Well, the fur is flying in Washington now. With the economy in crisis, Congress is pondering which options are best to help alleviate the crisis and begin the process of moving the American economy back towards stability. One thing Democrats and the Bush administration have in common is their willingness to spend the taxpayer’s money. So, whatever the decision, it will be a historic payout; there can be no doubt of that.
Of course, Congress has to step up and solve the problem. After all, the genesis of this crisis began in Washington and most of the blame rests there. There’s no need to point fingers at any one person or party. While Democrats have been historically pro-GSE, there is plenty of blame to go around.
This crisis began when the “dream” of American home ownership somehow morphed into the “right” for all Americans to own a home. As a concept in America, home ownership morphed from a “dream’ to yet another government entitlement.
Journalists like Howard Kurtz, whose “Media Notes” column I read daily, show the same lack of understanding as anyone else. “Both parties,” insists Kurtz, “pressured by lobbyists, failed to rein in Fannie Mae and Freddie Mac despite years of warnings.” Kevin Hassett of Bloomberg News blames the Democratic opposition to the 2005 GSE reform efforts.
These are all partial truths. The problem is, they just don’t go far enough. In reality the real problems began in the late 90’s when both parties, pressured by lobbyists, began to actively encourage Fannie and Freddie to take on more risk than they ever should have and ever would have had the industry been left to its own practices.
The obvious question is, what lobbying organizations were there to influence congress and what was their purpose? The primary organization for the mortgage industry, originally launched under the name “FM Watch,” is “FM Policy Focus.” The website for this organization, FMWatch.com, is no longer available. I wonder why?
The FM Policy Focus organization was begun and funded by companies in the mortgage industry to gain some influence over the GSEs who, because of their status with congress, have a tremendous amount of influence on the market. The relationship between GSEs and the private market has long been shaky, and thus this lobby gave the mortgage industry more political clout overall.
As early as 1999, FM Policy Focus began publishing articles and lobbying members of congress to pressure and, ideally, reign in the GSEs. Here is an excerpt from one of the first articles published by this organization:
Recently Fannie Mae’s and Freddie Mac’s loan limits were raised for single-family mortgage loans to $252,700, up from the current $240,000. Fannie and Freddie believe the higher limit will allow more families to obtain low-cost mortgage financing. While good for many upper-income families, (most families will have to earn over $90,000 to qualify for the higher Fannie Mae mortgage after real estate taxes and other costs are considered), this increase does nothing for families who cannot afford a $250,000 mortgage, a $100,000 mortgage, or even a $50,000 mortgage. These new higher loan limits must not cause Fannie and Freddie to concentrate on Americans who can afford higher mortgages but keep their focus on low-to moderate- income and first-time homebuyers not the wealthy.
As can be seen, the emphasis of the article, and many to follow, was on making resources available to the high risk sub-prime mortgage market. The thrust of FM Policy Focus’ efforts was to paint the GSEs as “biased” in their support to homeowners.
Even as late as 2006, with the new Democratically controlled congress just beginning it’s session, FM Policy Focus was accusing Freddie and Fannie of “neglecting homebuyers.” They turned the dream of homeownership into a entitlement by insisting that “[w]hile much of the nation enjoys record homeownership levels, the American dream of owning a home remains beyond the grasp of millions of low- and moderate-income and minority households, particularly African-Americans and Hispanics. More can and should be done.”
FM Policy Focus insisted that congress was not doing all it should even while they acknowledged that congress had already “directed the housing GSEs, Fannie Mae and Freddie Mac, to lead the market in helping low-income and minority households buy homes. “ The sentiment of supporting low-income households sounds good, but there’s a tricky element that is hard to understand unless you’ve worked in this industry.
Fannie and Freddie are, by law, prohibited from tracking gender and race information when it comes to the loans they purchase and securitize. And they don’t even really care. The only thing these GSEs care about is the credit rating of the person applying for the home loan.
If someone has good credit, they have a far better chance of getting a mortgage, and at a lower rate. Great credit means lower risk. And lower risk means that Freddie Mac or Fannie Mae will purchase the loan, allowing a bank or mortgage company to retain a small amount of profit and get the loan amount back so that they can support additional clients.
This is the efficiency of the markets at work. If you’re a good risk, you’ll get the loan. If you’re not a good risk, you might still get the loan, but you might pay more in loan fees or more in credit. This way the market continues to put people into homes while offsetting the cost of foreclosures and other problems.
The mortgage industry as a whole goes to great lengths to help people stay in their homes. Despite what many people think, Fannie, Freddie, and the mortgage industry in general hates foreclosures because it almost always results in lost profits. It’s generally more cost-effective to restructure a loan or find ways to alter payments than to foreclose. Over the decades, an entire industry has grown up around the effort to keep homes in the hands of their owners.
So, while true that some with poor credit pay more in fees and/or in the credit rate on a mortgage, as a whole, it protects the market. It’s a system that has become almost a science. And this science has protected the industry, even in times of national crisis, such as 9/11.
But FM Watch in particular began to accuse Fannie and Freddie of bias because, in general, minority credit ratings are not as high. How do they know this? Because, despite laws prohibiting the collection of data relating to gender and race, Congress requires that the GSEs, banks, and mortgage companies collect the data.
Consumers don’t have to give that information of course. A young couple could walk into a bank, secure a mortgage, and walk out, leaving the race/gender section of the loan agreement blank. But, as soon as they walk out the door, the mortgage consultant will fill in that information for them. If they don’t their, company could be penalized by the government.
The data then is reported to Congress, who keeps track of home ownership rates and all kinds of demographic data. Unfortunately, FM Watch began to point to the data, arguing that the system was stacked unfairly against low-income families.
The ultimate result of such lobbying efforts in Washington was a message given to the GSEs, “find a way to support sub-prime loans.” And the GSEs got the message loud and clear. Inside of Freddie Mac, for example, company officers suddenly began expressing their commitment to better serving the sub-prime market.
From there, as mortgage companies and banks observed a Fannie and Freddie suddenly more willing to fund the sub-prime market, they were in turn willing to fund those loans. From there came the invention of myriads of different types of loans, which banks and mortgage companies created to fulfill the mandate which ultimately came right from congress.
But risk is risk. As more high risk mortgages were created, it meant that a housing meltdown would definitely occur. It was just a matter of time. Eventually, the high risk loans, which default at a higher rate, were going to cause problems. It was not a matter of “if,” only of “when” and “how bad.”
The Wall Street Journal aptly summarized the problem, saying that “[i]n order to curry congressional support after their accounting scandals in 2003 and 2004, Fannie Mae and Freddie Mac committed to increased financing of ‘affordable housing.’ They became the largest buyers of subprime and Alt-A mortgages between 2004 and 2007, with total GSE exposure eventually exceeding $1 trillion. In doing so, they stimulated the growth of the subpar mortgage market and substantially magnified the costs of its collapse.”
As the mortgage meltdown began, the ripple effect began to hurt the financial industry as a whole. Now, of course, the federal government, having created the problem in the first place, is desperately trying to stem the tide of collapse.
Will Congress approve the President’s plan to absorb market losses or will those companies be allowed to collapse? Time will tell and, until then, the fur will continue to fly in Washington.
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