Government’s Role in Housing Bubble Memory Holed


Having not seen The Big Short, I don’t know whether the problem originates with the movie or with Providence Journal business editor John Kostrzewa’s review of the movie, but it’s discouraging to observe that the federal government’s role in creating the housing bubble has been airbrushed out of history:

For years, bankers made mortgages that they bundled together, called mortgage backed securities, that they sold on the bond market to investors. The bankers used the proceeds from the bond sales to lend more money to home buyers. Simple, so far.

But the process became corrupted when predatory lenders made mortgages to people who put no money down, had low credit scores and no income, at teaser rates that adjusted sharply upward after a couple of years. The mortgages, called subprime because of the risk, were bundled and then repackaged by Wall Street bankers who collected big fees when they sold the bonds. Corrupted ratings’ agencies gave the bonds high marks.

Notice that this “simple, so far” story makes no attempt to explain why so many investors believed they could leave somebody else holding the bag.  No mention of the role of Fannie Mae and Freddie Mac, with their implicit government backing.  No mention of the federal Community Reinvestment Act, and its push for more and more of these subprime loans.  No mention of Democrat President Bill Clinton and his administration’s elimination of banking regulations that partitioned banking and investment.  Definitely no mention of the reality that the government managed a surplus under Clinton mainly because he essentially privatized the creation of national debt.

We just get a tale of cartoon private-sector villains who brought down the world out of greed.  History of this sort is dangerous because the solutions that seem reasonable after the revision are likely to draw us right back into the arms of the real troublemaker.

  • Rhett Hardwick

    Although I can remember when “If you can fog a mirror, I can get you a mortgage” was the watch word of the trade, there is no doubting that the government facilitated it, perhaps encouraged it is a better word.

    What Justin fears, the loss of the story, has already happened. No one even seems to remember the “savings and loan crisis” of the early 90’s. Banks disappeared, or “consolidated” left and right. It was amusing to watch the news featuring armed federal agents seizing banks, it was always on Friday afternoons, knowing that the bank had received notice to “remove personal property” days before. I remember seeking a renovation mortgage in 1990. I went to three banks (community banks with which I had done business). When I returned with a completed application I found the banks shuttered. The last had been honest to tell me that “the FDIC is in the basement as we speak”. I can’t say the system was perfect. I can remember applying for mortgages when I was 22 and 23, I was asked if I wanted to “pack a car loan in the mortgage”. Another time, an S&L president was fired (but not prosecuted) for having his finger in the till, he was then hired as the banks appraiser (i.e. Joe, get us a good appraisal and there is a couple of hundred in it for you). Of course, in those days, the “appraisal” meant something. The banks would only loan 80% of appraised value. Second Mortgages (i.e. “Equity Loans”) were dirty business, they had to be hidden. I know a real estate broker who went to jail for that, now perfectly legal. A lot of the bank rules and regulations were common sense, and foreclosures were rare. If you had a good history, and a friend at the bank, a lot could be overlooked. “Why not wait until we see if we can approve the loan before giving us the application”, i.e. make the application conform to the loan. The government’s involvement? Well, there was a lot of it mostly under the guise of “deregulation”. Savings Banks had been limited to personal loans and residential mortgages, most recognized a “lending area”. The government removed the restrictions on them to make commercial loans. Suddenly we had community banks, with no commercial experience, making commercial loans to their friends. Try and find a “Savings & Loan” today.

    To prove Justin’s point, it is hard to find people who remember the “Savings & Loan Crisis”. Business people, outside of residential real estate, were probably already doing business with commercial banks and were only slightly effected..

  • Mike678

    Some of those details were in the book, but as you say, got lost in the movie as that doesn’t fit the “Wall Street/Free Markets are evil” narrative. That said, yes–many of these Wall Street people were evil and greedy; many more were in denial that things could go so bad so fast.

    This greed, however, was enabled by the Dem controlled Congress who, in the pursuit of elusive fairness (a term rarely defined) actually incentivized such behavior. In short, Wall Street did what it does best–it went for profits (though it should not have abandoned ethics). The regulators, our Fed Gov’t failed in its duty, period–and working Americans paid the price. Question–If the zookeeper opens the door to the lion cage and people die as a result, who would you blame for the deaths?

    • Rhett Hardwick

      Mike, I am not denying government responsibility in allowing it to happen, but “greed” certainly was an issue. I can remember when the banks decided to “incentivise lending”, i.e. put their salesmen on commission. I can remember a former coke dealer telling me that he had “never made so much money”. The deal was that he got $1500.0 for writing up a mortgage, then an additional $750.00 for every quarter point above the lowest available rate. So if he could sell them a point higher, he picked up another $3,000. It was so good I looked into becoming a “mortgage banker” myself. I was told “you’re too honest”.

      Small private lenders (“loan sharks”) were revolutionized. They would get themselves accredited with FMNA as “sellers”. They would then get a “warehouse loan” and use that to fund the mortgages they granted. Those loans could be sold to FMNA and the Warehouse loan paid. FNMA rules were published in the “Seller’s Guide”. I tried to get a copy of that once, no way.

      At bottom, it was a “boom”. Everyone was making money and no one wanted a “solution”. From the government’s point of view, home ownership was up, and that was what they desired. It was one of those times when “everybody knew”, but nobody knew. There was a small article about dubious mortgages in the Boston Globe. I called the reporter to tell him he hadn’t seen the tip of the iceberg. Basically hung up on me, telling me that I didn’t have “facts”. No, I wasn’t exposing anyone, but I did give him a “lead”. He had never heard of the “silent second mortgage”. There was another game the real estate brokers played with second mortgages which supplied the down payment, those were discharged immediately after recording. They enabled a “low down payment”. I forget the name for that one. In any case “low down payments” are now perfectly legal.

      • Mike678

        Hmm. I thought I captured the ‘greed’ part, but perhaps not. I agree that the bankers–especially Freddie and Fannie (see Barney Frank’s involvement–he’s a real piece of work) were complicit. My point–and I think Justin’s–is that they could not have acted that way without the green light–no active participation from Congress.

        Also understand the “home ownership makes good citizens” theory–but good intentions do not guarantee good results! (not to mention the theory was garbage. The Gov’t noted that homeowners were better citizens and simplistically decided that ownership made them so. Did no one think that they got it backwards? That good citizens owned homes?)

        Getting back to the lion/zookeeper analogy: Who is the root cause of this failure? Capitalists maximizing profits? Or the regulators that were supposed to be regulating? Who didn’t do their job?

        • Rhett Hardwick

          I am not really opposing your point, People simply did what the government allowed. That is certainly foreseeable. Since “everyone knew”, I find it amazing that the government did not. Everyone was making a ton of money and I think congress was bought. One story I remember, I think in Texas, the feds took over foreclosed property, evicted the previous owners and used the houses to house homeless. Why not just rent to the former owners? The government had taken over so many banks with “good” mortgages that they contracted out the mortgage servicing. I can’t remember the name now, but it was owned by someone in the Bush family. They got the contract, but didn’t even have a computer nor a program to manage the mortgage payments. Of course it was madness dealing with them. FNMA knew this and turned it to their advantage. If you argued with FNMA because your mortgage was up to date and they were pressuring you, they would threaten to turn you over to the servicer they had created.

          • Rhett Hardwick

            Since it may have got lost, I should mention that most of the examples I gave above are for the great bubble burst of 1990. The more recent bubble is slightly diofferent in kinds. Most of teh acts which were criminal in 1990 had been legalized. Down payments disappeared for one.

  • ShannonEntropy

    The Gum·mint meant well in creating the housing ‘bubble’ … they just typically screwed it up by confusing Cause and Effect

    They thought that since most middle-and-upper-middle-class folks have college degrees and own homes ,, all we gotta do is make it WAY easier for lower-class folks to get those two things and then THEY will become middle-class taxpayers

    Thus was born the student loan debt bomb and sub-prime mortgages — both money advanced to folks with no business being in either venture

    The Logical Error is that both college degrees and home ownership are the RESULT of pre-existing middle-class values … NOT the CAUSE of them

    The next time the Lib·tards get something right will be the first time

  • ShannonEntropy

    Well THIS has got to be a first … The Pro·Jo published an opinion piece on Jan 3rd that SUPPORTS Justin’s ideas =►

    p.s. As you can see … I read the Pro·Jo for the exact same reason I used to subscribe to PLAYBOY® Magazine … I like to get a little behind in my reading