The Housing Boom And Bust – Thomas Sowell

I have a personal and somewhat unique involvement with the housing bust so, before addressing Dr Sowell’s book, I thought it advisable to lay out some of the history as I know it.

1938

Fannie Mae (NYSE:FNM) is created during the Great Depression as a government agency to ensure the supply of mortgage funds. The aim was to boost banks’ capacity to offer home loans by buying up existing loans in exchange for cash

1968

Fannie Mae re-chartered by Congress as a shareholder-owned company, funded solely with private capital

1970

Freddie Mac created to provide competition in the secondary mortgage market and end Fannie Mae’s monopoly

1990

Quoting from a HUD document, dated 7/18/1990:

    The Home Mortgage Disclosure Act of 1975 (HMDA), as originally enacted, required financial institutions affiliated with depository institutions or holding  companies to disclose annually their originations and purchases of
mortgage loans by census tract and by type of loan.  HMDA was amended by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), which expanded the coverage of HMDA to include mortgage lenders
that are not affiliated with depository institutions or holding companies. 

The entire document is an attachment. There is also a reference to Dr Shaw, one of my all-time favorite people.

This change in the law had a direct impact on this author, an impact that lasted nearly a decade.

In response to the above requirement, the IT department in HUD was tasked to develop and implement a new data collection and reporting system. The Branch Chief of the IT Department, one Jim Beall came to my boss, Doug Manning and pointed to an article in a recent IT magazine article about the new concept of something call a “client-server system” and said: “I want one of those and it can’t be Oracle”. The system would be the one built to answer the new data processing requirement. I was, at the time, supporting HUD IT on their main-frames. My specific specialty was large scale databases. I had built the largest and most sophisticated statistical collection system that HUD had ever built, kown  as the F42 system: Single Family Statistical System. I was asked to build the first database system that was not on the main-frame. We chose Sybase as the database vendor and Netware as the platform. I built the hardware, installed and configured the Sybase software and designed and built the database. Another fellow was tasked to built the Windows front-end, using PowerBuilder.

I retain in my records many of the scripts that I wrote for this application. The document quoted from above contains, among other things, the layout for for Loan Application Record (LAR) that match to my scripts!

This was a very tense time in my career….new responsibilities, new software that noone had ever seen, building servers that noone had ever built and all on a very tight deadline. The project was successful; it was brought in on schedule and worked. There were a lot of first-time problems encountered and overcome. The Windows based application that displayed the HMDA data was called the Mortgage Lending Information System (MLIS). If you search the HUD web site, you can still find references to it.

1991

The MLIS system continued with the new data. The system was enhanced and distributed to HUD Field Offices. I made a trip with the sponsor to Atlanta to help with a training session.

1992

Following from:
http://www.washingtonpost.com/wp-dyn/content/article/2008/09/13/AR2008091302638.html?nav=rss_politics

In October 1992, a brief debate unfolded on the floor of the House of Representatives over a bill to create a new regulator for Fannie Mae and Freddie Mac. On one side stood Jim Leach, an Iowa Republican concerned that Congress was “hamstringing” this new regulator at the behest of the companies.  He warned that the two companies were changing “from being agencies of the public at large to money machines for the stock-holding few.”

On the other side stood Barney Frank, a Massachusetts Democrat who said the companies served a public purpose. They were in the business of lowering the price of mortgage loans. Congress chose to create a weak regulator, the Office of Federal Housing Enterprise Oversight. The agency was required to get its budget approved by Congress, while agencies that regulated banks set their own budgets. That gave congressional allies an easy way to exert pressure.

“Fannie Mae’s lobbyists worked to insure that [the] agency was poorly funded and its budget remained subject to approval in the annual appropriations process,” OFHEO said more than a decade later in a report on Fannie Mae. “The goal of senior management was straightforward: to force OFHEO to rely on the [Fannie] for information and expertise to the degree that Fannie Mae would essentially regulate itself.”

The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 created OFHEO as an independent regulator in the Department of Housing and Urban Development and directed OFHEO to formulate risk-based capital standards. The act called for a test to determine how much capital Fannie Mae and Freddie Mac would need to hold to survive a 10-year period of severe economic stress.

At this time, I am now working directly with some of the personnel inside OFHEO. I hear the initial reports of problems with the funding of the MLIS & HMDA projects.

1993

Work continues on the MLIS system as the front-end is enhanced. Data collection in the HMDA system is also increased.

1994

I continue to support the MLIS & HMDA system. Another fellow takes over the primary duties associated with the HMDA system. We are nearly shut down at the ending period of the HMDA data submission period as a consequence of a lack of funding in the OFHEO budget. Since this is a “Congressionally Mandated” system, HUD management is forced to find the necessary funds to support us contractors.

1995

U.S. President Bill Clinton strengthens Community Reinvestment Act regulations to require banks to loan to, and Freddie Mac and Fannie Mae to buy mortgages of, even less qualified borrowers.

Again, our operations related to HMDA are nearly terminated due to a lack of funds. Once again, HUD scrambles for the required funds at the last minute. We actually “stop work” on the project for a short time. Sometime during this year or the next, I complete several FOIA (Freedom of Information Act) requests for HMDA data for a variety of newspapers in the Chicago area. These requests are later processed by the news folks and result in very uncomplimentary and accusatory articles in the papers. I do not retain a copy of the emails that had quotes of the articles. The HUD folks are incensed by the inaccuracies in the reports and the unprofessional manner in which the data has been handled. The chief statistician at HUD, a good frien of a long time, is particularly critical of the poor quality of the reporting and analysis. I could not prove it, but my memory is that one of the organizations associated with the reports is ACORN.

<Added later: I’ve seen a report that the Acorn data request and subsequent law suits were assisted by one Barack Obama, later our President. The article named several other persons involved in the case and I personally remember their names from the work I did on this data request…>

1998

April 15, 1998: Franklin D. Raines, whose low-key pragmatism helped President Clinton bridge partisan differences to close the 1997 balanced-budget deal with congressional Republicans, announces he will step down after less than two years as White House budget director to become chairman and chief executive of Fannie Mae. He will later retire after receiving in excess of $100 million in compensation.

1999

Jan. 15, 1999: In a move designed to help home buyers with good credit but small savings, Fannie Mae says it will reduce the amount of mortgage insurance required for borrowers who make down payments of less than 20 percent of a home’s purchase price.

From the NY Times:
http://query.nytimes.com/gst/fullpage.html?res=9c0DE7DB153EF933A0575AC0A96F958260&sec=&spon=&pagewanted=all

Which includes the following:

“In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.The action, which will begin as a pilot program involving 24 banks in 15 markets — including the New York metropolitan region — will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.  In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates — anywhere from three to four percentage points higher than conventional loans.

”Fannie Mae has expanded home ownership for millions of families in the 1990’s by reducing down payment requirements,” said Franklin D. Raines, Fannie Mae’s chairman and chief executive officer. ”Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.”

2000

June 20, 2000: Treasury and HUD urge Fed to investigate sub-prime units of major banks. No Fed action follows

2001

The Bush Administration, in April of 2001 warned congress of a potential financial crisis. In their 2002 budget requests they declared the size of Fannie Mae and Freddie Mac “A potential problem… and can cause strong repercussions in the financial markets.”

2003

In 2003, Richard H. Baker (R-La.), chairman of the House Financial Services subcommittee with oversight over Fannie Mae and Freddie Mac, got information from OFHEO on the salaries paid to executives at both companies. Fannie Mae threatened to sue Baker if he released it, he recalled. Fearing the expense of a court battle, he kept the data secret for a year.

In 2003, the White House upgraded the warning on real estate mortgage loans. Their experts said that the way loans were being handled could spread beyond the housing sector. In fall of 2003 the Bush Administration was pushing congress hard to create a new federal agency that would monitor and supervise Fannie Mae and Freddie Mac; both are Government Sponsored Enterprises (GSE).

John Snow, Treasury Secretary at the time called for regulations and supervision of GSEs. He said in September 2003 “We need a strong world-class regulatory agency to oversee the prudential operations of the GSEs and the safety and the soundness of their financial activities.” Snow was pushed back from this position, by then ranking member, but the eventual Chairman of the Senate Banking Committee, Barney Frank (D) from Massachusetts. Frank denied there was any problem and was quoted as saying, “Fannie Mae and Freddie Mac are not in crisis.”  In fact, Barney Frank was encouraging the government to do more to get low income families into homes.

“The more people, in my judgment, exaggerate the threat of safety and soundness, the more people conjure up the potential for serious financial losses…. [a problem] I do not see. We see entities that are fundamentally sound financially and would stand some of the disastrous scenarios. But, even if there were a problem the government wont bails them out. The more pressure we see there then there is less, I think, we see in terms of affordable housing,” Barney Frank said in September of 2003.

The creation of a regulatory agency to oversee GSEs was ultimately blocked.

The NY Times reported: September 11, 2003

The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago. Under the plan, disclosed at a Congressional hearing today, a new agency would be created within the Treasury Department to assume supervision of Fannie Mae and Freddie Mac, the government-sponsored companies that are the two largest players in the mortgage lending industry. The new agency would have the authority, which now rests with Congress, to set one of the two capital-reserve requirements for the companies. It would exercise authority over any new lines of business. And it would determine whether the two are adequately managing the risks of their ballooning portfolios.The plan is an acknowledgment by the administration that oversight of Fannie Mae and Freddie Mac — which together have issued more than $1.5 trillion in outstanding debt — is broken. A report by outside investigators in July concluded that Freddie Mac manipulated its accounting to mislead investors, and critics have said Fannie Mae does not adequately hedge against rising interest rates.

Dec. 10, 2003:

Freddie Mac agrees to pay a $125 million civil fine levied by the Office of Federal Housing Enterprise Oversight (OFHEO) for understating its profits by $5 billion from 2000 to 2002. Note that the overstatement had the impact of also making the annual bonus received by Freddie Mac much larger.

2004

Feb. 24, 2004: Federal Reserve Chairman Alan Greenspan testifies before the Senate Committee on Banking, Housing, and Urban Affairs that the debt being incurred by Fannie Mae and Freddie Mac is cause for concern and, if left unchecked, they could expose the government to a potential bailout.

June 9: Freddie Mac yesterday fires its president, alleging that he altered and ripped out pages of his notebooks before handing them over to investigators probing the company’s accounting. The company also pushes out its chief executive and chief financial officer

Sept. 24, 2004:A 200 page report is released from the Office of Federal Housing Enterprise Oversight (OFHEO), accusing Fannie Mae of using “cookie jar” accounting to defer $200 million in expenses in 1998 to a future reporting period so that company executives could receive full bonus packages.

Mid-2004: In a memo written by Freddie Mac’s David Andrukonis, the former chief risk officer informs Freddie Mac’s CEO Richard Syron that the company’s bad bets on risky home loans poses enormous financial and reputational risks to Freddie Mac and the country. Andrukonis also makes reference to the company’s “shoddy” underwriting standards. The memo is discussed – and summarily dismissed – in a meeting with Stryon, who continues to expand Freddie Mac’s activities of buying and selling risky home loans.

Oct. 6: Speaking before a House subcommittee in his first public response to a critical report by the Office of Federal Housing Enterprise Oversight, Fannie Mae chief Franklin D. Raines criticizes the regulator for airing allegations that the company cooked its books so executives could receive bonuses. Armando Falcon Jr., OFHEO’s director, counters in a separate appearance that Fannie Mae deliberately flouted accounting rules to make its earnings growth appear steady and to boost executive compensation. Former Fannie Mae accountant Roger L. Barnes says in a written statement that the company used “threats, intimidation and reprisal” against him and others who raised concerns about accounting.

Dec. 22, 2004:Fannie Mae CEO Franklin Raines and Finance Chief Timothy Howard step down from their positions after regulators discover accounting problems totaling $9 billion. From 1998 to 2003, Raines earns more than $90 million, according to the Office of Federal Housing Enterprise Oversight.

2005

In February of 2005, Alan Greenspan spoke about the dangers of Fannie Mae and Freddie Mac after Fannie leaders admitted to accounting screw-ups.

Greenspan said, “Enabling these institutions to increase in size, and they will, once the crisis in their judgment passes. We are placing the total financial system of [in] the future at a substantial risk.”

Later that year Greenspan warned, “If we fail to place GSE regulation, we increase the possibility of insolvency and crisis.”

Fannie Mae and Freddie Mac had some strong defenders. One of them was democrat New York Senator Charles Schumer.

In April 2005 Schumer said, “I think Fannie and Freddie have done an incredibly good job, and are an intrinsic part of making America the best housed people in the world. If you look over the last 20 or whatever years, they’ve done a very, very good job.”

Senator John McCain co-sponsored legislation pushing for regulation of GSEs like Freddie and Fannie.

In a speech on the senate floor, McCain said, “For years I have been concerned about the regulatory structure that governs Fannie Mae and Freddie Mac…. and the sheer magnitude of these companies and the role they play in the housing market… the GSEs need to be reformed without delay.”

Senate Majority Leader Harry Reid, (D-NV) in 2005, in response to an effort by the GOP to trim Fanny & Freddy’s portfolios: “The legislation from the Senate banking committee, passed today on a party line vote by the Republican majority, includes measures that could cripple the ability of Fannie Mae and Freddie Mac to carry out their mission of expanding homeownership,” said Sen. Harry Reid, D-Nev., the Senate Minority Leader Thursday…”While I favor improving oversight by our federal housing regulators to ensure safety and soundness, we cannot pass legislation that could limit Americans from owning homes and potentially harm our economy in the process,” Reid said.

2006

In 2006, Barney Frank took over the chairmanship of the Senate Banking Committee and on his first day declared that he was going to work on making housing more affordable for low-income owners and that loans would be easier to get by relaxing loan regulations.

That bill (THE FEDERAL HOUSING ENTERPRISE REGULATORY REFORM ACT) made it out of the senate banking committee with a party line vote. All the democrats voted against it. By then there had been an election and democrats had won back control of the Senate. Republicans, knowing they did not have the numbers to get the bill passed, did not even bring it up for a vote that 2006 session. The full text of the bill (hr-1461) is attached.

April 18, 2006: Freddie Mac agrees to pay $3.8 million in civil penalties to the Federal Election Commission, which had accused the mortgage company of improperly funneling donations to candidates, as well as holding extravagant fund-raisers to influence individuals on various congressional committees.

May 23, 2006: The Office of Federal Housing Enterprise Oversight and the Securities and Exchange Commission (SEC) announce a $400 million civil penalty against Fannie Mae in a settlement over alleged accounting manipulation.

September 1: Statement by the new director of OFHEO, James Lockhart…At Fannie Mae, led by one super-connected Democratic party insider after another, “there was sort of a revolving door with, you know, political appointees and other people in Washington. In retrospect, we can all say they were too political and not enough managerial. They didn’t have the business skills or want to have the business skills,” says Lockhart. “We need the powers of a bank regulator,” Lockhart explains. “We need some modifications to allow emergency powers if there is a problem in the marketplace.” Money from the GSEs funds OFHEO’s operations, just as financial institutions fund their regulators. But OFHEO’s budget is still dependent upon the judgments of Congress through the appropriations process, which, before the GSE onion was peeled, limited OFHEO’s funding and ability to operate at the behest of the GSEs themselves.

2007

January 2007:According to a report by the Office of Federal Housing Enterprise Oversight (OFHEO), at the end of 2007 Fannie Mae and Freddie Mac own $267 billion in mortgage-backed securities issued by other firms.

Jan 2, 2007: Rep. Barney Frank (D-Mass.) assumes chairmanship of House Financial Services Committee. Finance, insurance, and real estate sector tops his list of contributors, with total of $746,000 for 2005-06 cycle.

Sept. 28, 2007: Freddie Mac agrees to pay $50 million to settle charges by the Securities and Exchange Commission (SEC) that it fraudulently misstated earnings over a four-year period.

2008

April 18, 2008:The federal government reaches a settlement with Fannie Mae’s then-CEO Franklin Raines, J. Timothy Howard, former chief financial officer, and Leanne G. Spencer, former controller, in which the three agree to pay fines totaling about $31 million for their roles in a 2004 accounting scandal.

Video summaries of the timeline:

http://www.youtube.com/watch?v=cMnSp4qEXNM From a Canadian of all people

This is an excerpt from a House Hearing in 2004….http://www.breitbart.tv/?p=184743


All of the above is provided as background to the book itself. The author is one of the most articulate economists alive and whose columns I regularly read.

Some quotes from the book:

“One of the conequences, however, of reselling mortgages on a large scale is that the initial lender has fewer incentives to be meticulous about the financial qualifications of the people to whom mortgage loans are made.”

“The decade of the 1970’s saw a rapid rise of laws and policies in California severely restricting the use of land.”

“…the affordability of housing is overwhelmingly a function of just one thing, the extent to which governments place artificial restrictions on the supply of residential land.”

“In 2002, less than 10 percent of new mortgages in the United States were interest-only mortgages, but that rose to 31 percent by 2005, as home prices rose.”

“…found that, during the housing boom, homes were bought as investments, rather than to live in, by 28 percent of home buyers in 2005 and by 22 percent of home buyers in 2006.”

“Many in politics have acted as if predatory lenders are what caused the housing crisis–a view especially common among those who themselves had a major role in bringing on the crisis.”

“Studies in the early 1990’s, showing different mortgage loan approval rates for blacks and whites. set off media sensations and denunciations, leading to both Congressional and White House pressures on agencies regulating banks to impose new lending rules, and to monitor statistics on loan approval rates by race, by community, and by incomes, with penalties on banks and other lenders for failing to meet politically-imposed norms or quotas.”

 I saw this personally and personally participated in the generation of these reports.

“In 1995, the regulators created new rules that sought to establish objective criteria for determining whether a bank was meeting CRA (Community Reinvestment Act) standards. Examiners no longer had the discretion they once had.. For banks, simply proving that they were looking for qualified borrowers wasn’t enough. Banks now had to show that they had actually made a requisite number of loans to low- and moderate income (LMI) borrowers. The new regulations also required the use of “innovative or flexible” lending practices to address credit needs of LMI borrowers and neighborhoods.”

“In 1993, the Department of Housing and Urban Development began bringing legal actions against mortgage bankers that declined a higher percentage of minority applicants than white applicants. Lenders then began lowering their down payment requirements and income requirements.”

Again – I saw this personally.

“After HUD became a regulator of Fannie Mae and Freddie Mac in 1992, these government-sponsored enterprises were set numerical goals – quotas – for what share of their lending was to be for ‘affordable housing’ mortgages. In practice, they were pushed to acquire more subprime mortgages.”

“in June 2004, in response to President Bush’s expressed concerns about the riskiness of Fannie mae and Freddie Mac, seventy-six Democrats in the House of Representative sent him a letter defending these government-sponsored enterprises, and again making the case that ‘an exclusive focus on safety and soundness is likely to come, in practice, at the expense of affordable housing.”

“when the Office of Federal Housing Enterprise Oversight – the agency overseeing these government-sponsored enterprises – turned up irregularities in fannie Mae’s accounting and in 2004 issued what Barron’s magazine called a ‘blistering 211-page report,’, Republican Senator Kit Bond called for an investigation of the Office of Federal Housing Enterprise Oversight, tried to have their budget slashed, and sought to have the leadership of the regulatory agency removed. Democratic Congressman Barney Frank likewise declared: ‘It is clear that a leadership change at OFHEO is overdue'”

Frankly, I could go on and on and on with similar references in the book. Anyone who cares about what really happened should read this.

The above is only about one-third of the passages I noted in the book.

The bottom line:

The crisis in the housing market was initiated by a well-intentioned desire on the part of Congress and President to expand the availability of housing to Americans of limited means. Unfortunately, the politicians ignored the realities of the market place that dictated that below a certain level, the quality of the borrowers were placing the entire system at risk. Fact is that the politicians drove the process of reducing requirements and reducing down-payments and did so even after they were repeatedly warned about the consequences. Fact is that these same politicians fought efforts to reduce the risks and expand the regulations and improve the safety of the systems.

It is these same politicians who now seek to shift the blame from themselves to the lending institutions they harassed and who consistently refuse to accept any of the blame for the problem we have.

But then, I ask, when has Congress EVER taken responsibility for any of its mistakes? NEVER.

 

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