How many people ever thought that their home would slowly be turned into an addictive substance even more dangerous than cocaine? Probably not too many.
However, that is exactly what happened to millions of people over the past decade. The entire agricultural framework of planters, growers, buyers, and sellers was thriving. And, as always, winners laughed and losers suffered as home ownership became more and more addictive.
It all began rather quietly in 1977 with the passing by President Carter of the Community Reinvestment Act (CRA). This Act was designed to reduce discriminatory credit practices against low-income neighborhoods, a practice known as redlining. To enforce this new bill, federal regulatory agencies were set up to examine banks to make sure they were in compliance. They let it be known that they would take this information into consideration when approving applications for new bank branches or for mergers and acquisitions. Slowly, community groups organized to take advantage of their right under the Act to complain about proper law enforcement of the regulations. Little by little, bank records were made more and more public so that advocacy groups could apply more pressures to obtain lesser quality loans in pursuit of affordable housing.
The planters were at work tilling the land.
In 1992 portions of the Federal Housing Enterprises Financial Safety and Soundness Act put additional pressure on the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, that were the purchasers of many of these new loans form the lending banks, to devote a percentage of their lending to support affordable housing. In October, Fannie Mae agreed to purchase $2 billion of “My Community Mortgage” loans, and in November announced that the Department of Housing and Urban Development (HUD) would soon require it to dedicate 50% of its business to low-and moderate-income families. Since 1997 “Fannie Mae had done nearly $7 billion in CRA business with depository institutions, but its goal was $20 billion. In 2001 Fannie Mae announced that it had acquired $10 billion in specifically targeted CRA loans and announced its goal to finance over $500 billion in CRA business by 2010.” In 1994 the Riegel-Neal Interstate Banking and Branching Efficiency Act was passed. It repealed restrictions on interstate banking and listed the CRA ratings received by any out-of -state bank as a consideration when determining whether to allow them to have interstate branches. Advocacy groups increasingly used the public comment process bank applications on CRA grounds. Federal agencies often held public comment hearings to allow public comment on a bank’s lending record to those with lower incomes. Woe to the bank that hadn’t done enough.
Now the planters were planting the crops.
A big boost to the growers came in 1995 when President Clinton signed the executive order mandating that banks and lenders expand their lending for mortgages to sub-prime borrowers. Failure to do so would result in the lending institution not having access to federal funds or to Fannie Mae and Freddie Mac, who were big purchasers of these sub- prime mortgages.
Naturally, the behavior of all these lenders changed dramatically. Lenders offered more and more loans to high-risk borrowers, including illegal immigrants. Sub-prime mortgages amounted to $35 billion in 1994 (5% of the total), $160 billion in 1999, and $600 billion in 2006 (20%). “In 2005 the median down payment for first-time home buyers was 2%, with 43% of those buyers making no down payment whatsoever.” Mortgage qualifications changed radically. Proof of income was no longer needed. Then the lender no longer required proof of employment; just show proof of some money in the bank account. Finally, NINA was developed – No Income, No Assets. All that was required was some sort of credit score. In July of 2005, there was a strong attempt by the Senate to adopt tough regulatory legislation for Fannie and Freddie. The Banking Committee passed it on a party line vote - all Republicans in favor, all Democrats opposed.
There was remarkably no action in the full Senate. It takes 60 votes to cut off debate in the Senate, and the Republicans had only 55. To close debate and proceed to the enactment of the committee-passed bill, the Republicans needed five Democrats to vote with them. But in a 45 member Democratic caucus that included Barack Obama and the current Senate Banking Chairman Christopher Dodd (D., Conn.), these votes could not be found. What a difference a few votes made.
Also, during this time span, all kinds of payment plans sprung up, from interest-only adjustable rate mortgages (ARMs), to “payment option” loans where a buyer could pay what he could, with any unpaid amount being added to the principal. Billions of dollars of bad loans were being made at the express urging of the government.
Now the growers were seeing the plants grow like crazy.
The crops that the government had watered were springing up in abundance. Addiction was setting in. Not only did Freddie and Fannie fund hundreds of billions of dollars worth of these sub-prime loans, they also bought hundreds of billions of sub-prime securities for their own portfolios to make money.
Finally, with this entire crop being harvested, there developed a real need for some street smart people to move it along. This giant pool of money – represented by trillions in worldwide fixed income investments – offered higher yields than US Treasury bonds. This pool had roughly doubled in size from 2000 to 2007, yet the supply of safe, income-generating investments had not grown as fast.
So now enter the street buyers and sellers of Wall Street.
The crop needed to be bought and to move, and street-smart sellers with know-how and imagination were needed. Cocaine doesn’t move without folks on the street to move it. They came up with the ‘mortgage-backed securities’ (MBS) and with ‘collateralized debt obligations’ (CDO) (really just pools of bonds which were already pools of mortgages), all of which were assigned relatively ‘safe’ triple B or triple A credit ratings by the folks at Moody’s and Standard and Poors, who really didn’t know what they were rating and seemed to care less. Eventually ‘credit default swaps’ (CDS) were developed, which were simply insurance policies that could be bought (and traded) to protect someone (or offer gains) in case the CDOs were to fail. It was the way of the street. Buy wrong and you suffer.
In reality, Wall Street connected this massive supply of crops (government sponsored and grown sub-prime mortgages) to the mortgage market in the US and around the world, with enormous fees going to those all the way up the mortgage chain – from the mortgage broker selling the loans, to small banks that funded the brokers, to the larger mortgage loan companies, to the larger banks, and finally to the government sponsored ‘grower’ - Fannie Mae and Freddie Mac.
Coming down off a high or getting busted is never easy. Unfortunately. But it seems as though the street sellers are going to be the only ones to take the hit. Rather than seeking out the truth, our nation is becoming a nation of liars at all levels, with everyone passing the buck to someone else. Piling on more rules and regulations will not do a damn thing.
And don't think ttat it has stopped. In a recent attempt in August of 2010 to stem taxpayer losses for bad loans guaranteed by federal housing agencies Fanny Mae and Freddy Mac, Senator Bob Corker (R-Tenn) proposed that borrowers be required to make a 5% down payment in order to qualify. His proposal was rejected 57-42 on a party-line vote because, as Senator Chris Dodd (D-Conn) explained, "passage of such a requirement would restrict home ownership to only those who can afford it." It's going to happen again. Just ask your local banker.
Addictive substances are always out there. The only thing that will work is a little honesty, coupled with morality and some honorable men and women in Washington.