Root Cause of the Mortgage Lending Crisis

What is the root cause of the current mortgage lending crisis?

Mortgages issued with no verification of income, no ability to make payments, and no down payments.

But why would anyone underwrite obviously risky mortgages?


Government regulation, led by prominent Democrats including former Clinton budget director and Fannie Mae CEO Franklin Raines. Raines managed to eke out a living by earning $90 million from 1998 to 2003 at Fannie.

In fact, the management team at Fannie Mae -- all four of whom were prominent Democrats -- pulled down nearly $200 million in pay over that time period.

Fannie Mae executives, aided and abetted by Congressional Democrats and the Clinton administration, went hog wild promoting low-quality loans. After all, their stock options and "earnings-per-share challenge grant awards" were at stake. A press release from 1999 -- announcing a $1 billion taxpayer-funded giveaway -- epitomized the era.

Congresswoman Eleanor Holmes Norton (D-DC) announced that she was introducing a bill today to make her $5,000 D.C. homebuyer credit permanent... "I have chosen to introduce the District of Columbia $5,000 Homebuyer Credit Act... because Fannie Mae has significantly increased the credit's value... by monetizing the $5,000 credit... As a result, for a $100,000 house, no down payment would be necessary..."

Not everyone was enamored with the "new Fannie Mae". A March 2002 Business Week article ("The Homes Keep Selling") sounded a lonely and unheeded alarm.

...gains in home prices are outstripping wage gains. That creates a gold-rush mentality in which potential homebuyers rush to grab a house as quickly as possible, even if they overpay. And mortgage lenders are willing to oblige, even in the case of buyers who might not have qualified before. ....the aggressive tactics of mortgage lenders have been made possible by the automated underwriting systems developed in recent years by the Federal National Mortgage Association (Fannie Mae)…. The new underwriting systems being used by Fannie Mae … allow for higher loan-to-income ratios than in the past to encourage home buying. …but the relaxed ratios could pose serious problems in the future. For one, there is already evidence that defaults are rising… For Fannie Mae … which only began expanding into subprime mortgages two years ago, deteriorating credit quality may be a new and unpleasant experience...

Unpleasant indeed.

Raines was finally forced out of FNMA in 2004 over accounting fraud allegations. Although he claimed innocence, he finally agreed to settle the suit with the government this year and said he would pay back a "few million of the [approximately] $50 million... he [allegedly] obtained illegally..."

Moreover, FNMA's secretive "Countrywide program" gave special loans to connected individuals including the Democratic Chairman of the Senate Banking Committee, Sen. Christopher Dodd, and the chairman of the Senate Budget Committee, Democrat Kent Conrad.

Greedy Democrats helped melt down the financial system by treating Fannie Mae like their own personal piggy bank.

In February 2004 Alan Greenspan warned that Fannie and Fredde could cost taxpayers dearly.

Mr. Greenspan said that Fannie Mae and Freddie Mac, which buy up and repackage billions of dollars' worth of mortgages every year, have grown so rapidly and accumulated so much debt that they cannot adequately hedge against the risks of financial crises... The Fed chairman said both companies, which hold about $2 trillion worth of obligations tied to home mortgages, have grown much faster than their competitors because investors think the federal government will bail them out in a crisis.

Turns out he was right.

In 2003 the Bush administration tried to stop the madness.

The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago... Under the plan, disclosed at a Congressional hearing today, a new agency would be created within the Treasury Department to assume supervision of Fannie Mae and Freddie Mac, the government-sponsored companies that are the two largest players in the mortgage lending industry...

...The new agency would have the authority, which now rests with Congress, to set one of the two capital-reserve requirements for the companies. It would exercise authority over any new lines of business. And it would determine whether the two are adequately managing the risks of their ballooning portfolios.

And why did the Bush administration attempts at a Fannie Mae reformation fail?

Among the groups denouncing the proposal today were the ...Congressional Democrats who fear that tighter regulation of the companies could sharply reduce their commitment to financing low-income and affordable housing.

”These two entities — Fannie Mae and Freddie Mac — are not facing any kind of financial crisis,” said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ”The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.” ...Representative Melvin L. Watt, Democrat of North Carolina, agreed.

Former Clinton Budget Director and FNMA CEO Franklin Raines made $90 million.

Clinton Deputy Attorney General and FNMA Vice Chair Jamie Gorelick made $26 million.

Kerry adviser and FNMA vice-chair James Johnson pulled down $21 million -- in one year.

Now consider: two of Barack Obama's key financial advisers are -- yep, you guessed it -- Franklin Raines and James Johnson.

Change!

Major hat tips: John Lott, Protein Wisdom, Ed Morrissey at Hot Air and The Volokh Conspiracy. Linked by: Brutally Honest, Fausta's Blog, Moving Left and Mitchell Langbert. Thanks!