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Bipartisan Housing Initiatives Helped To Fuel Massive Asset Bubble

By Frank Schiavone

“Expanding Homeownership: The President believes that homeownership is the cornerstone of America’s vibrant communities and benefits individual families by building stability and long-term financial security. In June 2002, President Bush issued America’s Homeownership Challenge to the real estate and mortgage finance industries to encourage them to join the effort to close the gap that exists between the homeownership rates of minorities and non-minorities. The President also announced the goal of increasing the number of minority homeowners by at least 5.5 million families before the end of the decade. Under his leadership, the overall U.S. homeownership rate in the second quarter of 2004 was at an all time high of 69.2 percent. Minority homeownership set a new record of 51 percent in the second quarter, up 0.2 percentage points from the first quarter and up 2.1 percentage points from a year ago.”

- White House, August 2004 press release

Public policy that encourages home ownership is nothing new. FDR, in his 1944 State of the Union Address, called for a “second bill of rights” with one of its provisions “The right of every family to a decent home”. Ever since, there has been a parade of legislative initiatives whose aim was to promote the time-honored value of hearth and home through the expansion of credit. Housing and mortgage affordability are paramount policy goals regardless of who’s in power.

In 1977, Congress enacted the Communities Reinvestment Act (CRA) in response to commercial banks’ reluctance to serve minority and low-income communities. The void left these communities open to exploitation by less savory sources of credit, such as payday lenders. Consumer advocates pushed Congress to end redlining because they wanted institutions who employed sound lending practices to drive predatory lenders out of those communities. The CRA and subsequent regulations asked banks and thrifts to work harder to find capable borrowers (not to make loans that were more likely to default).

The Depository Institutions Act of 1982 (a Reagan initiative) was supposed to “revitalize” the housing industry by freeing up the Savings & Loans to make more loans.

In 1995, a Clinton Administration initiative led to substantial revisions of CRA regulations in response to criticisms that the regulations were entirely too “burdensome and not sufficiently focused on actual results”. The Office of the Comptroller of the Currency (OCC) also revised its regulations, allowing CRA lenders “to claim community development loan credits for loans made to help finance the environmental cleanup or redevelopment of industrial sites when it was part of an effort to revitalize the low- and moderate-income community where the site was located”. In total, the new CRA and OCC regulations were designed to channel more credit to “inner city and distressed rural communities”.

Let’s also not forget that the Bush administration signed into law the American Dream Down Payment Act of 2003, which was intended to help approximately 40,000 families a year with their down payments and closing costs. Moreover, Bush secured commitments from more than two dozen lending institutions to increase minority home ownership by pledging to provide more than $1.1 trillion in mortgage lending for minority home buyers.

Lastly, of course and most significantly, Congress established Fannie Mae and Freddie Mac decades ago to increase the funding available for home mortgage financing. Fannie and Freddie make mortgage finance possible by providing liquidity to the secondary market for a limited range of home mortgages, either through credit guarantees on mortgage-backed securities (MBS) or by directly investing in mortgages and mortgage-related securities. They are loan purchasers not loan originators. Today, they have $5.4 trillion in outstanding obligations, nearly half of all US mortgages. According to Henry Paulson, their share of new mortgage business rose from 46% in the second quarter of 2007 to 84% in the second quarter of 2008.

Few would argue that promoting home ownership is not a good thing. But the explosion of cheap debt led to a housing bubble that burst so violently it ultimately shattered our already shaky financial system. Decades-long bipartisan government efforts to increase home ownership - of which the CRA, Fannie, and Freddie played just bit parts – served to add fuel to the fire. It was monetary, fiscal, regulatory, and tax policies (that heavily subsidize home ownership), however, that played the leading roles in this Greek tragedy. Turning a blind eye to insane lending practices such as “Ninja” (No income, no job applicants) and negative amortization loans wasn’t too smart either.

The best way to expand home ownership is to make it more affordable. Home appreciation was simply unsustainable. Home prices on average rose 70% from 1996 to 2006. The runaway train didn’t come to a stop until sometime in 2007. The appreciation was completely out of whack with wage inflation and price-to-rent ratios. Policy makers need to stabilize the housing market by allowing prices to return to trend levels. In other words, let the prices fall. The shakeout may take months or even years but artificially propping up home prices with tax gimmicks is yet another house of cards.

Copyright © 2008 Frank Schiavone