The precipitating factor was a high default rate in the United States subprime home mortgage sector. The expansion of this sector was encouraged by the Community Reinvestment Act (CRA), a US federal law designed to help low- and moderate-income Americans get mortgage loans. Many of these subprime (high risk) loans were then bundled and sold, finally accruing to quasi-government agencies (Fannie Mae and Freddie Mac). The implicit guarantee by the US federal government created a moral hazard and contributed to a glut of risky lending. Many of these loans were also bundled together and formed into new financial instruments called mortgage-backed securities, which could be sold as (ostensibly) low-risk securities partly because they were often backed by credit default swaps insurance. Because mortgage lenders could pass these mortgages (and the associated risks) on in this way, they could and did adopt loose underwriting criteria (encouraged by regulators), and some developed aggressive lending practices. The accumulation and subsequent high default rate of these mortgages led to the financial crisis and the consequent damage to the world economy.
Tuesday, July 18, 2017
#199 / Ready To Crash? (Silver Lining Department)
Kathleen Pender writes a business column in the San Francisco Chronicle. On July 2nd, here was her headline: "Taking on more mortgage, debt to get easier." Online, the title of Pender's column has been reworded to make it more precise: "Fannie Mae making it easier to spend half your income on debt."
Oh, boy, I thought. Here we go again!
It is generally accepted that the 2007-2008 economic meltdown in the United States, leading to a world financial crisis, began with a crash in the home mortgage market, leading to a chain-reaction of bank failures. As Wikipedia describes it:
Like I said, "Here we go again."
The former system encouraged people to buy (with a mortgage) real estate that they couldn't actually afford. Ever-increasing real estate prices (they call it a bubble) convinced homeowners that they were safe, because the price of their home would just keep rising. In other words, working people were encouraged to speculate with the only asset they had, and then they lost. They lost big! It all came from allowing homeowners to finance real estate that they didn't really have the income to afford.
The Pender column I am citing reported on recent actions by Fannie Mae, a government agency that was deeply implicated in the last crisis. Fannie Mae can buy or insure mortgages that meets its underwriting criteria, and starting on July 29th, Fannie Mae's automated underwriting software will approve loans with debt-to-income ratios as high as 50 percent. Of course, just because some borrowers will be able to spend up to half of their monthly pretax income on mortgage and other debt payments, that "doesn't mean they should." Pender does make that point, and Gillian Kindle, an adviser with Mosaic Financial Partners, completely agrees. "It's a pretty poor idea," says Kindle. "It flies in the face of common financial wisdom and best practices."
This upcoming action by Fannie Mae is something completely separate from the proposal to repeal the Dodd-Frank legislation that was adopted after the 2007-2008 financial crisis. But that is happening, too. Dodd-Frank seeks to prevent a future set of massive bank failures. The Trump Administration and the Republican Congress are determined to roll back banking regulations, and to put banks and other financial institutions back in the business of speculating with other people's money. Chances are, Dodd-Frank is a dead duck.
Is there any "silver lining" in this entire debacle? Well, the only one I can think of is this: In the last crisis, the banks took over hundreds of thousands of homes, everywhere in the United States, when their owners could no longer make mortgage payments. As the banks were on the verge of failures that could have totally wiped out the United States economy, they came to the federal government for a bailout, and they got it. But the federal government, then in the driver's seat, did not require the banks to turn over all those homes, taken by the banks when their owners couldn't pay. Next time, it could be different.
What if the federal government had taken those homes from the banks, in return for bailing them out, and then turned around and sold those homes to people at prices they could afford, but with a resale restriction, to keep them affordable for ever? Well, that would have been a major action making truly affordable housing available not only immediately, but in the future.
Check that graphic at the top of the page: "Here we go again!" Get ready to crash. This time, however, when the taxpayers bail out the banks, let's at least get hundreds of thousands of units of affordable housing as our price for being so nice to the rapacious financial institutions that are getting ready to do it to us once again!