Rick Pollack · Affordable housing, community organizers and the crisis

November 1st, 2008

There’s been debate on BFD about the cause of the financial crisis. One narrative stated that congressional pressure (by democrats) forced the GSEs to purchase subprime loans and that the government created this mess. While it is very true that Fannie and that the government bear considerable responsibility, the blanket assertion that democrats and Fannie are to blame misses the greater context. Additionally, the variations on this theme blaming community organizations, the Community Reinvestment Act, and other initiatives related to affordable housing are heavy on politics and light on fact. With the election just a few days a way these beliefs need to be openly challenged.

Fannie’s decision to pursue subprime loans was a business decision. They were losing market share, they were pressured by at least one major customer to either take on risky loans or lose business, they were pressured by shareholders to increase profits and they were pressured by investors to produce higher returns. Fannie did what businesses do, they followed the market. Moreover, most of their subprime purchases were refinancings and did not count toward their affordable housing goals. Fannie and Freddie are fundamentally flawed organizations as their chartered responsibility to provide affordable housing conflicts with their fiduciary responsibility to maximize profit for shareholders. Since at least 1998 the drive for profits (and executive bonuses) has dominated. Profits and market share led to the ill-fated move into subprime. The affordable housing aspect of their charter just provided political cover.

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12 Responses to “Affordable housing, community organizers and the crisis”

  1. J Murray Says:
    November 2nd, 2008 at 7:29 pm

    Rick, exactly right. That’s why the FMs shouldn’t have existed, but should certainly now be shot. Their special status as government-sponsored entities created the assumption that they wuold be bailed out by taxpayers if they had difficulties. This enabled them to borrow at lower rates than their competitors, which enabled them to then offer better terms for the more-profitable subprime loans.

    If all they had done was support affordable housing, they would have been much smaller. There would have been an honest policy debate about subsidizing home ownership for the uncreditworthy. Avoiding that debate is exactly why Democrats did it the way they did it.

  2. Carole Cohen Says:
    November 2nd, 2008 at 9:13 pm

    The culture of credit purchasing, buying things you can’t afford and having to have it all is to blame pure and simple. This causes predator lenders, consumers, all of us to do things that don’t help our economy. The credit crisis is just as important in all this as the mortgage lending issue and to me both are part of the bad foundation of culture. It has to be a change from the bottom up, in individual thinking. A paradigm shift that will get all of us back on track.

    Fannie and Freddie were and are useful tools for mortgages. Many of my clients get loans through them – clients who are fiscally responsbile and good candidates to own.

    How easy it is to say government did this. I keep going back to Bob Dylan’s thought that we are all in charge, don’t blame the polticians and leaders, we need to be the ones making the changes.

    So many people right now are just waiting for the crises to end so they can get back to ‘the old way of life’ meaning spending what they don’t have. Meaning investments in a stock market while they look the other way at corruption on wall street as long as they are making money.

    Fuel for our cars is close to $2.00 a gallon. But none of us can afford to get complacent and forget how we got to $4.00/gallon in the first place.

    Scam lending was just as responsible as freddie and fannie but that is not the point. It’s the culture, stupid. (Not calling anyone names, you know the phrase)

    We ARE in charge if we want to be

  3. Rick Pollack Says:
    November 3rd, 2008 at 6:15 pm

    Carole – I completely agree with you on the credit front.

    I also agree with you about Fannie/Freddie being useful. The problem is that since at least 1998 Fannie has been dominated by the profit side of the equation. For all of the bluster about affordable housing, Fannie is graded based on dwellings and not houses. So, if their percentage of mortgages don’t meet the affordable housing requirements, Fannie funds rental units – hundreds of thousands of rental units. The affordable ‘housing’ aspect of their housing responsibility is unenforceable.

    As far as I can tell, Fannie and our government were significant contributors but the not the cause of the crisis. The real problem with the GSEs is they have lost sight of their missions and have focused on profit. In the process they have built these massive captive portfolios that are highly volatile. Shaq is 7ft tall, 300 pounds, and wears size 25 (or so) shoes. Imagine that Shaq was 15ft tall, weighted 700 pounds and wore size 5 shoes. That is the situation with the GSEs, their capital is not enough to handle significant interest rate fluctuations and credit defaults. The good news is they are now being reined-in. And, at this point, though they have Alt-A and subprime exposure, their books of business (all the mortgages they guarantee) are not in bad shape. Though they relaxed their underwriting standards, they did not go wild. The only place they went wild was in their handling of accounting and their pursuit of profit.

    Back to the credit front…in the mid-90s, I did contract software development for a credit card issuer, it was a division of GE Consumer Credit. While I was there or shortly before I arrived, one of the GE managers wanted to prove a point so he filled out one of their credit applications, the kind you get in the mail, in his dog’s name. Sure enough, his dog was issued a card.

    I find credit cards to be extremely useful but using credit cards is like playing soccer on a mountain top – as long as the ball is under control there is no problem. But when it gets away…it can be a very long way down. When credit is so easily available that even a dog can get it…bad things will happen. The data is clear, a substantial portion of subprime loans in the 90s and early 2000s, when the subprime industry was growing (and before the real estate bubble) were refinancings to get credit card debt under control. Have you seen the documentary Maxed-out (about debt)? I just picked it up from the library – have not watched it yet. I also picked up the book, The Two Income Trap, by Elizabeth Warren.

    Also, I am reading Confessions of a Subprime Lender by Richard Bitner; he owned a $200 million subprime lending company. It provides a detailed and nuanced behind the scenes look at the subprime industry. Wow! If you want to really understand the financial crisis – read this book. Garbage in, garbage out. Unfortunately, in the section where he discusses fraud, the specific company he discusses is/was located right here in Cleveland.

  4. J Murray Says:
    November 4th, 2008 at 3:28 pm

    Rick, the housing crisis was fed by a credit bubble. The government, specifically the Federal Reserve, is the only entity that can cause a credit bubble, therefore the government did, indeed, cause the problem:)

  5. Tom Z(ych) Says:
    November 4th, 2008 at 3:55 pm

    Once again, J., you prove yourself the King of Ideologically-Driven Oversimplification. Yes you can!

  6. J Murray Says:
    November 4th, 2008 at 6:33 pm

    Tom, explain to me how the housing bubble occurs without the Fed keeping interest rates low for so long? Or, for that matter, how it occurs without Fannie Mae and Freddie Mac feeding low-cost money into the mortgage market? It really is as simple as that.

  7. Tom Z(ych) Says:
    November 4th, 2008 at 8:48 pm

    You’re asking the wrong question, because you’re stuck in a monocausal mindset. Low interest rates by themselves do not cause a housing bubble with bad securitizations with questionable bond ratings with unregulated credit default swap markets and on and on and on. You’re just oversimplifying things to focus on one link in the causal chain on which you are ideologically fixated. That’s all I’m saying. It’s like your flawed monocausal thinking about tax rates and economic growth.

    Oh, I forgot, yes we can!

  8. John Ettorre Says:
    November 4th, 2008 at 10:39 pm

    Monocausal mindset! Wow, I think you’ve coined a great new phrase (or perhaps you’re merely borrowing it from someone else, TZ). Either way, I love it.

  9. Carole Cohen Says:
    November 5th, 2008 at 6:44 am

    Rick, I agree with you about the ‘profit side of the equation’ being too prominent. They need to get back to their original purpose. I mean, staying in the black is a good thing but ignoring solid practices to appease the money guys, not so much.

    The housing bubble is not something I attribute to fannie and freddie. Go to San Diego and talk to people who bought homes for 300k more than the last home in the neighborhood sold for — listen to how they were only able to get a mortgage loan for 300k less so they put their cash monies into the home to get it down to that loan amount. It was nuts. And not related to these two government entities. I’m not saying they were not part of the problem, but there were a lot more things going on. The mentality was I want this house and I’ll offer 300k more so the other buyer doesn’t get it. It’s nuts!

  10. J Murray Says:
    November 5th, 2008 at 4:43 pm

    But you can’t have a for-profit company, owned by private shareholders, and tell it to voluntarily take less profit than it could earn. The managers of the company have a duty to shareholders, under law.

    If Congress wants subsidized housing for lower-income and uncreditworthy people, it should say so directly and advocate for ways to enable that to happen. By hiding that objective behind a for-profit company, though, they created unaligned interests among the various parties involved.

    Furthermore, the evidence clearly shows that Fannie Mae and Freddie Mac didn’t do much to support home ownership among lower income people anyway, which was their ostensible reason for existing. They did enable people who were already qualified for a mortgage to get better terms, in essence competing with for-private companies with money they were able to borrow at lower rates due to the assumed taxpayer guarantee of the FMs.

    All in all, a muddle of mixed motives if ever there was one. It’s no surprise to me that it blew up.

  11. Tom Z(ych) Says:
    November 5th, 2008 at 6:31 pm

    John:

    “Monocausal” is not mine. The concept was best used in a discussion of tax policy and the trope that a tax cut always has had a direct positive effect on growth. It’s a way of pointing out the “post hoc ergo prompter hoc” logical fallacy.

  12. K. Uhlir Says:
    November 13th, 2008 at 5:15 pm

    John McCain drafted legislation curbing FannieMae/Freddie/Mac as early as 2002!
    How’s that for leadership and perspective!!
    K.Uhlir