How Federal Policy Triggered the Mortgage Meltdown

Posted on May 29, 2010


By Carl Horowitz, TOWNHALL

Arguably the most crucial, and underappreciated, reason behind the collapse has been excessive federal intervention. Recent reports and articles from American Enterprise Institute (AEI) Senior Fellow Peter Wallison and AEI Visiting Fellow Charles Calomiris strongly suggest the pileup of bad mortgage paper has the words “Made in Washington,” written all over it. In other words, rogue capitalism is partly to blame, but rogue government has played a central enabling role.

The question arises: Why did this recklessness happen? As Wallison and Calomiris note, the federal government for years had applied intense pressure to primary and secondary lenders to lower credit standards in mortgage underwriting. Lax standards meant more applicants approved for credit. And more borrowers would translate into a higher homeownership rate, something presumably in the national interest. House price appreciation would serve as collateral in the event of foreclosure. It was optimism gone wild.

Banks and other primary lenders, for their part, created and/or shifted loan portfolios to exotic financial instruments such as sub-prime and Alt-A mortgages. They also focused more heavily on adjustable-rate mortgages, especially for subprime borrowers, in which payments typically reset at a higher level after the first two years. Lenders also promoted “cash-out” (loans exceeding the purchase price) and “interest-only” mortgages. Toward these ends, many banks acquired non-bank mortgage companies through which they could increase their volume of subprime loans.

Fannie Mae and Freddie Mac, each officially a “Government-Sponsored Enterprise” (GSE), also found themselves on the receiving end of federal heat. Starting in 1993, pursuant to new federal statutes, Fannie Mae and Freddie Mac’s regulator, the U.S. Department of Housing and Urban Development’s Office of Federal Housing Enterprise Oversight (OFHEO), established new “affordable housing” goals. Each GSE now would have to expand their purchases of mortgages made to low- and moderate-income households, especially members of racial minority groups. Civil-rights leaders such as Jesse Jackson, nonprofit radical activist groups such as the Association of Community Organizations for Reform Now (ACORN), and congressional allies such as Rep. Barney Frank, D-Mass., were adamant about using the Community Reinvestment Act of 1977 to punish primary and secondary lenders who allegedly “redlined” (unjustly denied credit) black and Hispanic neighborhoods.

They found willing accomplices in the Clinton administration. In 1999, HUD Secretary Andrew Cuomo announced a historic “agreement”: Fannie Mae and Freddie Mac would buy $2.4 trillion in mortgages over the next 10 years to create affordable housing for 28.1 million low- and moderate-income households. At least 50 percent of all mortgages would have to meet affordability standards of such borrowers, up from 42 percent.

The Bush administration also coaxed Fannie Mae and Freddie Mac into operating as virtual adjuncts to HUD. President Bush, his top political adviser Karl Rove, and other key officials saw creating an “ownership society” as priority number one. In a June 18, 2002 speech, Bush made clear his intent:

The goal is, everybody who wants to own a home has got a shot at doing so. The problem is we have what we call a homeownership gap in America. Three-quarters of Anglos own homes, and yet less than 50 percent of African-Americans and Hispanics own homes…So I’ve set this goal for the country. We want 5.5 million more minority homeowners by 2010.