-UPDATED- How Did The Foreclosure Crisis Start?

There has been quite the hot debate going on in the comment section of this blog post over at The Bakersfield Californian. Essentially, what's up for debate is the causal reason of the foreclosure crisis, and the subsequent recession. So, in an attempt to lay out what happened, when and who was involved, I submit the following.

Before we get to everything, there are two very important points I wish to make. First, were the Democratics solely responsible for the foreclosure crisis? No, not solely. They were, as you'll see below, primarily responsible. Second, every elected official (well, damn near all of them anyway) is scum. They primarily seek to enrich themselves and their specific interests. Why be a conservative then and not an anarchist? Because, I understand that some government is needed. The less, the better. How can anyone benefit with an over-reaching bureaucratic mess entangled in every part of your life? Better to support a party who, at least in theory, is for smaller and less government.

Let's begin.

• In 1977, while Jimmuh Carter was President and Tip O'Neill and Robert 'KKK' Byrd were Speaker of the House and Senate Majority Leader, respectively, the Community Reinvestment Act, or CRA, law was passed. Passed with the best intentions, the CRA was intended to cut down on discriminatory lending practices and open up loans to borrowers in low and moderate income neighborhoods.

• Then in 1980, with the same players in power, Congress passed the Depository Institutions Deregulation and Monetary Control Act. This act removed the state limits on interest rates banks could charge on mortgages. Amongst other things, this legislation was a continuation of the policy to get more low and moderate income home ownership, by giving banks more incentive to lend to riskier parties.

• In 1982, with Reagan in the White House, and Democratics still in control of both houses of congress, the Alternative Mortgage Transactions Parity Act was passed. AMTPA specifically allowed alternative types of financing on home loans other than traditional fixed rate mortgages. Again, here as with before, the intention was to open up home ownership to low and moderate-income households by offering additional methods to finance a house.

• Starting in 1995, the GSE's (read: oxymoron), Government Sponsored Enterprises, began to receive government tax incentives to purchase mortgage backed securities. This is a critical turning point in the foreclosure crisis, because later it will be shown that after HUD set goals for the GSE's to buy more subprime paper, which are riskier than traditional mortgages and have a higher rate of failure, the GSE's turned around and sold to investment banks as low-risk investments.

• In 1997, congress passed, and President Clinton signed the Taxpayer Relief Act of 1997. This legislation reduced the capital gains on the sale of homes under $500,000. This action alone did nothing to impact the foreclosure crisis. However, when coupled with insane subprime lending practices, these tax rates made home sales the best return on the dollar investment for the average person. Thus began the home speculation wave.

• In 1998, HUD Director Andrew Cuomo held a press conference detailing a settlement reached with a major bank on a lending discrimination case, presumably based on the CRA. The result of the settlement was $2.1 Billion for subprime loan offers. He admits that the lawsuit forced the bank to lower it's qualification standards as a remedy to the 'discriminatory' lending practices. This is is another crucial turn in the foreclosure crisis. The press conference was a warning to other lending institutions that the administration intended to interpret the CRA laws broadly and that the full force of the Clinton Administration would be aligned against any company that did not meet their standards of the CRA.
  
  
  
  It is these enforcement techniques coupled with the marketing of the MBS as low-risk investments which spurred the enthusiastic subprime lending from the private lenders. What was the risk? Offer risky loans to low-income applicants making a large profit, then sell the asset to the GSE's which then acquired the risk. No risk, high profit subprime loans then became a no lose option for the private lenders.

• The next step is one of supply and demand. With a flood of new 'qualified buyers' on the market for homes, the new home builders went gonzo. New home starts went through the roof, as demand never seemed to dry up. Demand out paced supply until sometime during mid 2006. Once the supply of homes outweighed the demand by consumers, home prices began to fall. It is this fall coupled with insane personal debt amounts that would begin the foreclosure crisis. During the boom years between 1998 and 2006, home owners were able to use their homes as banks, borrowing against the equity in their home at values higher than the home's actual value, all while banking on the increasing value of the home. Also at this time, Adjustable Rate Mortgages were in demand allowing a home owner to purchase the home with an introductory, low interest rate, which would adjust after 3-5 years. The expectation was that the value of the home would have risen during that time, allowing the owner to refinance into another ARM or traditional loan, at a lower interest rate. It was this expectation of an ever increasing home value that lead home owner after home owner to extend their personal debt beyond the sustainable point.
  
  Once home values began to fall, and adjustable rate mortgages adjusted, many home owners were no longer able to afford their monthly mortgage payments. As a result, foreclosures began to rise. In turn home values fell further causing the housing bubble to burst.

• Finally, and most despicably, the systematic fraud committed by the two GSE's in mis-stating earnings as to increase the bonus compensation for the executive staff's allowed the crisis to continue on long after it should have. The GSE's were government entities, so they could borrow money at lower interest rates, they required less capitalization and they had less regulations all of which were supposed to translate into more money available to securitize mortgages. Instead, names like Franklin Raines, Jamie Gorelick and Jim Johnson all cooked the books in order to increase their bonuses. At the same time, Alan Greenspan was pointing out the dangers of the GSE's weak capitalization. There were voices of reason, but few had ears to listen.

Liberals, Progressives and Democratics are all quick to point at the Republicans and claim that it was through deregulation that the subprime mortgage crisis began. As a point of fact, Democratics repeatedly attacked and undermined the regulators which oversaw the two GSE's, accusing them of being bigoted and attacking Franklin Raines, the CEO of Fannie Mae. In reality the foreclosure crisis is as a result of the Carter Administration's efforts to expand low and moderate-income home ownership through the CRA along with DIDMCA's removal of interest rate caps and AMTPA's opening up of non-traditional loan types, coupled with the Clinton Administration's aggressive enforcement of it's own broad interpretation of the CRA which coerced the free market into supporting subprime loans. The deregulation in and of itself had little to do with the foreclosure crisis. It was primarily through the efforts of the Clinton Administration that brought us the crisis.

In the early 2000's, some Republicans in congress were able to see the policy which kept the GSE's under capitalized and allowed the GSE's to purchase risky subprime paper and resell them as low risk investments had the potential to bring the financial system to its knees. These Republicans proposed new regulation attempting to increase the capital which the GSE's had on hand and attempted to reduce the quota's for subprime acquisitions set up by earlier sessions of congress. In the end, however, the Republicans failed to use their majority in both houses of congress to force the regulation instead acquiescing to the minority party. Watch below as several Democratic congresscritters attack the regulators from OFHEO.




So, here we are on the other side of this orgy of destruction, and who is to be held responsible?

Christopher Dodd (D-CT) The Chairman of the Senate Banking Committee blocked legislation from Republicans which attempted to rein in the GSE's undercapitalized vacuuming of subprime paper. He, the largest recipient of campaign donations from Freddie and Fannie, killed the legislation in committee.

William Jefferson 'BJ' Clinton (D-AR) The former President was instrumental in pushing the banking industry into expanding home loans to the low and moderate-income markets. So set on the increase in ownership that he was willfully ignorant of the destruction his policies would have on the financial markets of this country in the coming years.

Andrew Cuomo (D-NY) As Director of the Department of Housing and Urban Development, Cuomo set the standard by which all lending institutions would be judged. He used his bully pulpit to praise his department's efforts in winning a $2.1 Billion settlement which would be used to provide subprime loans. He went as far as to admit that the loans were riskier and had a higher rate of failure, yet did nothing to undo the damage he'd begun.

Honorable Mentions:

Barney Frank (D-MA) As the ranking Democratic on the House Financial Services Committee, he opposed a proposal in 2003 to remove the oversight of Fannie and Freddie to a new agency under the Treasury Department. The justification for the proposal was that congress neither had the tools nor the stature for adequate oversight, however, Frank opposed the move stating "These two entities... are not facing any type of financial crisis... The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing." It should also be noted that Mr. Frank had a relationship with Herb Moses, the CEO of Fannie Mae and referred to him as his "spouse" and his "lover."

Barack Obama (D-IL) The Race Baiter in Chief sued Citibank under the CRA laws to force them to make risky loans. Obama was listed in a class action lawsuit along with ACORN against Citibank alleging that the bank had specifically denied loans based upon racism. This NY Post article makes it clear that Obama was aware of the intimidation tactics being used against Citibank and yet still supported the plaintiff in the lawsuit. This leaves little doubt that Obama was not only aware of ACORN's tactics in attempting to strong arm banks into making risky loans, but was complicit, as well.

A word about lenders, borrowers and the free market. It is often alleged that predatory lenders were responsible for the foreclosure crisis by preying upon unsuspecting borrowers, encouraging them to take loans that the borrowers could never possibly afford to pay back. One would be foolish to believe that this did not happen. However, this scenario was spawned by every other action listed in this post. Predatory lenders had no influence on the CRA, DIDMCA, AMTPA, the dropping of capital gains taxes, the increased mandate for the GSE's to purchase subprime paper, and on and on. This was a by product of the failure of the government, period. In the list of people who need be held responsible, the consumer themselves should not be ruled out. Similarly to the predatory lenders, they were not responsible in starting the foreclosure crisis, but without their uninformed and greedy borrowing, this crisis would never has gotten as large as it became. Ultimately, when you place your signature on those 200 different forms, you are in effect saying that you understand the terms of the loan for which you are signing. It is your responsibility to understand what your are getting yourself into. When a person loses their home and cries that they had no idea, I feel little sorrow. For that person claimed on a legal document that they did, in fact, understand what they were getting into.

The free market is not to blame for what went wrong here. It was only through the manipulation of that free market and players within that market that this crisis came to be. The market left to it's own devices will regulate itself. Greedy and predatory lenders will go out of business as customers become wise to their practices and purchase from someone else. Lending institutions will offer loans which will be competitive with other lenders, but secure enough as not to be overly risky. No company goes into business looking to scare away potential customers and few customers go into a business relationship without knowing exactly what they are consuming and for how much. It is these principles that guide the free market to function and correct when it needs to.

-UPDATE-

Paul pointed out in the comments some facts I left out on predatory lenders: Uncollateralized loans.

The idea that someone could approve the loan of and move someone into a house without the borrower so much as having a job was also begun during the Clinton Administration's Gestapo forced lending tactics. A whole new cottage industry called "Mortgage Origination Offices" cropped up in all the neighborhoods where payday loan places do good business.

Paul goes on to reference this Wall Street Journal Article which shows the areas that are hardest hit by default rates. Paul notes the areas which are hardest hit also seem to have the highest unemployment rates, and the lowest incomes. The areas are referred to as Urban Enterprise Zones, which are areas in which development of blighted neighborhoods is encouraged through tax and regulatory relief. With the revelation of tactics used by community advocate groups such as ACORN, there is a strong possibility that these groups were instrumental in securing loans for some of those now in default.

-UPDATE II-

This subject is so large, and the damage so widespread that it is difficult to sum up all of the factors that played a roll in the eventual meltdown in a single post, let alone at 3:00 in the morning. A commenter at TBC points out that artificially low interest rates in the early 2000's encouraged lending practices that were out of control. This is true, however, it's important to note that low interest rates alone could not have caused this crisis. It is only when all of the pieces are strung together that you get the financial meltdown we are all currently experiencing.

Fed policy in the early 2000's was to keep the economy afloat after the dot com bubble and 9/11. In order to encourage people to continue spending money and making investments, and with the help of a wave of foreign cash from growing Asian economies, money was made cheap and available. The Fed policy was foolish, but, as pointed out with several other steps in the eventual crisis, not without good intentions. The intent was to keep the economy moving and minimize the downturn. As a result, the dot com bubble was not burst, but instead moved to become the housing bubble. This is why conservatives, but primarily libertarians believe that the Federal Government should not get involved in financial downturns or crashes. With limited exception, the FedGov always makes the situation worse.

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