Wednesday, October 12, 2011

Planting the seeds of the financial crisis

The usual narrative about the financial crisis of 2008-09 is that greedy and under-regulated Wall Street operators took down the economy with their reckless behavior.  This is certainly the narrative pushed in the press, and the Occupy Wall Street crowd seems to have bought into it.  The other, more plausible, narrative attributes much of the blame to reckless government housing policies that encouraged (to the extent of even requiring) lending to financially unsuitable homebuyers.  There is a good outline of this narrative in today's Wall Street Journal by Peter Wallison.

The seeds of the crisis were planted during the 1990s, and were fertilized in the 2000s:
Beginning in 1992, the government required Fannie Mae and Freddie Mac to direct a substantial portion of their mortgage financing to borrowers who were at or below the median income in their communities. The original legislative quota was 30%. But the Department of Housing and Urban Development was given authority to adjust it, and through the Bill Clinton and George W. Bush administrations HUD raised the quota to 50% by 2000 and 55% by 2007.
The crisis was in full bloom by 2007-08:
Research by Edward Pinto, a former chief credit officer of Fannie Mae (now a colleague of mine at the American Enterprise Institute) has shown that 27 million loans—half of all mortgages in the U.S.—were subprime or otherwise weak by 2008. That is, the loans were made to borrowers with blemished credit, or were loans with no or low down payments, no documentation, or required only interest payments.
Of these, over 70% were held or guaranteed by Fannie and Freddie or some other government agency or government-regulated institution. Thus it is clear where the demand for these deficient mortgages came from.