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The Financial Crisis -Not Caused by Government Housing Policy, Fannie -Freddie, or The CRA, And Banks Are Not Just Victims

The recent trend has been for pundits and politicians to cast the banks and investment houses as victims of the credit crisis and economic collapse, some in fact to say Fannie Mae and Freddie Mac are the source of the problem. This argument, described by Barry Ritholz as The Big Lie, is contrary to the facts. As California real estate has taken a big hit in the collapse, and Sacramento, Yolo, and Placer County real estate lawyers have since been trying to unravel the impacts on individual buyers throughout California, it is important not to be fooled.

The argument goes that Congress pressured policymakers & Fannie Mae and Freddie Mac (and other banks, through political pressure) to make loans to people who were on the edge of qualifying; as lending standards were forced downwards, the risk of default went up. This included the Community Reinvestment Act, which requires regulated banks and thrifts to provide credit nondiscriminatorily to low- and moderate-income borrowers. More and more people who were not qualified got loans, and, as a result, they starting a cascade of defaults which crashed the economy. However, this does nothing to explain the course of events:

dollar_army_4.jpga. Similar bubbles were created outside of residential housing, such as commercial real estate and consumer credit;

b. Similar crises occurred in other countries which did not have liberal housing policies;

c. The U.S. government’s share of housing (through Fannie Mae & Freddie Mac) was declining during the bubble of the 2000s.

d. The boom & bust in the US should have occurred primarily in the inner cities, where the accused policies were focused; instead the bust was in the suburbs.

In fact, the charges brought by the Securities and Exchange Commission against six former Fannie and Freddie executives tell a different story; it charges that the executives were motivated to begin buying subprime mortgages — belatedly, contrary to the Big Lie — because they were trying to reclaim lost market share, and thus maximize their bonuses.

Meanwhile, Washington lawmakers, while claiming to be phasing out the government’s role in housing, expanded it in last week’s payroll tax cut extension, by requiring Fannie & Freddie to divert funds to pay general government expenses over the next ten years. This will require the companies to increase fees on new mortgages by an average of 10 basis points, or .1 percentage point, effective April 1, to comply with the law.

So what did cause the collapse? There are plenty of authors (linked above) who can explain in detail. But to summarize, Congress radically deregulated the financial sector, doing away with many of the protections that had been in place for years. Nonbank (which means “unregulated”) mortgage underwriting exploded from 2001 to 2007, along with the private label securitization market. Private lenders not subject to congressional regulations (who did not need to make ‘confirming’ loans) collapsed lending standards, to make more profitable subprime loans. Private lenders made the bulk of the subprime loans, which were then securitized and sent out into the world with a cloak of respectability. Lets not let the Big Lie get too far.