and this especially with the fact that these organizations were putting a guarantee on loans for the banks. And again, in a naive « affirmative action » theory to supposedly « help » people who were considered « minorities », this had made a bad situation much worse.

In conclusion, this brings in perspective the ultimate failure of do-gooder policies in this area. As the state wanted to give easy credit to the « less fortunate » and this especially to minorities, it did burn itself to a third-degree after playing with fire. And the most ironic part is that some people are still living in a mirage where government intervention did absolutely nothing to irresponsibility to the lenders.

Would somebody seriously think that anybody would be crazy enough to lend without a guarantee to somebody who is non-solvable?

My only advice is for everybody to be VERY cautious of state-owned housing underwriters which have sometimes all the characteristics of a classic Ponzi scheme.

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