It’s the Economy, Stupid.

Wise words from James “Snakehead” Carville.

Much has been made of the mortgage companies and the finance industry causing the housing boom and bust and the resulting crash in the financial sector.  Democrats claim that the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Community Reinvestment Act (CRA) had nothing to do with it.

It appears that they did.

Mortgages are an exercise in an investment process – a mortgage is nothing but a securitized debt instrument that yields interest (just like a government bond or commercial paper) and can be bought and sold by the holder of the debt. Basically, a chartered bank, an investment bank or a mortgage bank will give you the cash to buy a house, then either keep the debt or package it with other similar debt to back mortgage securities, which are sold to investors. When they make loaned with the intent of selling them, that act is called origination.

Originators take a fee or “points” of the loan as payment for handling the loan, that is how they make their money, the subsequent transfers are facilitated by a “discount” against the value of the note over time, the seller gets their cash and a share of the future value of the note and gets out, the end buyer is in it for the payments over time to recover interest and principal. Sounds like a losing proposition but a $180,000 note at 6% for 30 years will yield a total of $347,047 in interest, making for a total repayment of $527,047. If you can hold it, you can double your investment, if not, take it to the debt market and sell it for a lower, but faster return.

The thing about businesses and corporations are that they are not in business to lose money. Even Liberals recognize this when the decry companies that “make too much money”. While it was convenient to blame the greed of financial community for the financial crisis, the fact of the matter is this: If there was no money to be made by originating and selling sub-prime mortgages, they would not have done it. If they did not have a willing buyer of the subprime paper, there is no way that they would have been in the business. Business is all about the assessment of risk and reward, only when the reward is greater than the risk will a business in a free market act. A transaction only occurs when a seller is willing to sell and a buyer is willing to buy.

Unless the market is distorted by another force.

There is a concept in the finance and investment world called a “market maker”. In the investment world, a “market maker” is a broker-dealer firm that accepts the risk of holding a certain number of shares of a particular security in order to facilitate trading in that security. In other words, the firm creates a market by facilitating trades with securities that they hold.

Who was the “market maker” for subprime mortgages?

Fannie Mae and Freddie Mac.

How do we know? We know because of this information from the Associated Press of Friday , May 6th, 2011:

Fannie Mae asked the government Friday for an additional $8.5 billion in aid after declining home prices caused more defaults on loans guaranteed by the mortgage giant.

The company said it lost $8.7 billion in the first three months of the year. Those losses led Fannie to request more than three times the federal aid it sought in the previous quarter. The total cost of rescuing the government-controlled mortgage buyer is nearing $100 billion – the most expensive bailout of a single company.

Combined with the bailout of sibling company Freddie Mac, the government expects their rescue to cost taxpayers about $259 billion. That money will cover the mortgage giants’ losses on soured loans made in the midst of the housing bubble.

Fannie and Freddie – and the American taxpayers are left holding the bag. Note that the AP states that this is “the most expensive bailout of a single company.”, dwarfing anything on Wall Street or with GM. The insidious thing is that this is taxpayer funded loans being bailed out by yet more taxpayer funds. A double dip.

Looking all the way back to 1998, even during the Clinton administration there were warnings. Former Senator Don Nickles (R-OK), said this on the floor of the Senate in support of a bill to strengthen the basic requirements of loan guarantees from the FHA.

Is FHA doing such a great job? They have three times the default rate of conventional loans. They are not doing that great if they have a default rate running at 8.4 percent, three times the national rate for conventional loans.

They have a smaller downpayment, which means a much greater risk. If you have a loan with FHA, I believe the loan to value ratio is 96 percent. That is far lower than conventional loans, so you have a lot more risk and three times the default rate.

[Page 15,694 of the Congressional Record, July 16, 1998]

Financial companies would only make these risky loans if they knew that they had some way to mitigate the risk – somewhere to park the loans. That somewhere was facilitated by the Community Reinvestment Act and the trio of Democrats Chris Dodd, Barney Frank and a cadre of Republicans in name only. The CRA has been around since Jimmy Carter, but it never had been used to pressure financial firms the way that Dodd, Frank and the “go along to get along” RINOs did from there respective seats in the banking and finance committees in Congress. In 2009, Forbes noted:

The low interest rates of the early 2000s may explain the growth of the housing bubble, but they don’t explain the poor quality of these mortgages. For that we have to look to the government’s distortion of the mortgage finance system through the Community Reinvestment Act and the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.

In a recent meeting with the Council on Foreign Relations, Barney Frank–the chair of the House Financial Services Committee and a longtime supporter of Fannie and Freddie–admitted that it had been a mistake to force homeownership on people who could not afford it. Renting, he said, would have been preferable. Now he tells us.

Long-term pressure from Frank and his colleagues to expand home ownership connects government housing policies to both the housing bubble and the poor quality of the mortgages on which it is based. In 1992, Congress gave a new affordable housing “mission” to Fannie and Freddie, and authorized the Department of Housing and Urban Development to define its scope through regulations.

Shortly thereafter, Fannie Mae, under Chairman Jim Johnson, made its first “trillion-dollar commitment” to increase financing for affordable housing. What this meant for the quality of the mortgages that Fannie–and later Freddie–would buy has not become clear until now.

On a parallel track was the Community Reinvestment Act. New CRA regulations in 1995 required banks to demonstrate that they were making mortgage loans to underserved communities, which inevitably included borrowers whose credit standing did not qualify them for a conventional mortgage loan.

To meet this new requirement, insured banks–like the GSEs–had to reduce the quality of the mortgages they would make or acquire. As the enforcers of CRA, the regulators themselves were co-opted into this process, approving lending practices that they would otherwise have scorned. The erosion of traditional mortgage standards had begun.

This is just the most recent example of how a government intervention skews and distorts a market that otherwise would have corrected itself. Fannie and Freddie removed the risk on subprime mortgages from the market and transferred it to the taxpayer and with this artificially low risk, opened a market that otherwise would not have existed. Had the financial community been playing with their own money and motivated by rate of return, money would never have been lent to people who couldn’t afford to pay it back – it is that simple. The government basically attempted to achieve a social goal by stretching the mortgage market to one side like a rubber band and when it snapped back (as free markets always do – they correct themselves), it took out the financial community and hit the taxpayer smack in the face.

This should be a dire warning to those who seek greater intervention by government in a free enterprise system. Behaviors like this can never stand. Rational markets always seek equilibrium. Take them too far out of balance or prevent them from correcting and the result is disaster.

26 thoughts on “It’s the Economy, Stupid.

  1. Pingback: It's the Economy, Stupid. | The Rio Norte Line | Home Loans UK

  2. Utah,

    Given that the govt. now owns some 90% of ALL private home mortgages and some 60+% of commercial notes, I am not convinced that the mess with Fannie and Freddy wasn’t done intentionally.

    Please remember, when the Wiemar Republic printed money to pay off its WW I debts, Hitler reset the German economy by using land – not gold and silver. I sincerely believe the idiots in charge of our govt. and the fed know they will have to print and/or digitize their way out of our debt, which will bring about hyper inflation on a scale similar to that in Wiemar Germany. I think they were just looking ahead for a way to acquire the land that will be necessary to repeat what Hitler did after they cause the economic meltdown they know is coming.

    Keep in mind that the govt. also owns some 60-70% or so off all the lands containing our primary natural resources, as well.

    I know how people feel about conspiracy theories, but when you can make one that is this tight, this consistent and this coherent; and that makes this much sense and has a nearly identical model; and that explains and even predicts so much that we are actually seeing happen, well, at some point you have to say my ‘economic conspiracy theory’ has fewer problems than the theory of evolution and we all know how adamant people are about that being ‘fact.’ 😉

    • B, Sounds like you have read “Hitler’s
      Beneficiaries”

      As for the mortgage crisis; it was purposeful. There were lots of experts pointing out what was happening, and inevitable result, that in fact occurred.

      • Sorry, no, I haven’t read that particular book, but my past profession saw to it that I was intimately familiar with Hitler’s Germany.

        Actually, the Allies benefited immensely from Hitler’s meddling with his nation’s economic affairs. For one thing, he did not place Germany on a total war footing until sometime in 1943. Then, even after he did, his favoritism led him to show partiality to certain businesses while allowing superior weapons systems to languish due to lack of political favor. many Allied lives were spared because of this ineptness; the same form of ineptness that needlessly cost so many Russian soldiers their lives.

        [btw: I like the avatar. 🙂 ]

      • http://spectator.org/archives/2011/05/13/the-true-story-of-the-financia

        An entity, private or public, individual or corporate, can only postpone economic consequences for a time period in an internationally inter-connected economy. The progressives purposely caused the actions, which created this catastrophe…. I leave it to “you” to decide whether the progressives were purposely stupid, or believed they would eventually profit politically from the disaster. I don’t believe they were stupid. Dodd, Frank, Clinton, and progressive supporters became rich during the inflation of the bubble.

        • Look at the results and what the actions that caused the debacle. Look at who attempted to warn Congress and the nation (President Bush and John McCain went to the hill years before the meltdown in an attempt to create real regulation Fannie Mae and Freddi Mac). The federal government being in control of the majority of mortgages, aligns with what theory of government? Constitutional Capitalism or Progressive Marxism?

            • A capitalist society as envisioned by our founders of course. : )

              Seriously? I would envision an environment as Milton Friedman, Thomas Sowell, and Walter Williams espouse.

              Minimal legal and regulatory intervention of free markets with free trade. Correcting the Corporate problems you noted in your essays. Allow more freedom, but require more responsibility commensurate with the freedom.

              • Hmmm,

                I think maybe we both need to keep noodling this one for a bit. I’m pretty sure our founders would have objected to our current economic system, but I’m not sure how we ‘fix’ what we have. Still, we need to get it back in line with something that resembles a free market where individuals have the rights to their labor and property without being given legal claim of immunity in the form of an artificially constructed corporate shield – especially in a world where those corporations rival our government in regards to how much power they wield.

        • You see, my reading of history doesn’t allow me to universally condemn ALL Progressives. I believe many did think they were doing something good. Their mistake is found in their conception of ‘good.’ Because many of them do not ground their world view in the Biblical principles upon which all individual rights and liberty are founded, they hold a corresponding misunderstanding of ‘good.’ You find this is the notion that suffering is bad. Having endured Paris Island, I can assure you, suffering can and does serve very useful purposes. Ask anyone who has ever tried to stand in the way of the USMC about how useful the suffering of boot camp proved to be to that fighting force.

          So, in the specific instance of when the Progressives linked our world economies, this is one of those times where their misunderstanding of human nature caused them to do great harm where they thought they were doing a global good. This is detailed in Carroll Quigley’s “Tragedy and Hope.”

          • Thank you for the lesson. As I study history, economics, and law; certain “truths” appear self evident to me. I tend to make the assumption all can understand the results of action or inaction when confronted with a problem. Maybe most have no wisdom. I shouldn’t jump to conclusions about others’ motives. However, numerous voices warned Congress of what eventually did occur. Those that promised the debacle would not occur and prevented corrective action by our government, profited either politically, financially, or both.

            • Not really meant as ‘a lesson,’ just helping out with a little history that has been intentionally taken from us.

              As for the warnings about the housing market: to be sure, there were many who knew this was going to happen, were warned and rather than do nothing, they actually acted to make sure it would be worse than it had to be. Personally, I think they should be prosecuted.

  3. All of the tort reform, supported by the Progressive Republicans, is BAD for individuals. I will write something explaining why sometime…

  4. The home financing business of the early 2000’s was the stupidest “business” I have ever witnessed. I was constantly amazed at the loans people with absolutely no chance of repaying them were getting. A friends daughter (a baby momma times 3 with absolutely zero job history) and her childrens daddy (an illegal air conditioning contractor who has never claimed any income) bought and financed 100% a home for $200,000. Naturally they never made even the first payment and after a little over a year the home was repo-ed. And of course it was destroyed by the time they were tossed out.
    Another example……………… a couple I know of got over $125,000 to buy some land and a new double wide. Same story, never made a payment, destryed the home and got it repo-ed. Only difference was that they were both drug addicts so the sold every part of the double wide that they could (appliances, a/c, furniture, fixtures) to support their habit.
    Neither of these buyers should have been given even a dollar from a lender………………………..but the govt said “lend them the money, take a dip of the profits and give us the note”, so naturally that is what happened.

    • When the hello are you gonna post, Dusty? Now that B. has decided to leave my poor, wandering, hopeless and helpless mind in the cold (Yes, I’m shivering at the mere thought of my misguided ignorance) I need help! I cannot think when I don’t have a wonky around. Please help me. I thank you.

  5. Pingback: Secession Tantrums And Selective Memory | The Rio Norte Line

  6. Pingback: The Community Reinvestment Act | The Rio Norte Line

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