In the wake of last week's major lending market collapse, many conservatives have drawn a bead on low income housing as the root of the problem. While there are some truths to their claims, I believe it is unfair to lay the blame completely at the feet of affordable housing advocates and their political allies.
To begin with, it is probably good to explain why we needed affordable housing legislation in the first place.
Seventy five to eighty years ago, inner-city neighborhoods were largely populated by European immigrants, who toiled at backbreaking blue collar jobs, and accumulated only minimal amounts of wealth. Many of these older residents lived as tenants all their lives, never owning a home or a stake in the apartments where they lived. The children of these residents, who weathered the Great Depression in these neighborhoods, came home from World War II and attended college on the GI Bill. Many of them became professionals, joined the expanding middle class, and moved to the suburbs in the 1950's and 1960's. When their parents retired, they moved out with them. A few of the original residents remained, but of those, most stayed because they could not afford to move.
After WWII, a new influx of blue collar tenants moved into these neighborhoods, the majority of which were "non-white" -- blacks from the South, and immigrants from the Caribbean, Mexico, and South America. These residents also rented, and owned little accumulated wealth. Almost without exception, none of these residents could afford to purchase apartment buildings or storefront businesses within these neighborhoods. A shadowy amalgamation of banks and other investors ended up owning these properties. In some cases, rent controls meant that the property owners could not earn enough money in rental income to afford regular maintenance of their properties. In others, the owners simply refused to spend the money.
Then during the 1960's, the urban renewal craze hit America's big cities. Municipalities discovered that old residential and commercial areas could be razed, and in their place parks, civic centers, sports stadiums (and ancillary businesses like parking garages, hotels, and restaurants) could be erected, providing millions of dollars in badly-needed revenues. This encouraged cities to deliberately neglect older neighborhoods, since it was much easier (and vastly cheaper) to acquire blighted neighborhoods through imminent domain powers than to have to purchase them on the open market.
As blue collar jobs began to move out of the inner cities, crime, out-of-wedlock pregnancies, drugs, alcoholism, and vandalism began to take their toll on inner city neighborhoods. Run-down properties became decrepit. When conditions deteriorated further, buildings were abandoned. In areas where urban renewal was unlikely to happen, property owners attempted to recover what value they could from their properties through self-inflicted vandalism and arson. As a result, insurers refused to underwrite those properties. Banks refused to loan any money for the purchase or renovation of properties in those neighborhoods. The outlook for the remaining residents seemed hopeless.
However, in the 1970's, pioneering community organizing efforts began to change that. Residents rallied around neighborhood landmarks and began demanding that cities invest money in their neighborhoods in proportion to what wealthier areas received. And they began pressuring banks and savings and loans to begin making small loans available to neighborhood residents.
A major community organizing milestone was the 1977 Community Reinvestment Act, signed into law by Jimmy Carter, which made it illegal for banks to "redline" blighted neighborhoods. As a result of the CRA, major improvements began to be made in many poor urban neighborhoods. This was a good thing. It brought a sense of accomplishment to community residents, and rekindled a spark of hope among the millions who were prisoners in America's inner cities.
Unfortunately, after a decade and a half, common sense financial planning in urban neighborhoods began to be supplanted by the notion that "more of a good thing is always a better thing."
Perhaps in an effort to contrast themselves from the mythical 1980's "decade of greed" allegedly masterminded by the Republican party and evil Wall Street financiers, the Clinton Administration began a steady push to expand housing loans in low-income areas. Investors Business Daily explains,
Lenders who refused would find themselves castigated publicly as racists. As noted this week in an IBD editorial, no fewer than four federal bank regulators scrutinized financial firms' books to make sure they were in compliance.
Failure to comply meant your bank might not be allowed to expand lending, add new branches or merge with other companies. Banks were given a so-called "CRA rating" that graded how diverse their lending portfolio was.
It was economic hardball.
"We have to use every means at our disposal to end discrimination and to end it as quickly as possible," Clinton's comptroller of the currency, Eugene Ludwig, told the Senate Banking Committee in 1993.
And they meant it.
In the name of diversity, banks began making huge numbers of loans that they previously would not have. They opened branches in poor areas to lift their CRA ratings.
Meanwhile, Congress gave Fannie and Freddie the go-ahead to finance it all by buying loans from banks, then repackaging and securitizing them for resale on the open market.
That's how the contagion began.
With those changes, the subprime market took off. From a mere $35 billion in loans in 1994, it soared to $1 trillion by 2008. (emphasis added)
During the late 1990's, financial accountability at large mortgage lending houses largely evaporated via two extremely risky policies.
First, loans to low-income borrowers were financed a sub-prime rates. Normally, interest rates are calculated based on the prime rate, which is determined by the Federal Reserve, plus reasonable adjustments that cover banking costs and potential risks associated with the borrower. Having a lower-than-average income usually translates into a higher potential risk, and therefore a higher interest rate. This practice has obviously been abused (credit cards companies come to mind immediately) but in an effort to make loans more affordable to low income borrowers, banks were encouraged to loan money at rates below the prime rate. This meant that banks were not collecting enough money in interest payments to offset the cost of defaulted loans.
Second, banks were allowed to make unsecured loans; in other words, banks were allowed to increase the value of their loans beyond the security value of their deposits, which is a very dangerous thing to do. The mechanism that allowed them to do this was a clever scheme that allowed Fannie Mae to bundle unsecured mortgage loans and other financial instruments from banks and other lending institutions together, and sell them as givernment-vetted long-term securities (bonds, essentially) in the secondary market -- "Pooled FNMA Certificates." Curiously, the first firm granted this privilege was Bear, Stearns, & Co.
Although I cannot find sufficient evidence to back up this theory at the time of this writing, it seems reasonable to me to assume that much of the financing for the so-called Tech Bubble of the late 90's could have been raised, and then absorbed as losses, through the mechanism of secondary market bundled mortgage securities -- if bonds or other instruments used to raise cash for the tech market financing were bundled with the unsecured mortgages. As long as the value of the mortgages remained high, losses from the Tech Bubble could have been absorbed with relative safety by major financial institutions and insurers.
It also seems reasonable to assume that the tech bust of 2000 - 2001 would have driven more investors (who were disillusioned with the stock markets, specifically the tech sector) toward mortgage securities, which then would have driven the value of these securities even higher due to increased demand. In addition, the Federal Reserve has continually printed more and more money and made it available at lower and lower interest rates, in an effort to keep the economy growing.
All of this worked beautifully as long as the value of real estate continued to climb. Greater demand for homes and a ready supply of mortgage cash meant that home prices soared year after year. And as the book value for real properties steadily increased, the resulting increases in equity value translated into more and more money that could be borrowed against the current (and future) value of the property.
During the late 90's and early 2000's, bankers, politicians, and investors swore by the old maxim that "no bad news is good news." This philosophy was responsible for the major accounting scandals of 2001 - 2002, which revealed that many business executives were more interested in perpetually rising earnings and stock valuations than they were in using standard accounting principles or actually making money. It should come as no surprise that Fannie Mae itself was involved in a multi-billion-dollar accounting shell game that came unraveled in 2005.
Warning signs were abundant, yet criticism dating back as far as 1997 was generally ignored. In 2003, the Bush Administration attempted to impose stricter oversight over Fannie Mae and Freddie Mac, specifically through the creation of a special department within the US Treasury to oversee those institutions. Democrats balked at the idea and eventually defeated it, claiming that Fannie and Freddie were sound financially, and that any attempt to increase regulation would result in a decrease in available affordable housing ... and no one wanted to be accused of racism. Republicans proposed another mortgage lending regulation program in 2005. This program also failed after House Democrats drastically altered the Senate version of the bill, and it died in committee.
The whole thing came crashing down this year, with the softening and eventual meltdown of the overinflated California and east coast real estate markets, the near-bankruptcies of Merrill Lynch, Bear, Stearns, & Co., and CitiGroup, the bankruptcy of Lehman Brothers, the collapse of Fannie Mae and Freddie Mac, and the meltdown of insurance giant AIG (which had heavily invested its cash reserves in Fannie and Freddie). Now the Federal Reserve and US Treasury Department are negotiating with Congress to approve a plan for the Federal Government to underwrite a minimum of $700 billion in bad debts.
So where does the blame lie? Certainly not with the original Community Investment Act, or with the funds that the act originally managed to channel into blighted neighborhoods across the nation.
The correct answer, I think, is related to good old American greed, and virtually no one is completely exempt:
greed of homeowners who used their homes as ATM's, because they
believed that the value of their homes would never decrease, and that
they were free to spend as much borrowed money as they wanted, without
ever having to worry about paying it back
- The greed of banks, who continued to loan unsecured money simply
because bundled loan securities were selling like hotcakes, and the
influx of cash from those sales was intoxicating
- The greed of investment groups, and their political allies, who
earned billions off the trading of those mortgage loan securities
- The greed of investors, who bought billions and billions of dollars
worth of those mortgage securities, because those investments were
promised to be fail-safe
- The greed of mortgage lenders and their agents, who took home
billions of dollars in fees, commissions, and bonuses, based on the
sale of risky sub-prime mortgages, interest-only loans, and reverse
- The greed and ignorance of first-time home buyers who should never
have qualified for a mortgage in the first place, who believed that they
were entitled to get something for nothing, and felt no need to honor their financial obligations
- The greed of housing advocacy groups, who had no problem playing the race card if it meant generating a
continuous supply of low-income borrowers for mortgage lenders, and therefore millions upon
millions of dollars in fees and grants
- The greed of politicians who sold out to Fannie Mae, Freddie Mac, and affordable housing advocacy groups through lobbying money and campaign contributions, playing the race card and playing partisan politics as long as it kept those funds coming through the door
The Bible famously states that the love of money is the root of all evil. I've never been against earning an honest buck, but perhaps it would do us all a lot of good to consider that sacred advice the next time we see a financial scheme that seems too good to be true.
The Anchoress has a thought-provoking explanation of much of this as related by Mark Levin on his radio program Friday. Levin is audibly upset and passionate as he explains his take on the issue, and I think he comes down a little too hard on the affordable housing market. Otherwise, it's a fascinating listen.
Also, Britain's Financial Times places a substantial portion of the responsibility for our current financial mess on the shoulders of Alan Greenspan. Are they correct?
ADDED: Since I checked her blog this morning, The Anchoress has yet another fabulous post about the faith aspect of all this. She bemoans the fact that none of our current leadership seems to have the humility to ask God for wisdom and an understanding mind, like Solomon. She explains:
And the prayer should not be, “O, Lord, fix this economy so that we do not suffer,” or “O Lord, fix the economy so that our guy wins!” It should be something like:
“Have mercy on us in our confusion and weakness. Give unto us and our nation, and our leaders, Lord, an understanding heart, that we might trust your guidance and do your will, that, should it please you, we may recognize the firm path of rescue, one that treads upon honest ground and leads us to a place of secure foundation. You are our Rock, O Lord. Help us to lean upon you in these troubled times, to turn toward your light and truth, that we may safely steer this dangerous and murky road. Help us to mindful of those in particular need, the elderly, the unwell, that they do not escape our vision, but call us to proceed with extra care, and a determined dependence upon your light. We ask this through our Lord, Jesus Christ, your Son, who lives and reigns with you and the Holy Spirit, One God, forever.”
As I said, “something like that.” Solomon’s prayer seems pretty good to me, all by itself.